OCBC Earnings: Singaporean Bank Surprises to Upside as Net Interest Margins Drop Less Than Forecast

We maintain our narrow moat rating and fair value estimate of SGD 16 for Oversea-Chinese Banking O39, after its first-quarter earnings. Annualized return on equity, or ROE, was 14.7%, well above our full-year forecast of 12.6% (which we are now raising to 13.5%), mainly due to some unexpected firmness in net interest margin, down only 1 basis point from the prior quarter to 2.30%, compared with OCBC’s previous guidance for full-year NIM to be around 2.10%. OCBC lifted that guidance and now sees NIM around 2.20%; our new full-year assumption is 2.22%.

Despite the upward revision to our NIM assumption for this year, we leave our fair value unchanged as we still see OCBC’s midcycle ROE at 12.7% once the interest-rate cycle turns. The other drivers of upside in the first-quarter earnings—annualized credit costs of only 12 basis points of loans (versus full-year guidance of 15 to 20 basis points) and OCBC’s cost/income ratio of only 37.1%—are mostly related to timing and accounting changes, in our view. It’s positive that OCBC’s nonperforming asset ratio fell to 1.1%, but we still see credit costs averaging around 19 basis points of loans over the full credit cycle. As for the cost/income ratio, much of the drop was related to the change in insurance accounting that also lowers insurance revenue. We aren’t yet certain how to interpret the change, but if OCBC is able to maintain a cost/income ratio below 40% consistently, we would see it as a positive development.

Our fair value estimate of SGD 16, 29% above the current price, represents a price/book ratio of 1.38 times based on book value as of March 2023, and a fair price/earnings ratio of 10.9 times assuming midcycle ROE of 12.7%. This implies a fair dividend yield of around 5.1%, assuming OCBC pays out 50% of earnings as core dividend and adds another 5% on average as periodic special dividends.