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Morningstar | DBS Group Delivers Strong Fiscal 2018 Results Despite Softer Fourth Quarter. See Updated Analyst Note from 18 Feb 2019

Despite rising uncertainty and slower growth at the end of last year, DBS Group posted an in line fourth quarter result. Higher interest income was offset by weaker net fee and commission income, which was impacted by softer investor sentiments. This resulted in lower brokerage income and sales of equity- and funds-related products for the wealth management division. The difficult conditions in the capital markets also resulted in lower trading income and investment banking income. While the softening global growth and uncertainty in capital markets were reflected in weaker top-line growth in the fourth quarter, our positive thesis on the bank’s position to benefit from region growth is unchanged. This is supported by the bank’s investments in technology and strong execution. In our view, the latter is reflected in the transformation of Hong Kong business, which led to the strengthening of its deposit franchise in Hong Kong. The Hong Kong business was again the highlight with net profit rising 40% to SGD 1.4 billion.

Our fair value estimate of SGD 27 is unchanged and represents a fair price/book of 1.4 times. We expect the bank to generate a return on equity of close to 12% with a fiscal 2019 forecast dividend yield of 5.2%. Its capital position remains strong with a common equity Tier 1 ratio at 13.9%. Bank stocks in general have underperformed relative to the market in the second half of last year on concerns over slowing global growth. We believe the risk is partially priced into the current share price, though we require a larger margin of safety and as such, our 3-star rating is unchanged. A settlement between the U.S. and China on trade is a near-term catalyst for the bank’s share price to converge toward our fair value estimate. More importantly for long-term investors, the bank’s competitive advantage in funding costs is unchanged. This is supported by strong Singapore dollar deposit market share and reflected in our narrow economic moat rating.

Management’s fiscal 2019 guidance remains positive with mid-single-digit loan growth expected, and net interest margin, or NIM, continues to improve as the loan book is progressively repriced. Loan growth will continue to be supported by non-trade corporate loans across a number of sectors and demand from Chinese businesses expanding offshore. The bank noted a shift in supply chain out of China as a result of trade uncertainty has been slow, rather its clients are adjusting production capacity. Fiscal stimulus and infrastructure investments are also anticipated to support loan growth. Our loan growth assumption of 6% over the medium term is unchanged.

With loan growth remaining resilient and margins expected to improve, we expect net interest income growth to remain resilient. NIM improvement of 4 to 5 basis points is expected from the repricing of its loan book and further improvements if the U.S. Fed decides to increase rates this year. Our house view assumes no interest rate increase in 2019 and one interest rate increase in 2020. As highlighted in our last note, interbank rates in Singapore rose in 2018 and have sustained at that level this year to date. This should translate into greater margin improvement for the Singapore loan book. However, interbank rates in Hong Kong declined around 30 basis points to 70 basis points in early 2019 from highs in July 2018. We continue to expect net interest margin in Hong Kong to be higher as interbank rates still above the level in first half 2018. Our medium-term forecast assumes net interest margin increases in fiscal 2019 and 2020, though we conservatively factor in flat net interest margin thereafter.

Another key area of focus for the banks in 2018 was the low level of credit cost and benign level of non-performing loans. Credit conditions remain favourable with interest rates at a low level and new non-performing assets were in line with previous quarters. With a higher level of upgrades and recovery, non-performing assets were lower on an absolute level at SGD 5.68 billion in the fourth quarter. Non-performing loans were steady at 1.5% of total loans. As such, overall credit costs tracked in line with previous quarters. Our forecasts assume credit costs to increase slightly over the medium term as global growth moderates.