• 2Q18 PATMI of S$1.33bn missed our forecast by 7%.
• The downside surprise came mainly from higher than expected income tax expense. However, NII and profit before tax was in line with our expectations.
• The standout performers were higher NIMs and loans growth.
• 1H18 dividends at 60 cents/share (+82% YoY), in line with guidance. DBS is now trading at a dividend yield of 4.5%.
• We tweaked our target price to S$33.32 (previously S$32.70). Our rating has been upgraded to BUY due to higher book value assumption.

The Positives

+ NIM at two-year highs. NIM touched 1.85%, expanding 11bps YoY; the highest in seven quarters. NIM expansion was driven by higher SIBOR and HIBOR this year. In view of 2 more expected rate hikes and healthy pass through rate, guidance is for FY18e NIMs to rise by 1-2 bps above previous guidance of 1.85% (Figure 1).

+NII driven by broad-based loans growth. Loans growth was strong at 11.5% YoY, driven by double-digit growth in building and construction, housing loans and loans to financial institutions. Housing loans spiked to 14.1% YoY, continuing the strong QoQ momentum. DBS’ market share of Singapore housing loan remains strong at 31%.

+ Hong Kong earnings surged 33% YoY in 2Q18. Net profit for Hong Kong grew 33% YoY to S$304mn. NII grew 28% YoY, driven by rising interest rates which gave a 28 bps increase in NIM to 1.98%. The rise in HIBOR in Hong Kong has become much more significant with a growing CASA base and loans growth was robust at 12.3% YoY. Fee income grew 12% YoY on the back of growth in wealth management and cash management business.

The Negatives

– Treasury market income missed the mark. Revenue from treasury markets declined 58.5% YoY to S$107million. The poor performance resulted in a pre-tax loss of S$50mn as compared to a profit of S$107mn in 2Q17.

– Lacklustre performance from other non-interest income. Other non-interest income declined 31.8% YoY due to a flattening yield curve and wider credit spreads due to trade tensions.

Outlook

With the recent property cooling measures implemented, management is expecting a slowdown in housing loans and property related business loans growth. Trade war tensions are anticipated to have an impact on trade loans as well and the spillover effects has already been seen in the weaker Treaury Markets performance this quarter. As a result, guidance for full year loans growth target has been adjusted to 6-7% from 8%. Despite the softer expectation of loans growth due to market headwinds, NIM will still be on a positive trajectory as trade issues will impact trade volumes more significantly than overall margins.

There are multiple drivers to 2018 growth. Firstly, margin expansion from rising SIBOR, SOR and HIBOR. Secondly, volume growth as overall domestic economy improves. Hong Kong loans growth has been stellar and although Singapore housing loans growth may be subdued, we can still expect the stable growth that we have seen so far because despite the 50 bps increase in SIBOR this year, housing loans remained resilient. Thirdly, asset quality is benign and the high new NPA we saw this quarter is mainly from one corporation. Fourthly, wealth management is enjoying structural growth as DBS builds a stronger franchise globally and digitalise platforms.

Investment Actions

We raised our target price to S$33.32 (previously S$32.70). Our rating has been upgraded at BUY due to higher book value assumption.