• FY18 Revenue and PATMI met our estimates.
• FY18 NIM expanded 13 bps YoY to 1.85% (FY17: 1.75%). 4Q18 NIM rose 1 bps QoQ to 1.87% (3Q18: 1.86%).
• Loans grew 6.7% YoY, driven by non-trade corporate loans across the region.
• Allowances declined 71.0% YoY due to accelerated provisions made for weak oil and gas support service last year. NPL ratio improved to 1.6% (4Q17: 1.7%).
• Full-year ROE rose 2.4% to 12.1%, the highest since FY2007.
• A proposed final dividend of $0.60/share, bringing full-year dividend to $1.20/share.
• Maintain BUY at an unchanged target price of S$29.00.

The Positives

+ NIM at an almost three-year high. 4Q18’s NIM touched 1.87%, meeting the full year guidance and expanding 9bps YoY and 1 bps QoQ. NIM expansion was boosted by higher interest rates in Singapore and Hong Kong. Loan, interbank and securities yields improved 59bps YoY, 19bps YoY and 34bps YoY; while the cost of funds rose 46bps YoY. Higher interest rates in Singapore and Hong Kong were offset by lower NIM from Treasury Market (TM) activities. Excluding TM, FY18 NIM would be 2.06%. We expect the cost of funds to rise as more deposits migrate from CASA to fixed deposits and bonds in a rising interest rate environment. With the recent dovish tone on future rate hikes by the U.S. Federal Reserve, we lower our NIM estimates for FY19e from 1.94% to 1.91%.

+ Loan growth stable at mid-single digit of 6% YoY, led by regional broad-based non-trade corporate loans (+12% YoY) and consumer loans (+3% YoY). Consumer loan growth was softer in 2H18 due to property cooling measures. Trade loans declined 6% as maturing loans were not renewed due to rising interest rates. DBS’s market share of Singapore housing loan remains healthy at 31%. We believe that the slowdown in mortgage loans will persist and loan growth to be dampened by rising interest rates and geopolitical events. Hence we tone down our FY19e loan growth estimates from 6.7% to 6.0%.

+ Allowances halved and specific provision at 19bps of total loans. The plunge in allowances was due to substantially accelerated provisions made for the O&G sector last year. 

+ Hong Kong’s full-year earnings surged 40% YoY. Hong Kong’s NII grew 30% YoY, driven by rising interest rates which gave a 27 bps increase in NIM to 2.01%. The rise in HIBOR in Hong Kong has become much more significant with a growing CASA base and loans growth was robust at 11% YoY. Hong Kong contributed 20% to total revenue.  

The Negatives

– 4Q18’s Treasury Markets income declined 54% YoY to $92mn, the lowest ever recorded. Unfavourable market conditions resulted in lower contributions from equity and credit activities. Compared to the previous quarter, total income declined 59% due to lower contributions across all products. However, we believe the greater proportion of high-returns businesses such as the Wealth Management and Cash and SFS in DBS’s franchise mix will be able to offset the near term contraction in Treasury Markets income. The Wealth Management and Cash management businesses are already contributing to a third of the bank’s revenue.

– Full-year CIR rose to 44.1% from FY17’s 43.7% due to higher reported expenses from Treasury Markets and ANZ of around +8% YoY. Excluding the impact from ANZ and Treasury Markets, FY18’s underlying CIR would be stable at 41%, similar to FY17. Operating expenses increased 8.2% YoY in 4Q18, faster than operating income’s growth of 6.2% YoY; due to more costs than income brought on by ANZ which accounted for 6% of the increase in expenses. More costs could be expected in 2019 as DBS expands into India.

Outlook

More NIM expansion to be expected. While it generally takes a few months for loans pegged to floating rates to reprice, it takes a couple of years for a fixed rate loan to do so. Hence, even if the Fed pauses in their rate hikes, a large portion of the rise in interest rates has yet to be repriced into Singapore’s books. More repricing of loans expected in 2019 and beyond.

Mortgage book growth to decelerate due to property cooling measures. Guidance for new mortgage loan formation has been revised to $1.5-2.0bn in 2019, a decrease from $2.5bn guided for FY18e. However, loan growth could be supported by demand from Chinese businesses moving out of China and fiscal stimulus as countries including Thailand, Indonesia and India prepare for elections this year.

Macroeconomic slowdown and volatile markets. Management expressed concerns about the impact of uncertain geopolitical events such as the trade war, Brexit and US election, resulting in synchronised economic slowdown globally. In our opinion, the ability and resilience DBS’s franchise will allow it to capitalize on the region’s prospects as companies shift their supply chain out of China and into South-East Asia.

Investment Actions

We maintain BUY at an unchanged target price of S$29.00.

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. The banking sector will enjoy greater pricing power as the US continues to raise its interest rates. Looking forward, asset quality is expected to be stable, and greater cost efficiencies will provide upside to earnings. DBS remains attractive with a dividend yield of 4.8%.

Key risks include (i) lower pass-through of interest rates; (ii) lesser U.S. Federal Reserve rate hikes; (iii) market volatility continues to pressure Treasury Market revenues downwards; (iv) weaker sentiments due to trade tensions.