SINGAPORE (June 18): Oversea-Chinese Banking Corp CEO Samuel Tsien speaks in a deliberate, understated manner. He does not boast about OCBC’s digital achievements or its ranking as one of Asia’s top private banks (through Bank of Singapore). Nor does he claim that OCBC is the world’s best digital bank or has the most application programme interfaces (APIs) for its technology initiatives. Like much else about OCBC, its digital moves are made incrementally.
In the same methodical manner, Tsien has identified key global trends shaping Asia’s growth: intra-Asia trade and cross-border capital flows, rising Asian wealth, urbanisation and the continued rise of small and medium-sized enterprises in Asia, the increasing economic presence of China and advancements in technology.
“The megatrends that we have identified continue to apply. As a matter of fact, we look at the longer term to make sure that those megatrends will continue to better our operations,” Tsien says in a recent briefing, choosing his words very carefully. “When we talk about corporate strategy, core markets, core businesses, core competencies, we also discuss the megatrends that influence our decision on this corporate strategy. And many of those [megatrends] are becoming more visible; for example, the dominance of China, the rise of inter-regional trade and the technology advancement that impacts banking.”
OCBC is well positioned to take advantage of these megatrends. Its acquisition of Wing Hang Bank in Hong Kong in 2014 gives it a presence in China’s Greater Bay Area (GBA), a central government initiative.
What this means for OCBC’s shareholders is that the bank is likely to maintain dividend payout ratios at the 40%-to-50% range and yet have sufficient retained earnings set aside as part of its core capital for growth. And, as various divisions and units within the banking group take advantage of the megatrends and cross-sell products and services, that growth — instead of being incremental — could turn exponential, which can only have a positive feedback loop for investors.
The dominance of China
As the US retreats from the global trade order, China is increasing its sphere of influence. Its Belt and Road Initiative (BRI), GBA and internationalisation of the renminbi have implications for banks such as OCBC. “Moving forward, we will be deepening our presence in GBA to capture the opportunities that will arise from the inbound and outbound business, and investment and wealth flows in this region,” Tsien says.
On the 20th anniversary of Hong Kong’s return to China in 2017, the Chinese government articulated a grand plan to develop GBA into an integrated economic and business hub to rival other bay areas such as New York, Tokyo and San Francisco. The strategy is to develop the 11 cities in the Greater Pearl River Delta — the big four (Hong Kong, Macau, Guangzhou and Shenzhen) along with Zhuhai, Foshan, Zhongshan, Dongguan, Huizhou, Jiangmen and Zhaoqing — into an integrated economic and business hub. By 2030, it is envisaged that GBA is expected to play a leading role in advanced manufacturing, innovation, shipping, trade and finance.
Hong Kong will remain GBA’s foremost financial centre. Shenzhen has turned into a Silicon Valley of sorts. Both Huawei Technologies and Tencent Holdings hail from this Special Economic Zone. The Special Administrative Region of Macao is the only place in China where casinos are legal; it is the Middle Kingdom’s entertainment hub. Guangzhou is the trading hub; Dongguan, once a manufacturing hub, has moved to higher-value-added technology products and services.
In 2017, the combined GDP of the 11 cities in GBA reached US$1.4 trillion ($1.87 trillion), or 12% of the national economy, even though it is home to only 5% of the country’s population. As the area develops, the government’s aim is for its influence to extend beyond the geographical boundaries of its city cluster to play a key role in China’s BRI, serving as a key link that connects the countries along the 21st century Maritime Silk Road.
Deloitte believes measures are likely to be introduced to encourage links between the GBA cities. It says: “To seize the business opportunities arising from Mainland China’s [BRI], measures will be introduced to link Hong Kong, Macau, Guangzhou, Shenzhen, Zhuhai, Foshan, Zhongshan, Dongguan, Huizhou, Jiangmen and Zhaoqing into an integrated economic and business hub, the ‘Guangdong-Hong Kong-Macau GBA’. A discussion unit is expected to be set up to enhance cooperation between these cities. We are pleased to see the government’s commitment to strengthening Hong Kong’s competitiveness in serving as the gateway to Mainland China and Asia. Nevertheless, we anticipate that implementation of the GBA measures will face challenges in aligning the different tax policies/regimes of the governments of the various constituencies.”
OCBC says in its 2017 annual report that it will continue to “build upon our strong foundation in Greater China, where we have more than 100 branches and offices in China, Hong Kong and Macau under OCBC Wing Hang”.
During 1QFY2018, OCBC Wing Hang’s net profit rose 8% q-o-q and 29% y-o-y to HK$626 million ($106.6 million). Loans rose 16% y-o-y to HK$189 billion, while deposits were up 13% to HK$219 billion. Net interest margins ticked up 1.61% y-o-y during the quarter. For FY2017, OCBC Wing Hang’s net profit rose 19% y-o-y to HK$2.8 billion. Total loans rose 12% y-o-y, while deposits grew 14% y-o-y.
OCBC Wing Hang received good response from customers to new products that it launched in 2017, including overseas mortgages, insurance premium and policy financing, an OCBC spokeswoman says in an email response. The Hong Kong units also expanded its wealth management business with an 87% y-o-y increase in new Elite Gold sign-ups.
Banking made easy with technology
In FY2017, OCBC spent 11.3% of total expenses of around $4 billion on technology, excluding staff costs. It also launched a one-stop advisory portal, OCBC OneAdvisor, partnering with other home purchase service providers to give information on property listings, rules and regulations, and affordability advice to customers on property purchases.
Separately, OCBC tested a facial recognition pilot at its Holland Village branch, digitalising the way registration for Premier customers is conducted.
In 2016, OCBC launched OCBC OneWealth, an integrated mobile wealth management app, for customers to quickly access customised, up-to-date market information and investment suggestions from OCBC Bank experts, purchase unit trusts, monitor their investments and get personalised mobile alerts relevant to their investments.
The bank also piloted a customer self-directed robo-advisory service in partnership with fintech company Weinvest. Elsewhere in its wealth management unit, technology has made onboarding wealth management customers more efficient. OCBC is tapping artificial intelligence (AI) and machine learning to tackle the increasing scale and complexity of anti-money laundering transaction monitoring as part of its KYC (know your client) objectives.
OCBC was the first local bank to articulate an API strategy. It has partnered with the Inland Revenue Authority of Singapore for instant GIRO set-ups.
On June 5, OCBC became the first Singapore bank to roll out a digital instant account-opening service for customers who are Singaporeans or permanent residents. “Even if you do not currently have any relationship with OCBC Bank, you can leverage national data repository MyInfo and — for the first time — OCBC’s real-time, digital KYC process (e-KYC) to open an OCBC 360 Account using your mobile device or desktop. It all takes less than five minutes via the bank’s website, with no need to visit a bank branch or provide documents. Verification and authentication happens in real time; once this is completed, you get a new account number within seconds of a successful application,” the press release states.
MyInfo is a one-stop data platform that saves time by automatically filling out government e-forms. With the MyInfo integration and OCBC’s real time e-KYC process, account approvals are instant for successful applications. Customers will be able to use the OCBC 360 Account opened online to immediately make fund transfers via PayNow or Fast.
“We have successfully created new business opportunities, enhanced service delivery, increased operational efficiency and strengthened our risk management capabilities. We will continue to harness big data, predictive analytics, AI, machine learning and other new technologies in a discerning manner to introduce new innovations and better products that are relevant to our customers’ needs, and embed our services more seamlessly into customers’ everyday behaviour,” an OCBC spokeswoman says.
Efficiencies and cost-saving from technology are particularly useful for consumer banking, where account sizes are small.
“Going digital is driving significant value creation for OCBC, especially in our consumer business,” the OCBC spokeswoman says. According to her, 45% of the bank’s retail customers are digitally active, with 85% of financial transactions by retail customers done via digital channels. Wealth management products are increasingly being purchased through digital channels. “Digital customers are more profitable and engaged — both profitability and product holdings are relatively higher by 1.6 times,” the spokeswoman says. And, digital customers now account for about 63% of OCBC’s consumer banking revenue.
The banking group has a large private banking arm. Bank of Singapore has been one of the fastest-growing private banks in Asia for the last two years (December 2015 to December 2017), recording a 34% compound annual growth rate for its assets under management. In February 2018, its AUM crossed the US$100 billion mark, two years ahead of the bank’s original target date. For 1QFY2018, income from wealth management grew 22% y-o-y to $727 million.
The importance of capital
Risk-weighted assets (RWA) are an estimate of risk that determines the minimum level of regulatory capital a bank must maintain to deal with unexpected losses. A prudent and credible calculation of RWA is an integral element of the risk-based capital framework.
Banks fund their investments with capital and debt, such as customer deposits. Capital can absorb losses in a way that reduces the likelihood of a bank failing and the impact if it does. Regulatory capital consists of Common Equity Tier 1 (common shares, retained earnings and other reserves); Additional Tier 1 (capital instruments with no fixed maturity); and Tier 2 (subordinated debt and general loan-loss reserves).
Banks with more regulatory capital are better able to fund lending growth. A bank’s assets typically include cash, securities and loans made to individuals, businesses, other banks and governments. Each type of asset has different risk characteristics. A risk weight is assigned to each type of asset as an indication of how risky it is for the bank to hold the asset.
To work out how much capital banks should maintain to guard against unexpected losses, the value of the asset (that is, the exposure) is multiplied by the relevant risk weight. Banks need less capital to cover exposures to safer assets and more capital to cover riskier exposures.
The internal ratings-based (IRB) approach for credit risk allows banks, under certain conditions, to use their internal models to estimate credit risk, and therefore RWA. The 2017 reforms introduced some constraints to banks’ estimates of risk parameters. There are two main IRB approaches: foundation IRB (F-IRB) and advanced IRB (A-IRB).
Banks’ calculations of RWA generated by internal models cannot, in aggregate, fall below 72.5% of the RWA computed by the standardised approaches. This limits the benefit a bank can gain from using internal models to 27.5%.
A capital idea to improve shareholder value
For 1QFY2018, Oversea-Chinese Banking Corp announced a net profit of $1.11 billion, up 8% q-o-q and 29% y-o-y. Excluding 87.7%-owned subsidiary Great Eastern Holdings (GEH), net profit increased 48% q-o-q and 25% y-o-y to $990 million. The first-quarter results show that the Wing Hang Bank acquisition has worked out well. Investor perception of a Hong Kong bank acquisition had been clouded by DBS Group Holdings’ 2002 purchase of Dao Heng Bank, which had not quite performed to its potential.
Fast forward to 2018, and OCBC is the most regionally diverse of the local banks. Profit before tax rose 30% y-o-y to $1.39 billion. More interestingly, 50% of PBT was from Singapore, with 21% from Greater China, its largest geographic segment.
Moreover, in the next two years, OCBC Wing Hang Bank is likely to do even better. It will become more capital-efficient when OCBC moves its Hong Kong unit to what is known as the internal ratings-based (IRB) approach.
For credit risk, the rest of the bank has adopted the foundation internal ratings-based (F-IRB) approach, as well as supervisory slotting criteria to calculate credit risk-weighted assets (RWA) for major wholesale portfolios, and the advanced internal ratings-based (A-IRB) approach for major consumer, small business and margin lending portfolios. Other credit portfolios, including those belonging to OCBC Wing Hang Bank and Bank OCBC NISP, are using the standardised approach. They will be progressively migrated to the IRB approach.
Says Darren Tan, OCBC’s chief financial officer: “[Migrating] to the RWA [approach] is an ongoing process. In the previous quarter, we said that would require certain amounts of discussion before adoption. If, ultimately, OCBC Wing Hang Bank adopts it, you’re looking at savings on RWA. We think this could only take effect two years from now.”
RWA is the denominator in a bank’s capital adequacy ratio (see “The importance of capital”). The numerator is the other component in the ratio and a key part of CAR. The best form of capital is core equity capital, comprising ordinary/common shares, and retained earnings. The regulatory capital to be set aside for credit RWA depends on various factors, including internal risk grades, product type, counterparty type and maturity. For instance, corporate loans and mortgages backed by property carry lower risk weights than unsecured loans.
“OCBC plans to implement A-IRB to compute RWA for OCBC Wing Hang by 2019. OCBC Wing Hang’s RWA intensity was higher at 64% for 2017 versus 50.7% for OCBC on a groupwide basis. We estimate OCBC would be able to reduce its RWA by 4% if OCBC Wing Hang lowers its RWA intensity to 50% under A-IRB, and this would improve OCBC’s CET-1 [Common Equity Tier 1] CAR by 0.6ppt,” says UOB Kay Hian.
OCBC’s CET1 ratio as at March 31 was 13.1%, the lowest among the local banks at that date. Note that DBS’ CET1 ratio would have fallen in May to around the same level as OCBC’s when it paid out $2.814 billion in dividends, including a $1.279 billion special dividend.
Interestingly, OCBC is likely to play catch-up with its peers later this year. Malaysia has placed a limit of 70% on foreign ownership of insurance companies. Hence, the shareholdings of insurance companies, such as the Malaysian unit of OCBC’s 87.7%-owned subsidiary GEH, need to be pared down.
OCBC could unlock value through an IPO of GEH’s Malaysian unit. According to UOB Kay Hian, this 30% stake is worth the equivalent of $760 million. “OCBC is expected to recognise divestment gains of $608 million in 4Q2018, which improves its CET-1 CAR by 0.2ppt,” the UOB Kay Hian report says.
OCBC Wing Hang has agreed to sell its 33.33% stake in Hong Kong Life Insurance (HKLI) to First Origin International for HK$2,366.7 million ($402.4 million) in cash. First Origin International is an investment holding company that focuses on the financial and technology sectors in Asia. “We estimate divestment gains at HK$2,102 million, given that the unaudited net tangible asset value of HKLI was HK$793 million as at December 2016. We estimate the divestment would improve OCBC’s CET-1 CAR by 0.1ppt,” UOB Kay Hian says. Together, the two divestments could lift CET-1 CAR by 0.3ppt to 13.4%.
A fourth improvement in CET-1 CAR could materialise if OCBC decides to revert to its scrip dividend scheme. The scheme ensures that a greater portion of earnings is retained to support future growth, while still rewarding shareholders with a higher dividend payout. “We estimate OCBC’s CET-1 CAR would be enhanced by 0.7ppt for 2018, assuming new shares are issued at a 10% discount to the current share price of $12.54 and shareholders’ acceptance rate for scrip dividends is 80%,” UOB Kay Hian estimates.
In the meantime, OCBC CEO Samuel Tsien has charted a growth strategy that would lead to earnings growth and the accumulation of more capital through retained earnings (see “Megatrends continue to propel OCBC’s earnings higher”). All this means shareholders have everything to look forward to by holding on to their OCBC shares.