OCBC - Key risk is loans growth

Economic outlook unfavorable The Ministry of Trade and Industry announced recently that it expects Singapore’s GDP to contract by 6.0% to 9.0%. According to our PSR economist, we are looking at -7.2% sa. One of the key factors impeding the recovery of Singapore’s economy is the reduction of global trade as WTO estimates that the volume of trade is projected to decline 9% in 2009. As a result, most countries in the region have also seen their exports collapsed as global tradesdwindle. Singapore’s total exports declined 23.7% in March 2009, Japan’s and China’s export registered a contraction of 49.4% and 25.6% respectively in February. This financial crisis is a mood of unwinding 30 years of global excesses and it willbecome clearer that US consumption will no longer be consumer of the first and last resort. This process will impact the bank earnings significantly due to weak demand of loans, lower margins and higher provisions. We trim our earnings by another 5.0% to S$1.45bil and reduce our call rating to sell with target price of $4.61.

Key risk is loans growth Singapore total loans contracted for the 4th time in February to –0.24% mom. Just for the two months of January and February, YTD total loans contracted 0.61%. There were only two occurrences in the last 20 years that we saw loans contract, -2.9% in 1999 and –1% in 2002 and since loans growth is closely tied to the economy, it is probable that loans will contract for the third time since 1999. We are projecting system loans to contract 4%. In fact, we expect loans growth to remain weak in 2010 going into 2011 even as the economy recovers. Borrowers draw down credit lines to tide over liquidity crisis rather than capital expansions and growth. We need to see the economy to resume growth and absorb the loan excesses from 2008 (loans growth of 16.6%) before system loans begin to expand.

Sustainable interest margins to compensate loans contraction OCBC’s efforts in improving margins via innovative saving products are commendable as net interest margins improved significantly from 2.14% to 2.47% in 4Q08. We think products like Mighty Savers deposit schemes are able to secure regular long term, low cost fundings and thus be able to mitigate the effect of lower interest rates in Singapore. Despite 3MSIBOR has been low of 0.675%, we are projecting net interest margins to soften but not deteriorate significantly.

Provisions to remain high The Group provided net allowances of S$447mil for loans and other assets. Although this amount is more than 10 times last year, we note that this was due to successful efforts in loan recoveries, repayments and upgrades in 2007. However, we expect allowances to remain elevated in 2009 through 2010 due to the weak economic conditions. We forecast NPL ratio to rise to 2.0% in 2009 and 2.4% in 2010.

Recommendation As with lower operating profits and higher allowances, we are trimming our 2009 earnings by another 5.0% from S$1.53bil to S$1.45bil and cutting our long term ROE assumption from 10.0% to 9.5%. Accordingly, our target price has been reduced to S$4.61, pegged to 1.02x FY09 NAV as we input the lower ROE and growth assumption in our Gordon growth model. Downgrade to SELL on revised fair value. We think the 42.3% run up within 30 trading days is a little excessive, as economic turnarounds do not happen within such a short span of time.

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