DBS Group: share price reflects few potential risks

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DBS Logo (DBS)

Investment thesis

Three months ago, I upgraded DBS Group (OTCPK:DBSDY) (OTCPK:DBSDF), Southeast Asia’s largest bank, from hold to buy pending higher net interest interest rate income is beginning to be felt.

The bank has just published its results for the first half and the second quarter of 2022, and we will dissect their results as well as its commercial development.

2022 half-year financial results

Net profit for the second quarter was SGD 1.8 billion, which was similar to the net profit for the first quarter. The difference was only SGD 14 million.

One geographic area that saw a drop in net profit is their bank in Hong Kong. It went from 617 million SGD in the FH last year to 593 million SGD this year.

The group’s EPS in the first half of 2022 was SGD 2.80, only eight cents lower than the previous year.

Their return on equity went from 13.1% in Q1 to 13.4% in Q2.

The dividend was maintained at SGD 0.36 per share for the quarter, which, based on the current share price, gives investors a yield of 4.5%.

Acceptable performance but not great.

In 2020, fixed-income securities, such as Singapore 10-year Treasury bills, were offering less than 1%, and you would get a 3.5% equity risk premium. However, now that the 10-year bond yield has risen to 3.5%, you get an ERP of just 1%.

As expected, the NIM trend started to rise. It improved considerably from 1.46% to 1.58% QoQ. The bank’s management expects it to continue to rise and should end this year around 2%.

NIM trend is up

NIM trend is up (DBS FH 2022 CFO presentation)

Net interest income increased from SGD 2.19 billion in the first quarter to SGD 2.45 billion in the second quarter thanks to the growth in loans and deposits and the rise in the NIM.

The Group’s results were negatively affected by a 14% drop in commission income in Q2. It ended at SGD 768 million. This was primarily due to the 17% decline in wealth management fees as equity market conditions kept client activity at low levels. However, Wealth Management’s assets under management have actually increased by an additional SGD 10 billion, so it can reasonably be expected that at some point their clients will increase their trading activities at a time when confidence begins to improve.

The decline was somewhat offset by higher credit card fee income, which rose 9% as travel by Singaporeans began to pick up.

  • Estimation of credit losses and non-performing loans

The asset quality of the bank’s loan portfolio is stable, with the NPL ratio standing at 1.3% over the past six months.

When we look at ECL, we want to focus on stage 3, which is the credit that has been outstanding the longest and has the highest risk of losses. In the first half of 2022, it was SGD 235 million, compared to SGD 135 million in the second half of 2021.

This amount should be viewed in the context of the bank holding total allowance reserves of SGD$6.69 billion.

Their mortgage portfolio in Singapore is substantial. It amounts to 196 billion SGD.

With a rising interest rate, this will have a gradual impact on borrowers once loans are re-evaluated, and immediately for new loans that are created. The bank ran different stress test models to gauge what would happen if interest rates on these mortgages hit 6-7%. Based on the current revenue streams from the lender and the loan to property value, the bank is comfortable with what it sees.

They will become more worried if we see a spike in unemployment.

Singapore’s latest figure on the official seasonally adjusted resident unemployment rate fell to 3.0%, the lowest rate since late 2018. Total employment is still 2.5% below the level of before the pandemic – mainly because Singapore has lost 15% of its non-resident workforce since December 2019.

The bank’s cost/income ratio increased steadily. That’s to be expected in part because inflation has driven salaries up and the acquisitions they’ve made in the last twelve months are also forcing the bank to spend on integrating that.

Higher costs

Higher costs (presentation DBS CFO FH 2022)

However, I would also expect the bank to cut costs like its rival HSBC (HSBC) is doing with improved efficiency through technology and a smaller real estate footprint.

Business development

On HSBC, in a recent Bloomberg opinion piece, the author suggested that in the event that HSBC were to turn its Asia business into a separately listed unit, DBS could effectively challenge its position.

I think the likelihood of HSBC being split up is very low. Few truly global banks remain, and many multinational organizations benefit from HSBC’s significant presence and size.

The author also said that this was partly because DBS had the advantage of a strong Singaporean market. In particular, the real estate market. Hong Kong, on the other hand, he argued, is experiencing much weaker sentiment.

This fear of DBS and HSBC’s exposure to real estate in China is, in my view, overblown. Both lenders are very conservative in who they lend to. DBS CEO Piyush Gupta told analysts that their exposure to commercial real estate in China is S$16 billion, the bulk of which is in state-owned companies such as CapitaLand (OTCPK:CLILF) and their subsidiaries. These companies have good balance sheets and a long WALE.

Hong Kong’s property market may be weaker, but last week major property developers such as Sun Hung Kai (OTCPK:SUHJY) and Henderson Land (OTCPK:HLDCY) offered new developments for sale, and the most units were taken. one day, there must therefore be willing buyers.

At the end of January this year, DBS agreed with Citigroup (C) to buy their consumer banking operation in Taiwan. The integration is ongoing and the deal is expected to close and begin to take effect from the third quarter of 2023. The bank communicated during the Q&A session of its latest analyst presentation that it expects that it adds another SGD 800 million to turnover and about SGD 250. million to the group’s net income.

If their estimates are right, it gives the bank a very good return on investment. The purchase price was SGD 956 million plus net assets held in bank. Added to that is their onboarding cost, but that should easily give them a ROTE above their average of 13.4%

Conclusion

The bank is certainly on track to potentially beat last year’s annual profit, as I bet in my article three months ago.

The stock price is currently at SGD 32.70, which means the market is pricing in the additional income that will come from the positive trend in the NIM.

Despite this, even their CEO sees potential for dark clouds and the outcome of geopolitical events and it is debatable whether inflation can be brought down as quickly as the central bank would like. When people wonder if we’re heading into a recession, we’re usually already inside of it.

Asia should do well for now. And Singapore in particular is technically not in recession with its GDP growing around 4% in the last quarter, but the island nation is also very dependent on the economy of its major trading partners like China, the United States. United and Europe.

The net asset value per share of DBS Group is SGD 20.78 and has been declining over the past two quarters. If we look at the stock price of SGD 32.70, the P/NAV is not cheap at 1.57.

I don’t know if the stock price reflects this potential risk.

Therefore, while I don’t like to change positions too often, I see the need to switch from a long to a hold given the uncertainties.

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