SINGAPORE (Aug 27): During a results briefing on Aug 6, Samuel Tsien, CEO of Oversea-Chinese Banking Corp, assured analysts and media that the bank’s long-term growth drivers remained intact in spite of US President Donald Trump’s trade tantrum. Tsien has identified four megatrends that continue to underpin the banking group’s growth strategy: (trade and investment) flows, China, wealth management and digitalisation (in no particular order).
Digitalisation appears to be bearing fruit for all three banks as viewed through the prism of their cost-to-income ratios, which fell q-o-q and y-o-y for OCBC and United Overseas Banking. OCBC’s CIR was the lowest among the three at 42.9% for 2QFY2018 versus 43.6% for UOB and 44.3% for DBS Group Holdings.
In a statement, OCBC says the average profitability of digital customers is 1.5 times higher than for non-digital customers. Also, the cross-sell ratio of digital versus non-digital customers is 2.7 versus 1.7. In addition, the percentage of digitally active customers is 47% of the bank’s two million retail customers.
“In a narrow sense, it is quite possible to reduce the cost significantly but, in an overall sense, you have to recognise there are increasing costs we need to focus on such as regulatory compliance costs, costs of creating new products and so on. So, overall, we are still guiding for a CIR of 40% to 45%. Had it not been for efforts in digitalisation, our CIR would be higher than this range,” Tsien says.
“If you compare customers who only bank digitally with normal customers who bank through the branches, digital customers are indeed cheaper, but if you are only going after that segment, that segment is representative of only 20% of [our] market and you give up 80% of the market. We don’t believe in that,” he continues. At present, the most profitable individual customer is likely to be a non-totally digital customer, Tsien adds.
But all customers are becoming increasingly digital and OCBC rolls out a digital product almost every week. In 2017, it deployed Emma, an artificial intelligence-powered chatbot, to facilitate home loan, renovation, tuition fee loan and wealth investment queries. Emma is quite prolific and has helped OCBC close more than $160 million in housing loans. The bank was the first to launch biometrics such as fingerprint and facial recognition to access consumer and business banking apps. It started voice-enabled access to banking transactions in 2017. And, of course, it has OCBC OneWealth, an integrated wealth management app.
Now, OCBC is studying the viability of launching digital banking in Indonesia. “We are working on the idea of pursuing a digital bank in Indonesia, but our thinking is that it will be within the franchise,” Tsien says. This means that OCBC’s offering is unlikely to be a stand-alone digital bank like DBS’s digibank and UOB’s Asean digital bank. “There will be a separate division set up that will be devoted to customer interaction digitally, but the back end’s digital [infrastructure] will be across the bank, whether it is digital or conventional,” Tsien points out.
Trade and investment flows to continue
OCBC has several growth drivers. “The ‘flow’ business continues to be very strong and is something that OCBC focuses on because it continues to be our competitive advantage. The trade war that is happening won’t significantly impact our flow business because the flow business we are working on is the flow between China and Southeast Asia,” Tsien says. “As a matter of fact, it is possible that that flow will increase because the Chinese will want to make sure there is investment that is made outside China in order to reduce the trapped liquidity inside China.”
A second source for the flow business is likely to be Taiwan. President Tsai Ing-wen implemented the New Southbound Policy in 2016 to promote trade and investment, educational exchange, tourism and labour flows to and from Asean. The NSP aims to enhance economic collaboration and regional links, share resources and encourage talent exchange. One of the aims of the NSP is to reduce reliance on China.
According to a Brookings report on the NSP, to promote economic collaboration, Taipei will create partnerships by integrating into Asean’s supply chains and foster bilateral and multilateral cooperation in various sectors, including culture and tourism, agriculture, technology and small and medium-sized enterprises.
“There are early indicators that more investment from Taiwan [will come into] Southeast Asia. We are already positioning for that and it is our expectation that that will be supplementing the flow business,” Tsien says.
Earlier this year, OCBC announced that, through OCBC Wing Hang, the banking group is focusing on the Greater Bay Area in China. Profits before tax from GBA is likely to double to $1 billion by 2023, Tsien had said in June. The increased level of profits will be supported by a 15% yearly rise in loans in GBA, from about $35 billion currently to some $80 billion by 2023. The banking group is budgeting to spend $200 million on its expansion drive in GBA. Of the investment, two-thirds will be on IT and one-third on people.
Last year, China began referring to GBA, comprising cities in the Pearl River Delta region. Since then, the term has come to represent a broad initiative to link up nine key cities in the area — Guangzhou, Shenzhen, Zhuhai, Foshan, Zhongshan, Dongguan, Huizhou, Jiangmen and Zhaoqing — with Hong Kong and Macau to form a formidable integrated economic and business hub. GBA covers less than 1% of China’s land area and is home to less than 5% of the country’s total population, but it contributed 12% of China’s GDP last year.
Asked whether the trade war could affect these flows, Tsien says: “Our investment in GBA will not be reduced because we believe that, as an integrated economic region about three times the size of Indonesia, it will generate new and additional activities for us. The flow from GBA into Southeast Asia will also continue.”
Growing trade loans
A surprise in OCBC’s 2QFY2018 results was an increase in trade loans. According to Tsien, OCBC formed a Global Commodities Finance team to take advantage of the increased commodities demand by China. “Our trade efforts are a conscientious effort to be more involved in the conventional type of trade, which is the financing of the movement of goods. These trades are with worldwide trading houses. The margins are thinner, but that is a trend we believe will continue as the movement of goods into and out of China continues to rise,” Tsien says.
Of OCBC’s 2% q-o-q loan growth, 30% of the increase came from trade, which includes normal commercial and commodities trading. Trade loans are 15% to 20% of OCBC’s loan portfolio, but yields on trade loans are low, averaging 1.6% to 1.7%, compared with an overall yield of 3.13% on all interest-earning assets in 2QFY2018. However, the risk is well managed and the loans well structured, Tsien notes. “The stream and origination of earnings are very important, provided the risk can be managed, and [trade] continues to be a good economic activity for us to be involved in,” he says.
Long-term wealth management trend intact
Wealth management income in 2QFY2018 was affected by a volatile market, yet OCBC’s private banking assets under management stayed flat because net new money continued to rise q-o-q. The market valuation of AUM declined because the assets were marked to market and the market fell. Tsien acknowledges that in the next quarter or so, wealth management activity could be lower because of the declining market.
OCBC reported a net profit of $2.32 billion for 1HFY2018, up 22% y-o-y. For 2QFY2018, net profit rose 16% y-o-y and 9% q-o-q to $1.21 billion. The 2QFY2018 result was above consensus forecasts. UOB Kay Hian says it was also 10.5% above its aggressive forecast of $1,094 million.
Loans grew 11% y-o-y to $252 billion, while customer deposits rose 10% y-o-y to $290 billion, translating into a loan-to-deposit ratio of 85.9%. For 2QFY2018, the bank’s net interest margin remained flat q-o-q, but was up two basis points y-o-y to 1.67%. This was lower than the NIMs of DBS (1.85%) and UOB (1.83%). DBS’s loan-to-deposit ratio was 87.2% as at June 30, the highest among the banks, followed by OCBC’s at 85.9% and UOB’s at 85.7%.
The local banks, in particular OCBC and UOB, appeared to have intentionally created additional liquidity buffers both in anticipation of stronger loans growth and in reaction to the rising US federal funds rate, which is now at 2%. Southeast Asian currencies, including the Singapore dollar, were relatively weak against the US dollar during the second quarter. This, too, could have prompted the banks to get excess deposits.
“We have been generating more deposits since the end of last year and early this year in anticipation of higher loan growth, which has tapered down. We have been gradually making sure that those deposits that are less attractive to us are phased out,” Tsien says.
OCBC’s total cost of funds, including other borrowings, rose to 1.54% in 2QFY2018 compared with 1.37% in 1QFY2018 and 1.17% in 2QFY2017. Cost of funds is an amalgamation of different currencies. OCBC has a significant portion on US dollars because it finances capital and trade flows, which are usually in US dollars.
Also, OCBC was unable to reprice some of its loans as quickly as it had its deposits. Tsien indicated that a significant portion of its mortgages could be repriced in 3QFY2018. Mortgages accounted for 26.1% of OCBC’s total loans.
UOB Kay Hian is forecasting a net profit of $4.44 billion for this year and $4.55 billion for FY2019. “The final dividend could be 22 cents if OCBC pays out 40% of earnings as dividends in 2018,” UOB Kay Hian says. It is maintaining its “buy” recommendation, with a higher price target of $13.68.
For 1HFY2018, OCBC has declared a dividend of 20 cents a share, although shareholders can opt for a scrip dividend at a 10% discount to the weighted average price from Aug 15 to 17 when the range was $11.22 to $11.36. The payout ratio for 1HFY2018 is only 36%, parsimonious compared with 53% for DBS and 41% for UOB. This is to ensure that OCBC’s Common Equity Tier 1 ratio stays in the 12.5%-to-13.5% range. The scrip dividend should keep CET1 stable. As at June 30, CET1 stood at 13.2%, which is why UOB Kay Hian believes there is room to raise dividends.
