The Positives
+ Strong WM. 2Q17 WM income was S$511mn (+21% YoY) supported by investment products (+12% YoY) and loans and deposit (+4% YoY). The strong WM income helped offset the weak 2Q17 Retail income (-2.8% YoY) to bring 2Q17 CBG income 6.5% higher YoY.
+ Trade loans 6% higher YoY; IBG Cash/SFS income 35% higher YoY. We believe the trade loans are boosted by the offshore RMB trade loans as the spread between the onshore SHIBOR and the offshore CNH HIBOR narrowed in recent months. 2Q17 IBG Cash/SFS income showed strong growth as Non-trade corporate (+8% YoY), and Trade loans (+6% YoY) grew.
+ Stronger Net Interest Income growth was due to higher volumes of interest-bearing assets. Stronger NII YoY was led by loans growth (6.6% higher YoY) offset by lower NIM. Stronger NII QoQ was supported by pass through of higher rates in Singapore market offset by unfavourable rates for HIBOR pegged loans in Hong Kong and higher LDR of 88% (2Q17: 87%).
+ Recovering Singapore property market. DBS experienced strong pick up in resale and refinancing mortgage activities in 2Q17 as it has 28.7% market share in Singapore housing mortgage.
The Negatives
– Unfavourable rate and volume dynamics could remain a challenge. Despite positive non-trade corporate loans growth, IBG NII fell 5.8% YoY from S$721mn in 2Q16 to S$679mn in 2Q17. We estimate the IBG NII make up c.22% of Total Income (c.30% of Total NII). IBG Treasury income fell 16.7% YoY from S$204mn in 2Q16 to S$170mn in 2Q17. On the CBG business, the unfavourable HIBOR has mainly affected the HIBOR pegged housing mortgage loans thus causing Hong Kong NIM to decline 9 basis points QoQ.
– Treasury customer income fell 8% YoY because of lower RMB hedging activities from customers and continuing poor performance in the interest rate activities in Treasury Markets.
– Lumpy write offs in the offshore O&G sector has weighed on provision expense and coverage ratio. Recall that DBS used the S$350mn gain from the sale of PwC building in 1Q17 to bolster its general provisions and improve the coverage ratio from 97% to 103%. However, for the current quarter, the lumpy write-offs and new NPL formation in 2Q17 brought the coverage ratio back down to 100%. There are still ongoing concerns on offshore services vessel collateral values as charter rates continue to be low. Liquidity driven events such as bond maturities will be key risks to NPL formation in the near future. DBS’ exposure to the O&G support services is S$5.4bn.
Outlook
Our FY17e total income growth estimate is 5.7% as we expect FY17e NII growth to be c.3%. Though the management has guided for FY17e provision expense of S$1bn, we believe it is insufficient because 1H17 provision expense was already S$854mn yet coverage ratio is 100%. Unless there is certainty of stable write-offs and net NPL formation, we think that S$150mn provision expense for 2H17 could be insufficient. Therefore, we are revising our FY17e to S$1.16bn from the previous estimate of S$1.1bn.
The operations in the IBG segment appears to be challenged with a negative jaw of -2% YoY for 1H17. We continue to see unfavourable loan rate dynamics in non-trade corporate loans and a continuing poor performance in DBS’ Treasury Markets in 2017. The retail segment in CBG appears to be sluggish (2Q17 Retail income -2.8% YoY). But the bright spots are – a) the WM segment continues to grow through product synergies between loans, deposits, investment products and cards b) Strong Cash/SFS income growth as trade and corporate loans increase.
The “larger than expected” specific allowance in 2Q17 was an immediate reaction to the lumpy write-off and net NPL formation in the same quarter. The situation corroborates with our longstanding argument that DBS has little bandwidth to manage its provision expense owing to low coverage ratio wherein too little provision expense would bring the coverage below 100%, but too much provision expense will eat into the PATMI growth. Whilst a stronger growth in Total Income can support higher provision expense, we highlight that unfavourable conditions continue to impact total income growth – a) DBS already has a high LDR, so it does not have a wide headroom to stretch it further to raise NII b) As we have already observed; unfavourable loan volume and rate dynamics, benchmark rates and competition in mature markets can crimp NII growth. c) Hong Kong’s funding costs may be more sensitive to capital flows as Hong Kong’s CASA (cheap and sticky deposits) ratio is c.56% compared to Singapore’s CASA ratio of c.91%.
In the near term, however, economic sentiments are improving, and volatility is low from the start of 2017. Singapore housing market has bottomed and recovering. Therefore we are revising our valuation to reflect these improvements.
Valuation: Gordon Growth Model
3-Year Historical Price-to-Book
Investment Actions
Maintain “Reduce” rating with a higher target price of S$17.92 (previously S$17.24) based on Gordon Growth Model (previously 0.95x FY17F PBR, excluding preference shares).
List of Abbreviations
WM – Wealth Management
IBG – Institutional Banking Group
CBG – Consumer Banking Group
NII – Net Interest Income
NIM – Net Interest Margin
LDR – Loan to Deposit Ratio
NPL – Non-performing Loans
CASA – Current Account, Savings Account
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Jeremy covers primarily the Banking and Finance sector. He has 6 years’ experience in equities related dealing and research roles.
He graduated with Bachelors of Mechanical Engineering from Nanyang Technological University.
