DBS Group Holdings - UOB Kay Hian 2015-11-03: 3Q15 ~ Steady Performance Despite Adverse Operating Environment

DBS GROUP HOLDINGS LTD D05.SI

DBS Group Holdings (DBS SP) 3Q15: Steady Performance Despite Adverse Operating Environment

3Q15 net profit would have grown 10.7% yoy if adjusted for the one-time charge of S$50m for adopting FVA to valuations of derivatives.
NIM expanded 3bp qoq, demonstrating DBS’ strong funding franchise.
Asset quality has stayed resilient as well. Its ability to deliver solid earnings despite the adverse operating environment is a testament of DBS’ strong management.
Maintain BUY. Target price: S$22.34.

DBS reported net profit of S$1,066m for 3Q15, in line with our expectations of S$1,071m and consensus’ estimate of S$1,057m.
Positive surprise from NIM expansion. NIM expanded by 3bp qoq to 1.78% due to improvement in cost of deposits. CASA ratio remained at a healthy 60.2%. Management allowed high-cost US dollar-denominated fixed deposits to run off as trade loans have contracted 6% qoq. Demand for trade loans from Chinese customers has slowed, especially in August and September, due to the narrowing of interest rate differential between onshore and offshore renminbi.
Volatility in financial markets affected fee income. Fees declined 6.8% yoy and 11.2% qoq. The sequential decline in fees was from market-sensitive sources such as brokerage, investment banking and wealth management.
Negative impact from adopting best practices in accounting. Net trading income was robust at S$286m, up 5.5% yoy and 4.8% qoq. There was a one-time charge of S$50m from adopting funding valuation adjustment (FVA) to fair values of derivatives.
Asset quality resilient. NPLs declined marginally by 0.6% qoq and NPL ratio was unchanged at 0.9%. The slight increase in NPLs experienced in Hong Kong and South & Southeast Asia was offset by decrease in Greater China. Loan-loss coverage was preserved at a healthy 145.4%.

Management expects loan growth of 5% based on constant currency terms assuming trade loans hold at current level and non-trade loans expand at 6%. Fees are expected to increase at a double-digit growth rate while net trading income should sustain a single-digit growth rate. Overall, total income is expected to increase by 7-8%. Cost-to-income ratio is expected to be about 45%. Credit costs should rise moderately by a few basis points in 2016. Bottom-line is expected to increase in 2016, as opposed to gloomy expectations of earnings contraction.

DBS has made further disclosure on its exposure to the commodities sector, oil & gas and China. Total exposure to commodities, excluding the oil & gas sub-sector, is S$21b. The exposure to oil & gas, encompassing producers, traders, processors and others, is S$22b. These figures include off-balance items. The loan-to-value (LTV) ratio for loans extended to smaller companies in the offshore marine transportation, oilfield services and shipyard space is healthy at 60-65%. Total exposure to China was reduced from S$50b to S$43b, primarily due to the decline in trade loans.

Management has stress tested its exposure to the oil & gas sub-sector assuming oil price stays at WTI US$35/Brent US$40 per barrel for two years. About 5% of the accounts are deemed to be vulnerable and credit costs are anticipated to be about S$100m in this extreme scenario.
The increase in NPLs for South & Southeast Asia was due to a mid-cap company in India that was affected when the Supreme Court cancelled its coal license.

DBS has already achieved some early success in its Digital Transformation. It has digitised its bancassurance platform on an end-to-end basis, which has helped increase its market share from 20% to 30%. It has provided payment solutions for both cross-border and domestic transactions. It has also provided a range of treasury products, especially foreign exchange services, online.

It is a “virtual” bank that interfaces with customers through smartphones. The commercial launch will be carried out over the next few months. DBS aims to reach out to a broader base of consumers. Management also intends to service SME customers through this initiative. The Digital Bank will be scaled up in 2016.

When the going gets tough, the tough get going. DBS was able to meet expectations and asset quality remained resilient despite the tough operating environment. We forecast earnings growth to slow down to 3% in 2016 due to slower loan growth and higher credit costs. We expect DBS to resume its usual pace of earnings growth at 10.5% in 2017.

We have kept our net profit forecast for 2015 relatively unchanged.
We have cut our net profit forecasts by 3.2% for 2016 due to:
1. We estimated loan growth at 5.9% for 2016 (previous: 8.1%).
2. We expect absolute NPLs to increase by another 39.2% and NPL ratio to peak at 1.1% in 2Q16.
We expect credit costs to be 26.5bp for 2016, relatively unchanged as the increase in specific provisions was offset by lower general provisions.

Our target price of S$22.34 is based on 1.44x P/B, which is derived from the Gordon Growth Model (ROE: 11.0%, COE: 7.8% and Growth: 0.5%).

DBS focuses on its nine strategic priorities to grow organically. Growth drivers include regional businesses such as global transaction service, wealth management and SMEs.
Growth from overseas markets, such as China, Hong Kong, India, Indonesia and Taiwan.

Jonathan Koh CFA UOB Kay Hian | http://research.uobkayhian.com/ 2015-11-03

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 22.34 Down 23.75