Potential hike in Ningbo bank stake behind OCBC's conservative dividends?

DOES OCBC Bank need that much capital? What does it want to do with all that excess capital?

These questions are regularly asked of the bank by shareholders at its annual general meetings.

To recap, the bank for 2018 paid a total full-year dividend of 43 Singapore cents a share, taking total dividend payout ratio to 40 per cent of its core 2018 net profit. Shareholders naturally want to know why OCBC has been reluctant to dole out a dividend payout that is closer to that of its peers. OCBC's peers raised their dividend payout to some 50 per cent of earnings, all in cash. OCBC also offered scrip dividend.

(DBS announced it would pay quarterly dividends from the first quarter of 2019, leading OCBC shareholders to ask at a shareholder's meeting that afternoon after DBS Group Holdings' results if OCBC would offer quarterly payouts instead of semi-annual payouts. OCBC said this practice incurs a "high administrative cost".)

With the reigniting of China-US trade tensions over the last few days, it is useful to review what the extra capital buffer means for OCBC and its investors. Much of that may come down to how OCBC assesses the opportunities and risks arising out of China, specifically, in terms of mergers and acquisitions (M&As).

Analysts were told by OCBC management during the Q1 results briefing earlier this month that the bank is keen on building its presence in China's Greater Bay Area and Pearl River Delta region.

As it is, OCBC expects to hit at least S$1 billion in pre-tax profits from the Greater Bay Area - made up of Hong Kong, Macau, and several cities in Guangdong province - by 2023. This is double its current pre-tax profit level of S$500 million as at 2017.

When OCBC gave this projection in mid-2018, it said the strategy is to capture investment and capital flows between China and South-east Asia through its Wing Hang acquisition in 2014. It also said it could tap financing demand out of Shenzhen - a high-tech Chinese city - by partnering with its associate company Bank of Ningbo, which has 14 branches in Shenzhen. The target then seemed to rest mainly on organic growth.

But a Citi report following the results briefing this month said that OCBC appeared interested to raise its 20 per cent stake in Bank of Ningbo over time as and when regulations allow.

"OCBC noted that there is strong and regular cooperation with Bank of Ningbo at multiple levels and senior management discussions every other week," said the report, adding that Bank of Ningbo can also work with OCBC Wing Hang as opportunities in the Greater Bay Area arise.

Other analysts, likewise, see an appetite for acquisitions in Greater China coming from OCBC. A Jefferies Singapore report said that "management reaffirmed capital buffers for offensive and defensive purposes, though commentary was more focused on inorganic growth opportunities in China resulting from gradually evolving regulatory landscape".

Last year, China loosened restrictions on foreign holdings in domestic banks, removing the previous 20-per-cent cap on foreign stakes in a single institution in a Chinese lender. Jefferies estimated that a 20 per cent incremental stake in Bank of Ningbo would cost OCBC roughly S$4 billion now.

OCBC's last headline fund injection in Bank of Ningbo was made in 2014, when it spent about S$380 million via a private placement to raise its stake in Bank of Ningbo to its current holding of 20 per cent, up from 15.34 per cent.

Banks are building pipelines to connect investment and capital flows. Given the trade tensions between the US and China, there is a sense that intra-Asia connectivity will be ever more critical.

In aiming to seize an expanding economic pie by tapping on the Greater Bay Area - set to become the world's largest bay area in GDP terms by 2030 - OCBC will continue to command the largest Southeast Asian presence of the top-four foreign banks in the Gre ater Bay Area.

Beyond having the fire power to boost its stake in Bank of Ningbo, OCBC may also look to deepen its financing presence in Greater China by building on its onshore fund management business. OCBC has a 28 per cent stake in a fund management company that is, in turn, a subsidiary of Bank of Ningbo.

Tapping more deeply into China's growth may bring it closer to the geographical earnings make-up of DBS. Currently, Hong Kong and Greater China contribute up to roughly 30 per cent of DBS' pre-tax profit. In comparison, they make up about 20 per cent of OCBC's pre-tax profit, Citi's estimates show.

But to be clear, other factors must also come into play to ensure that capital and investment flows come through. M&A case studies have shown that the success of acquisitions does not merely come from ample funding, but also in aligning people of different work cultures and, particularly for banks, integrating different pieces of technology for better capturing of capital flows.

There is also, of course, that big caveat, which is that financial liberalisation in China cannot be assumed to run on a neat and linear curve. Against the current trade tensions, China - as a managed economy - is unlikely to risk large moves that introduce outsized volatility in capital movements. The other large shareholder in Bank of Ningbo is the Ningbo Municipal Government, which holds about 23 per cent in the bank, Bank of Ningbo's website showed.

Whether such M&A opportunities in China will truly emerge for OCBC - or any other bank - is not as clear-cut as that in a market-driven economy. OCBC will have to time its strategy to fit the ever-evolving circumstances.

So when an investor buys into OCBC, it is in some ways riding on OCBC's option on China, paying for it by forgoing a richer dividend for now.

The rise of China is an inevitable long-term structural trend, so this investing hypothesis should not come as a surprise. Investors should watch how OCBC will strike on its China bet.