3 Things to Know About OCBC's New SGD PNC5 AT1 Security

This article was originally published on bondsupermart.com earlier today.

1. Bond information

Oversea-Chinese Banking Corp Ltd (“OCBC”) has announced the launch of a new SGD Additional Tier 1 security (“AT1”) on a perpetual non-callable 5 basis (“PNC5”). PNC5 means the bonds are first callable in August 2023, and then every six months thereafter.

The new OCBC PNC5 AT1s have an initial price guidance (“IPG”) in the 4.375% area. Coupon distributions are fully discretionary by OCBC and non-cumulative, though there is a distribution stopper clause that prohibits OCBC by making distributions to more junior claims (e.g. shareholders) if it skips a coupon payment on the bonds. The distribution rate will reset on the first call date and every five years thereafter, to a new fixed rate equivalent to the sum of the prevailing five-year SGD Swap Offer Rate (“SOR”) plus the initial spread.

OCBC currently has the credit ratings of Aa1 (Moody’s) and AA- (S&P and Fitch), with a stable outlook on all the ratings. Its new PNC5 AT1s are expected to be rated Baa1, BBB-, and BBB by Moody’s, S&P, and Fitch respectively.

As AT1 securities, the new OCBC perps are unsecured and subordinated obligations ranking behind all senior creditors. The bonds also have a loss absorption feature that will be triggered when the Monetary Authority of Singapore deems the issuer as “non-viable” or likely to fail, which is usually when the capital levels of a financial institution fall below regulatory minimums. In that event, OCBC has the right to write off the principal amount and any accrued but unpaid interest on the bonds by an amount that will restore its capital to levels deemed satisfactory by the regulator.

2. Strong 2Q18 results

In line with its local peers DBS and UOB, OCBC reported a solid set of 2Q18 and 1H18 results. 2Q18 total income rose 5% to S$2.47 billion, driven by strong performance across OCBC’s banking, wealth management, and insurance businesses.

Strong loan growth and higher net interest margin (“NIM”) pushed 2Q18 net interest income to S$1.45 billion (+8% YoY). Customer loans grew 10% YoY to S$252 billion (2Q17: S$229 billion), while NIM widened 2 bps YoY to 1.67%, due to higher asset yields in Singapore and Malaysia. While OCBC’s NIM was flattish on a quarterly basis (1Q18: 1.67%), we think margins are likely to expand in the near term, benefitting from higher interest rates in Singapore (see Chart 1).

Chart 1: Interest rates are higher this year

OCBC’s wealth management income and income from fees and commissions remained steady in 2Q18, and drove a 2% YoY growth in its non-interest income to S$1.02 billion. The bank’s wealth management unit, Bank of Singapore, saw its assets under management climbed 14% YoY to USD 102 billion, which should support OCBC’s profitability with its steady wealth management fees.

Operating expenses rose 4% YoY to S$1.04 billion (2Q17: S$993m) due to increase in staff costs and technology-related expenses, as OCBC continued to invest in its digitalization strategy. As expenses rose at a slower pace than total income, OCBC’s cost-to-income ratio improved to 41.9% (2Q17: 42.2%), demonstrating the lender’s discipline in cost management.

Allowances for credit and other losses sank 87% YoY to S$21m (2Q17: S$169m), driven by an improvement in the operating environment of the oil and gas (“O&G”) support vessels and services sector. As a result, OCBC’s profit before tax jumped 17% YoY to S$1.50 billion in 2Q18 (2Q17: S$1.28 billion), and net profit similarly rose 16% YoY to a record S$1.21 billion (2Q17: S$1.04 billion).

Asset quality remained sound, with NPL ratio improving to 1.4% (2Q17: 1.3%) and credit costs at a low level of 5bps for impaired loans. Moving forward, we think credit costs should stabilize due to OCBC’s proactiveness in recognizing its O&G-related problem loans in the past, and implementation of SFRS (I) 9 accounting standards, which require banks to calculate credit loss allowances using a forward-looking expected credit loss model.

OCBC’s capital position remained strong and well above regulatory requirements. Despite its healthy loan growth, OCBC’s risk-weighted assets (+1.0% QoQ) increased at a slower rate than its Common Equity Tier 1 Capital (“CET1”; +1.7% QoQ). Consequently, the bank’s CET1 and Tier 1 capital adequacy ratios (“CAR”) rose slightly to 13.2% (1Q18: 13.1%) and 14.3% (1Q18: 14.2%) respectively, comfortably above the regulatory minima of 6.5% and 8.0%. Total capital CAR however dropped YoY to 15.9% (2Q17: 16.1%), but was still significantly higher than the regulatory requirement of 10%.

Looking forward, we think OCBC’s full-year results for 2018 should continue to show robust profitability and good asset quality. The rising interest rate environment is likely to boost the bank’s NIM, while its steady wealth management business and OCBC Wing Hang’s operations in greater China buoy income growth.

3. Bond pricing

At its IPG of around 4.375%, the new OCBC PNC5 AT1s are priced at a spread of 216bps above SGD swaps. They provide good value within the SGD-denominated AT1 universe (see Table 1), although Julius Baer’s 5.75% perps look interesting with their higher yield against a shorter tenor (assuming redemption at first call). While the new OCBC AT1s seem to offer little to nil new issue concession, that is unsurprising as Singapore banks typically command a price premium for their capital instruments—they are usually more expensive relative to issues of foreign financial institutions with similar credit profile.

Table 1: Selected SGD AT1 securities

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.