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Oversea-Chinese Banking Corporation Banks in Record Net Interest Income

Oversea-Chinese Banking Corporation (SGX: O39), the second largest financial services group in Southeast Asia by assets, announced its full-year results for 2013 earlier this morning and saw its top- and bottom-line both decline by double-digit percentages.

The bank has a multi-national network of 450 branches and offices in 17 countries and territories with its key markets being Singapore, Malaysia, Indonesia, and Greater China. The bank also has an important insurance subsidiary in Great Eastern Holdings (SGX: G07), which is the largest insurance group in Singapore and Malaysia in terms of its assets.

Some basic numbers

For the 12 months ended 2013, OCBC’s total income – which is essentially the ‘sales’ the bank made – had dropped by 17% year-on-year to S$6.62 billion while profits actually went down even further by 31% to S$2.77 billion.

A drop of that magnitude for OCBC in its top- and bottom-lines might seem like bad news on first glance. But the reality is that the bank’s results in 2012 were bolstered by huge one-off increases in both its total income and profits due to the sale of its stakes in Asia Pacific Breweries and Fraser & Neave (SGX: F99). Strip those away and the bank’s core operations of banking and insurance look much better than what the headline numbers might suggest.

A bank’s top-line is usually classified into two distinct segments: net interest income; and non-interest income. OCBC managed to achieve net interest income of S$3.88 billion in 2013, some 4% higher than in 2012 and a record for the bank. Part of that growth was fuelled by customer loans which increased by 18% year-on-year to S$170 billion from “broad-based growth in Singapore and key overseas markets” such as “trade finance and loans to the housing and building & construction sectors.”

But while net interest income had grown, OCBC had reported a yearly decline in net interest margin – the spread between the interest it receives from the loans it makes and the interest it pays out on the sources of funding it has (such as deposits or other borrowings) – from 1.77% to 1.64%.

The bank cited “the persistently low interest rate environment and the re-pricing of existing mortgage loans in response to market competition” as a result of the phenomenon. An improvement in corporate and commercial loan spreads and lower costs from deposit funding (i.e. low interest rates in our savings accounts!) had helped to mitigate the situation however.

DBS Group Holdings (SGX: D05), which also reported its full-year results this morning, saw its net interest margin fall as well from 1.70% to 1.62%. So, OCBC isn’t alone in this. Nonetheless, it’s something that investors have to watch because falling net interest margins would mean that a bank has to grow its loan volumes to improve its net interest income, all things equal. That might also mean a bank could, in theory, relax its lending standards in pursuit of business volume, which would not be what investors want.

Meanwhile, OCBC’s non-interest income had dropped by 35% year-on-year to S$2.74 billion primarily because of the one-off sale of APB and Fraser & Neave that occurred in 2012. The table below shows the changes for the bank’s main sources of non-interest income:

 

2013

Year-on-year change

Profit from life assurance

S$599 million

-13%

Premium income from general insurance

S$157 million

8%

Fees and commissions (net)

S$1.355 billion

13%

Dividends

S$75 million

-15%

Rental income

S$67 million

-7%

Other income*

S$485 million

-76%

*Other income comprises of the one-off sale of APB and Fraser & Neave

Source: OCBC 2013 earnings release

If we put the one-off sale aside, we can see that fee and commission income would be the main driver for OCBC’s non-interest income and it grew 13% from S$1.20 billion in 2012 to S$1.355 billion on the back of growth in wealth management, fund management, credit card, and loan-related activities.

The next big component would be profit from life assurance, and on that front, Great Eastern Holdings had seen a drop due to unrealised mark-to-market losses (the change in value of financial assets to reflect prevailing market conditions) in its Non-Participating Fund.

Moving down the bank’s income statement, we see operating expenses that are “well-managed” as it went up by only 3% to S$2.78 billion, mainly due to increased staff costs. This helped bring OCBC’s profits to S$2.77 billion, which is only a 2% dip from what it earned in 2012 if we strip away the one-off gains of S$1.17 billion.

Operational highlights and the balance sheet

OCBC’s non-performing-loans (NPL) ratio had improved from 0.8% to 0.7%, signifying an even stronger loan portfolio.

The bank’s loans-to-deposits ratio had also gone down slightly from 86.2% to 85.7%. This helps improve OCBC’s liquidity over the short-term as an unduly high ratio of loans-to-deposits could mean the bank being unable to meet unusually large withdrawals from depositors as its cash are ‘trapped’ in loans.

OCBC’s balance sheet had weakened from a year ago using the ratio of total equity over total assets, which fell from 9.7% in 2012 to 8.3% as of 31 Dec 2013. Meanwhile, the bank’s capital adequacy ratio – a measure of the ‘cushion’ a bank has on its balance sheet to absorb losses – had also dropped compared to 2012, though it must be pointed out that OCBC’s ratios are well above the minimum requirements mandated by the Monetary Authority of Singapore.

Capital adequacy ratios

MAS Requirement

2013

2012

Tier 1

6%

14.5%

16.6%

Total

10%

16.3%

18.5%

Source: OCBC 2013 earnings release

What’s next for OCBC

The bank had declared a final dividend of S$0.17 per share which brings the total dividend for 2013 to S$0.34, a 3% increase from the dividend of S$0.33 paid in 2012.

Samuel Tsien, chief executive of OCBC, commented on the bank’s results:

Our full year performance underscores the fundamentals of our banking, insurance and wealth management franchise. The strong momentum across our customer-related businesses was maintained throughout the year, which substantially offset the lower income from market-related trading and insurance activities.

Looking ahead, our overall outlook remains optimistic, given the positive macroeconomic environment and the underlying growth prospects in our key markets. We will continue to grow prudently, make the best use of our resources, work comfortably within our regulatory obligations and invest in our network and capabilities to support our customers. With our strong financial position and established customer franchise in our chosen markets, we are well-placed to continue delivering long-term shareholder value.”

Valuation

Shares of OCBC are currently up 0.4% to S$9.37 and valued at 1.36 times its book value. The bank also carries a trailing dividend yield of 3.6% based on its S$0.34 per share pay-out.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.