OREANDA-NEWS. The fall in Oversea-Chinese Banking Corp's (OCBC; AA-/F1+/Stable) net profit reflects the current challenging operating environment, says Fitch Ratings. Despite this, the bank's healthy loss-absorption buffers and stable funding and liquidity position continue to underpin its strong overall credit profile.

OCBC's net profit fell 14% yoy to SGD856m in 1Q16 due to weak investment mark-to-market income, particularly at insurance subsidiary Great Eastern Holdings; lacklustre fee generation; and higher credit costs.

OCBC is the only Singapore bank with a major insurance subsidiary. This makes reported profits more susceptible to financial market volatility, through mark-to-market swings in its insurance investment portfolio and revaluations of its long-dated life insurance obligations. Mark-to-market fluctuations can be reversed over time as the entity holds its investments to maturity.

OCBC's banking profits have begun to show the effects of sluggish volumes and higher impairment costs, although they remained broadly resilient over the quarter. 1Q16 banking net profit was flat on the previous quarter and only 4% lower than a year ago, despite loan impairment charges rising to 30bp of average gross loans (4Q15: 28bp; 1Q15: 13bp). Nonetheless, we expect further pressure on the bank's earnings amid a more uncertain economic and investment environment in the near term.

Asset-quality deterioration has largely been driven by higher delinquencies and loan restructuring in the bank's oil & gas offshore support services portfolio - a segment that has been left vulnerable given the rout in oil prices over the last two years. The bank takes a relatively conservative approach and classifies all restructured loans as non-performing loans (NPLs). OCBC states that its loans are restructured on a commercial basis, and 58% of offshore support service loans classified as NPLs were fulfilling their interest and principal obligations - on restructured terms - at end-March.

Loans to offshore support service providers comprise roughly 45% of OCBC's SGD12.4bn (33% of equity) oil & gas loan portfolio, and about 15% of this sub-segment was classified as non-performing at end-March 2016. This sub-segment accounted for the bulk of OCBC's oil & gas-related NPLs and roughly 40% of total NPLs at end-March. Specific allowances continued to climb to 19bp in 1Q16 (4Q15: 14bps; 1Q15: 9bps) as the bank adjusted its recovery expectations in line with falling vessel valuations.

The group NPL ratio of 1.0% at end-March 2016 is the highest since mid-2010, but still low in absolute terms. Excluding the offshore support services portfolio, the NPL ratio on the rest of OCBC's loans was unchanged at 0.6% (end-2014: 0.6%). This stability extends to the bank's China exposure, which continues to decline with lower China-related trade financing. The NPL ratio on its Greater China portfolio remained steady at 0.4% at end-March 2016, although this may weaken as growth in China slows.

We expect further deterioration in overall asset quality as economic conditions remain weak in many of OCBC's key markets. However, credit costs are still low, and the bank's loss-absorption buffers - in the form of its pre-provision earnings (2.6% of risk-weighted assets in 1Q16), provision coverage (113% of non-performing assets) and core capital - remain healthy.

OCBC's capitalisation and leverage remain sound and in line with local peers, as indicated by the fully loaded common equity Tier 1 ratio of 12.4% and reported leverage ratio of 8.2%. Its funding and liquidity position was also comfortable, with a loan/deposit ratio of 86% at the group level (90% in Singapore dollars), and Singapore-dollar and all-currency liquidity coverage ratios of 259% and 122% respectively. These balance sheet strengths underpin the resilience of the bank's credit profile despite near- to medium-term uncertainty, in our view.