DBS GROUP HOLDINGS LTD - Phillip Securities 2016-11-01: Asset Quality is the Red Herring

DBS GROUP HOLDINGS LTD D05.SI

DBS GROUP HOLDINGS LTD - Asset Quality is the Red Herring

3Q16 NPAT up y-o-y attributed to increase in Non-interest income and decrease in total expense.
3Q16 NIM decreased 10 bps q-o-q on the back of lower SIBOR/SOR.
3Q16 NPL was hit a high 1.32% as asset quality deteriorates.
Ability to grow income is paramount to dealing with deteriorating asset quality.

Maintain “Accumulate” with a lower target price of S$15.71 (previously S$16.09), pegged at unchanged 0.95x FY16F book value (excluding perpetual capital securities).

Strong loans growth in Housing loans, up 10.2% yo-y attributed by higher Singapore mortgage loans. Trade loans remained unchanged quarter-on-quarter (“q-o-q”) at S$37bn but declined 14% y-o-y contributed by declines in Chinese trade loans.
On a q-o-q basis, loans growth from Rest of Greater China and South and Southeast Asia regions offset decline in loans from Singapore where SME loans are experiencing weakness from slowing economy.

Average rates on interest earning assets declined 11bps q-o-q, tracking the declines in SOR and SIBOR, while average rates for interest bearing liabilities declined only 1bps q-o-q.
We opine that DBS’ Loan-toDeposit ratio which is pushing to a high of c.90% means it is already maximising the volume of loans it can maintain against its funding from deposits. Now, DBS has less room to optimise NIM further by growing loan volumes faster than deposits.
In a low rates environment, DBS would seek to grow the loan volumes to offset the fall in rates on interest earning assets in order to maintain interest income. However, since it is already at a Loan-to-Deposit ratio of c.90% it has less room to grow loans without first taking care of the funding from the liability side.
If it tries to grow deposits in tandem, it has to increase rates on deposits but that would run counter to low rates on the interest earning assets and compress NIMs further. Also it may not be able to reduce interest expense simply by cutting rates more aggressively on liability side lest funding drains out and pushes Loan-to-Deposits higher even as loan volumes remain unchanged.
We believe the unfavourable rate and volume dynamics is corollary to its current high Loan-to-Deposit ratio and as a result, DBS would have less bandwidth to manage Net Interest Income higher in a low rates environment.

Coverage ratio declined to 100% from 113% in 2Q16 and 161% in 3Q15 as a result of NPLs growing faster than allowance charged.
We have alluded to DBS having less bandwidth to manage Net Interest Income higher in a low rates environment, therefore it also implies that it will have to be more cautious in charging higher allowance to the income statement lest it affects the overall profit performance. The situation today is worsened as asset quality is falling and more allowance is expected but the lack of it is leaving the market bamboozled.
We believe that DBS had played its cards to drive efficiency too early; only to find itself in a quandary of low rates and falling asset quality happening together.

Net fee income rose 19% y-o-y to S$614mn led by Wealth Management, up 47% y-o-y from higher bancassurance contributions; by Investment Banking, up 74% y-o-y from higher equity market, fixed income fees and increased advisory activities; by Cards, up 15% y-o-y from growth in credit and debit card transactions.
With increased investments into digital and wealth management infrastructure, we believe DBS is seeking to improve the performance of fee income to provide a reliable and consistent boost of offset any potential lacklustre performance from Net interest income segment.

We believe that the acquisition of ANZ wealth and retail business in five markets (Hong Kong, Singapore, China, Taiwan and Indonesia) is timely because DBS can bolt on the much needed loans and deposits growth.
DBS will have access to S$11bn worth of customer loans, representing 3.74% of DBS’ customer loans and S$17bn worth of customer deposits, representing 5.24% of DBS’ customer deposits.
DBS can also grow its Cards and Wealth Management franchise across this customer base.

DBS’ 3Q16 NPAT of S$1.102bn was in line with our expectations of S$1.1bn. The market is focused on the DBS’ asset quality and whether sufficient measures are in place to ensure that.
Whereas our view is in as much as taking on riskier loans is a concern, the ability to generate higher net interest income is the prerogative to manage higher provisioning to buffer against deteriorating asset quality.
We view that the strong Non-interest income segment can help offset the near term weakness in Net interest income and the timely acquisition of ANZ wealth and retail business in five markets will provide the loans and deposit growth support.
Maintain to “Accumulate” with a lower target price of S$15.71 (previously S$16.09), pegged at unchanged 0.95x FY16F book value (excluding perpetual capital securities).
The lower share price reflects dilution from scrip dividends.

Jeremy Teong Phillip Securities | http://www.poems.com.sg/ 2016-11-01

Phillip Securities SGX Stock Analyst Report ACCUMULATE Maintain ACCUMULATE 15.71 Down 16.090