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Morningstar | DBS Group's 2Q Result Weaker on Lower Trading Income; Underlying Business Performing Well. See Updated Analyst Note from 02 Aug 2018

Unlike the first quarter, narrow-moat DBS Group’s second-quarter result was not firing on all cylinders, but the underlying business continues to perform well. The slightly weaker result was mainly due to lower net trading income and other noninterest income. The two income lines tend to be volatile, with trading income weighed by weaker fixed-income trading from higher credit spreads and flattening yield curves. The result does not alter our long-term view on the bank, as more important income lines in net interest income, fees and commission, and wealth management are performing in line with our expectations. Expenses are tracking in line with our full-year forecast, while credit cost benefited from a write-back of an oil and gas exposure. The first-half dividend of SGD 0.60 was also within our expectation. Our forecasts are adjusted slightly lower on the weaker net trading income, while our net interest income forecast is largely unchanged, with the higher net interest margin offsetting the slower loan growth. We reaffirm our fair value estimate of SGD 27, and we still see the bank as fairly valued.

While quarterly loan growth of 2% on constant-currency terms was on pace with last quarter, loan growth may slow as a result of the tightening measures on residential real estate in Singapore, as cited in our note last month. Along with rising trade tension between China and the U.S., management lowered guidance for loan growth to a range of 6%-7% from 8%. Positively, net interest margin is expected to be 1-2 basis points higher than previous guidance of 1.85%.

Asset yields maintained their upward trajectory, rising 16 basis points to 2.8% and outpacing the funding cost increase. As such, net interest margin edged 2 basis points higher to 1.85%. This is in line with our earlier thinking that the sustained improvement in U.S. economic conditions will allow the Federal Reserve to continue lifting interest rates over the next two years, resulting in higher interbank rates in Singapore and Hong Kong. DBS Group remains a larger beneficiary relative to its peers, given its sizable Singapore-dollar-denominated deposit base.

Strong performance for wealth management and Hong Kong operation was sustained in the second quarter. Assets under management increased 3.8% in the quarter to SGD 216 billion. We still see wealth management as a key growth driver for fees. While part of the income is dependent on capital market conditions, the overall revenue stream is recurring and benefits from moat traits in switching cost. In Hong Kong, net interest margin continues to improve, underpinned by rising interbank rates and a better deposit franchise. Loan growth also accelerated in the second quarter.

DBS Group's credit quality and capital position remain strong. While new nonperforming assets amounted to SGD 358 million compared with SGD 195 million last quarter, the increase was much lower than in the past two years, as the bank’s oil and gas exposure has been written down. Combined with a write-back of an oil and gas exposure, overall nonperforming loans/total loans of 1.6% was steady on the last quarter. The pro forma common equity Tier 1 ratio declined 40 basis points to 13.6% after the payment of a special dividend and a higher final dividend payment. A decline in risk weighted assets also softened the decline in the capital ratio. Management noted that optimization of its risk weight calculation could see risk-weighted assets further decline in risk weight intensity. Excess capital will likely be retained, despite the common equity Tier 1 ratio tracking above management's target of 12.5%-13.5%.