OCBC earnings release

Results review OCBC reported a decline in core net earnings to S$396mil (-6.8%
yoy, +3.9% qoq, 2Q08: S$381mil) due to higher operating profits but negated by
higher allowances.
Net interest income grew to S$684mil (+20.9% yoy, +1.0% qoq) attributable to 20.2%
growth in loans and improved NIM of 13bps to 2.18% due to lower cost of funds and
higher spreads. Non-interest income was 4.0% lower at S$462mil from lower fee
income, lower foreign exchange income and net losses of S$26mil on disposal of
investment securities. Expenses increased to S$492mil (+15.5% yoy, +4.0% qoq)
due to increased salaries and headcount, overseas investment, business-volume
related costs and consolidation of PacificMas Berhad’s expenses. Cost to income
was higher at 43.0%.
Gross loans expanded to S$81.4bil (+19.6% yoy, +3.8% qoq), driven by corporate
and SME loans in Singapore. Building and construction loans grew 38.9% to
S$16.5bil while housing loans increased 5.6% to S$19.7bil.
The Bank took a S$156mil allowance for loans and other assets comprising of S$
30mil for specific allowances, S$9mil for portfolio allowances, S$4.0mil for corporate
CDOs and S$113mil for debt securities.
NPLs fell 19.0% over the year to S$1.20bil while the NPL ratio improved to 1.3% from
2.1% last year. Total cumulative allowances amounted to 128% of NPLs as
compared to 107% last year. CAR ratio increased to 14.7% with Tier 1 higher at
14.4% after the issuance of S$2.5bil of Tier 1 preference shares.
Revise earnings estimate From history, OCBC recorded higher impairment charge
of 291bps of loans in 1998 as Singapore went through a recession during the Asian
Financial Crisis. Similarly in the Dotcom bust, OCBC charge off 108bps of loans as
impairment both in 2001 and 2002 following the contraction of the Singapore
economy in 2001.

The Material provided above is for information only and does not constitute an offer or solicitation to purchase or sell the shares mentioned

Banks: Provisions hiked to factor in rising NPLs

Slower Singapore economic growth. Given the 0.5% Singapore GDP YoY contraction for 3Q08 (as per the flash numbers released by the Singapore
Ministry of Trade & Industry), expectations are for further economic weakness
going ahead. The Singapore government has also lowered its 2008 GDP
forecast to 3%.
We have lowered our earnings forecasts for the banks:
• 2008 loan expansion forecast in the low teens is expected to be followed by
low single-digit in 2009.
• Fee & commission income is seen to weak as capital market activities slow
down and sales of wealth management products soften.
• Loan loss provisions is seen to increase more significantly in 2009 as some
asset quality deterioration take place.
Further risk of earnings deterioration could arise from provisions coming
even higher than our revised levels. Our sensitivity analysis shows that an
increase of provisions amounting to 10 bps of average interest earning assets
could lead to a further 7.4% fall in DBS 2009 net profit, 5.6% for OCBC and
5.7% for UOB. The higher sensitivity for DBS makes it relatively less attractive
when compared against its two peers.
Our banks’ price targets have also been cut. We now value the banks by
applying a premium over the 2003 low P/B levels. The recent concerns on the
global credit situation has made the market much more focused on the
economic slowdown going ahead into 2009. Hence, the Singapore banks are
more likely to trade at P/B levels closer to the 2003 levels.
Amongst the banks, we continue to favour OCBC. OCBC has been less
aggressive in loan expansion over the past 3.5 years (Dec 04 till Jun 08) than
DBS, and this should lead to a lower rise in NPL ratio going ahead. In addition,
it has a strong capital position, given its recent raising of Tier 1 capital over the
past 3-4 months. OCBC remains a BUY with a target price of S$7.80, based on
1.5x of 2009 book.
We also recommend BUY on UOB (target price of S$18.40, pegged to 1.5x of
2009 book). UOB has also been more conservative in lending over the past few
years, and this should help to protect its balance sheet strength going ahead. In
addition, UOB has historically kept its expense-income ratio relatively low and
this will help to support earnings in such periods of economic weakness. Lastly,
the S$1.32b of capital raised in Sep 08 has strengthened its balance sheet
robustness.

Stock Recommendations
DBS Group Holdings
S$14.86 NEUTRAL (TP: S$15.50)

OCBC
S$6.42 BUY (TP: S$7.80)

UOB
S$15.70 BUY (TP: S$18.40)

analysis by DMG

The Material provided above is for information only and does not constitute an offer or solicitation to purchase or sell the shares mentioned