• 4Q16 PATMI of SGD913mn missed our 4Q16 estimate of SGD1.08bn by 15%.
• Surprise came from higher-than-expected provisions in 4Q16. But lower y-o-y net interest income growth was in line with our expectations.
• Downgrade “Reduce” from previous “Neutral” rating with a lower target price of S$16.73 (previously S$16.85), pegged at unchanged 0.95x FY17F book value (excluding perpetual capital securities).

• Loans grew 6.4% year-on-year (“y-o-y”). Strong loans growth led by Housing loans, up 10.1% y-o-y from higher Singapore mortgage loans; Building and construction loans, up by 5.0% y-o-y from government construction projects. Overseas expansion by local developers and investment holding companies into United Kingdom and Australia also contributed significantly to loans growth.

• 4Q16 Net interest income declined 2% y-o-y to SGD1.82bn due to NIM compression of 13bps y-o-y to 1.71%. The average rate on Customer non-trade loans which make up c.60% of interest earning assets declined 11bps y-o-y, offsetting a volume increase of 7.3% y-o-y. At the same time, average rate and volume of Customer deposits, which make up c.85% of interest bearing liabilities, increased 1bps y-o-y and 6.5% y-o-y respectively. The higher deposit growth witnessed in 4Q16 was partly due to DBS’ active liquidity management during the US elections in November 2016. As a result, loan-to-deposit ratio (“LDR”) declined from 89.5% in 3Q16 to 86.8% in 4Q16. Management shared in the earnings brief that they are comfortable to bring LDR back to c.90% which is in line with our assumption that DBS is more aggressive to maintain high a LDR to squeeze out more net interest income.

• Coverage ratio declined to 97% from 100% in 3Q16 and 148% in 4Q15 as a result of NPLs formation accelerated from 0.9% in 4Q15 to 1.4% in 4Q16. As in our past result updates and bank sector report, we had alluded to DBS’ high LDR and unfavourable loans volume and rate dynamics as reasons for poor net interest income growth. The inability to drive that growth would invariably crimp the ability to set aside provisions as quickly as the formation of non-performing assets therefore we are not surprised that the coverage ratio could fall below the psychological 100%. Notwithstanding that, we are less encouraged by the fact that the divestment gains of SGD350mn from the sale of PwC building would be set aside for General Allowance to boost the coverage ratio to 104%. This adds credence to the argument that forward earnings from core operations may not be sufficient to buffer against formation of non-performing loans. For coverage ratio to remain at 104% by 4QFY17F, we estimate that NPL must not rise beyond 1.54% based on our 4QFY17F gross loans of SGD314bn.

• Strong fee and commission income supports performance. Net fee income and commission income rose 6% y-o-y to S$515mn led by Wealth Management, up 32% y-o-y from higher bancassurance contributions; Cards, up 15% y-o-y from growth in credit and debit card transactions. We expect better performance from fee and commissions as DBS is slated to integrate 4 out of 5 markets of ANZ’s wealth business in Asia by end of 2017. The ANZ acquisition would give DBS access to Credit cards business in Taiwan and Indonesia which DBS currently does not have a strong penetration.

• Exposure to Offshore Oil and Gas Loans. DBS’ offshore oil and gas exposure is approximately SGD7.3bn (2.4% of Gross Customer Loans). Of which, state-owned and government-linked shipyards make up SGD1.8bn and 95 debtors make up SGD5.5bn. Management deems the SGD5.5bn to be at higher risk of non-performance. Based on the earnings brief. We estimate at least SGD1.35bn in the pool of SGD5.5bn are still at risk of non-performance. This could potentially add 43 basis points (based on 4QFY17F gross customer loans) to Non-Performing Loans (“NPL”). In such an extreme situation, we estimate coverage ratio to reach 88% based on our 4QFY17F total allowance estimates.

Investment Actions

Management’s guidance for 2017 loans and income growth is mid-single digit. Therefore we have revised our total income growth estimate from 2% to 5%. Management also provided guidance that the total allowance in 2017 would be similar to 2016 excluding provisions for Swiber. Based on the total allowance guidance and the divestment gains from the sale of the PwC Building, we estimate net profit growth to be more than 10%. However, we still think that a mid-single digit income growth may not be sufficient to secure growth of shareholder returns if non-performing loans escalates more than expected. Downgrade to “Reduce” from previous “Neutral” rating with a lower target price of S$16.73 (previously S$16.85), pegged at unchanged 0.95x FY17F book value (excluding perpetual capital securities).