OCBC to suffer from rising earnings headwinds

Higher-yielding unsecured personal lending will not be enough to offset higher funding costs.

According to Barclays, profit contribution from Great Eastern Holdings may be a source of positive surprise in 3Q12 as credit spreads narrowed slightly and equity prices improved, but we see limited upside in the medium term in the persistently low interest rate environment.

Here's more from Barclays:

We believe management’s attempt to focus on higher-yielding unsecured personal lending will not be enough to offset higher funding costs and falling corporate loan yields.

We believe margins going forward will be under pressure on both loan and deposit pricing, and see downside risk to management’s guidance for stable to slightly lower margins (at 1.77%). We forecast another 4bp q/q margin contraction to 1.73% in 3Q12.

Loan yields will continue to compress driven by the continual downward repricing of the mortgage book. Deposit costs are rising led by strong funding competition from the foreign banks and as banks focus on “stable” sources of funding in preparation for Basel III implementation.

Cutting FY13-14E earnings estimates by 2-3%, maintain EW
We lower our FY13-14 estimates by 2-3%, mainly reflecting our lower margin assumption at 1.73% in 3Q12E and 1.71% in 4Q12E (vs management’s guidance for stable to slightly lower margins at 1.77%).

We revise our FY12E profit higher to incorporate a one-off S$1.1bn gain on divestment of non-core assets in 4Q12E. Trading on 1.3x FY13E P/B for 10.5% ROE, we believe OCBC is fairly valued.

We lower our PT to S$9.00, from S$10.20 previously, based on our unchanged blended valuation methodology and roll forward to FY13E estimates.

Key upside risks include: 1) stronger-than-expected loan demand; and 2) further gains from disposal of non-core investments.

Key downside risks include: 1) greater-than-expected margin pressure from retaining more US$ liquidity and growing reliance on long-term stable funding sources; and 2) rising credit costs if economic conditions deteriorate (SMEs ~15% of total loans).