DBS Q121 Result Analysis – What to do with your shares?

DBS was the first bank to release its results 2 weeks ago and it reported a blowout result where its quarterly net profit crossed $2 billion for the first time despite revenue declining 4% YoY. Many investors wonder whether there is still room for capital appreciation as its shares are up 17% YTD. In this article, we will cover DBS‘ financial result released on 30 April 2021 and look into the outlook given by the company and the growth prospect of the bank. This article will guide you in deciding whether to hold, sell or initiate a new position in DBS.

DBS Q121 Result

Net Interest Income of $2.1 billion was 15% lower compared to a year ago as there was a decline of 37 bp in Net Interest Margin due to global interest rate cuts. This was partially offset by loan growth of 7% and Net Interest Income would have grown 9% if NIM were stable. 

Net Interest Income declined 15% from $2.482 billion to $2.107 billion in the latest quarter as the bank suffered a decline of 37bp to its Net Interest Margin from 1.86% to 1.49%. The decline in Net Interest Income was partially offset by loan growth of 7% in constant currency. On a quarter to quarter comparison, Net Interest Income was flat as NIM stabilised at 1.49% as sequential loan growth grew 3% in constant currency. 

Despite the steepening yield curve in the US, DBS’ NIM is impacted by the short end of the yield curve, loans are priced off short-term rates (such as one month or three months of SOR/SIBOR/LIBOR). However, there are still some headwinds to the NIM as such rates are used to price loans. Take for example, although SIBOR rates have been holding up, HIBOR and LIBOR and creeping down. There will still be fixed loan repricing that will continue this year, this will put pressure on raising the Net Interest Margin guidance thus the bank continues to expect its NIM to be between 1.45% and 1.50%.  

Net Fee and Commission Income increased 15% compared to a year ago as fees from wealth management and transaction services reached a record though they were being offset by lower loan-related and card fees. Other income increased 12% as trading income doubled as Treasury Markets non-interest income and treasury customer income rose to new highs. Therefore, total income fell by 4% as growth in non-interest income resulting from strong business momentum was able to partially offset the decline in net interest income. 

Expenses were just 2% higher compared to a year ago due to the integration of LVB and this resulted in Profit before allowance to decline by 8% to $2.2 billion from $2.47 billion.

Asset quality stabilised and improved this quarter due to credit upgrades of customers, improvement in  economic outlook and loan repayments. This resulted in a general allowance write-back of $190 million, causing the general allowances reserves to decline by 4%. Specific allowances for the quarter was $200 million, in line with pre-pandemic levels. Total allowance provisioned inclusive of specific allowance provision was $10 million for the quarter. This resulted in Profit before tax and Net Profit to increase by 63% and 72% respectively, compared to a year ago. 

Asset Quality and Credit Outlook

Non Performing Assets at the end of the period fell about 2% from the previous quarter to $6.59 billion as new Non Performing Assets formation was about half of the quarters formed in 2020, this was due to the pick up in economic activities across sectors. Write off and recoveries were more than enough to offset formation thus resulting in Non Performing Loan rate to fall from 1.6% to 1.5%. Furthermore, despite the tapering of loan moratoriums, asset quality continued to be healthy as delinquencies for both corporate and consumer segments continued to be low. 

DBS had about $5 billion loans under moratoriums in its Singapore SME book last year. This figure was down to $1.1 billion at the end of last year and another $700 million of loan under moratorium ended in the first quarter of this year. As of now, DBS is not seeing any significant pick up in delinquencies though it is still too early to tell. The remaining $400 million of loan under moratorium will end in the second quarter of this year. Over in Hong Kong, DBS had about $6.6 billion under moratorium but this was down to about $3.2 billion at the end of the year. It is now down to just $2.8 billion. Majority of loans still under moratorium belong to large corporate customers who have higher credit quality. 

DBS believes that its asset quality outlook is encouraging and confident that the worst is over for loan moratoriums in Singapore. There are two reasons backing this opinion. Firstly, portfolio quality is improving with more upgrades than downgrades in the first quarter. Secondly, DBS had $5 billion housing loans under moratoriums in Singapore and majority of them are back to regular payments. Also, about $500 million are on extended moratorium where applicants have to make partial principal payments, delinquencies are negligible. On the other hand, as Hong Kong extended its loan moratoriums into 2022, DBS does not have clarity of delinquencies of the loan but it emphasised that it is unlikely to cause any material stress. Nonetheless, one potential upside for DBS is that delinquencies in all of its portfolios are not anywhere near the levels they expected, investors could expect more greater writebacks going forward.

General Allowance and Potential Writebacks

The General Allowance Reserves of $4.13 billion in the first quarter consists of two components – Model Driven and Management Overlay. Model driven, which reflects the economic conditions, constitutes the majority of DBS’ GP reserves. DBS has about $1-1.3 billion worth of Management Overlay, this is set aside by the management that covers potential credit costs, such as loan moratoriums, that cannot be captured or accounted for by the model. It takes into account multiple factors, such as unemployment rate and stress scenarios are considered when deciding the allocation into Management Overlay. The $190 million of general allowance write back in the first quarter came from the model driven due to stabilised and improved asset quality from credit upgrades of customers, improvement in economic outlook and loan repayments. 

Previously, DBS guided the total allowances for the financial year would be at $1 billion but as overall prospects are looking better compared to a quarter ago. DBS is now guiding total allowances to come well below $1 billion. 

There are three aspects in deriving this guidance. The first aspect is Specific Allowances where it only recorded $200 million in the first quarter, in line to pre-pandemic level. The second aspect is Portfolio Quality, as asset quality improved due to repayments and stronger company financials led by strong economic bounce back. DBS expects model driven GP write back to continue if the trend continues. The last aspect will be Management Overlay that covers potential credit costs that cannot be captured or accounted for by the model. 

So far, DBS has yet to reverse any general allowances from the management overlay as it is too premature to do so. The question will be how much overlay can be written back if moratoriums continue to taper throughout the year and if asset quality continues to improve. The pace of write-backs in general will depend on economic conditions, which is also capped by how much DBS can write back, which is $1 billion.

DBS’ Growth Engines

DBS has been making multiple announcements since the start of the pandemic on how it could reposition the bank to emerge stronger from the crisis. DBS first announced in September that it has received approval from the Chinese regulators to establish a securities company in China. Subsequently it announced the amalgamation of Lakshmi Vilas Bank with DBS Bank India in November. In December, DBS announced that it launched a full service digital exchange – providing tokenisation, trading and custody ecosystem for digital assets. Just last month, it announced both a 13% stake in Shenzhen Rural Commercial Bank and also a platform to transform interbank value movements, leveraging blockchain technology. 

In the next few sections, we will discuss how these growth opportunities will reposition DBS as a stronger bank post pandemic.

China Joint Venture Securities Company

DBS announced in September that it has received approval from the Chinese regulators to establish a securities company. The joint venture will engage in brokerage, securities investment consulting, securities underwriting, sponsorship and proprietary trading. The securities company where DBS has a controlling stake of 51% is a joint venture between different SOEs controlled by Shanghai State-owned Assets Supervision and Administration Commission and Shanghai Huangpu District.

DBS believes the timing to set up the China Securities company is on point as business volumes will grow rapidly as China’s capital market starts to liberalise with the establishment of both Stock Connect and Bond Connect, in addition to trade internationalisation. With the establishment of this China Securities company, DBS would be able to bring to market both cross-border and onshore deals. DBS is of the opinion that liberalisation will have a big impact over the decade as China’s capital market is tiny as a proportion of its GDP, and its weight in global economic affairs is relatively small despite the size of its economy. Therefore, with this joint venture, DBS is well positioned to gain advantage of the potential and this will be a significant growth driver moving forward.

LVB

LVB is a 94 year history bank in India that has a well established retail and SME customer and has a strong presence and dominant presence in South India. About 90% of its bank branches are situated in South India in states such as Hyderabad, Bangalore and Chennai where these states have higher GDP per capita compared to the rest of India. These states are better managed and have a high amount of large corporate activities.

The amalgamation between LVB and DBS India allows DBS to scale its customer base and network, particularly in South India. DBS now has an expanded network of 600 branches and 1000 ATMs, with an improved customer footprint where it added two million retail and 125k non-retail customers. Before the amalgamation, DBS India was primarily wholesale funded with a retail deposit base at only 23%. Post amalgamation resulted in an increase of retail deposits to 48% and the remaining from corporate and others. This gives DBS India a substantial sticky retail deposit base that is important for future growth in domestic India business. 

Furthermore, the amalgamation also exposes DBS India into business that it does not have which includes loans against properties and gold loans which is interesting and lucrative. DBS is confident that the amalgamation will enhance the growth of DBS India and is optimistic that LVB will be profitable within 1 to 2 years with accretive to ROE within 2 to 3 years.

Digital Exchange

Launched in December, DBS Digital Exchange is a members-only exchange for institutional and accredited investors to tap into a fully integrated tokenisation, trading and custody ecosystem for digital assets. DBS Digital Exchange utilises blockchain technology to provide an ecosystem for fundraising through asset tokenisation and secondary trading of digital assets including cryptocurrencies. DBS Digital Exchange offers the following services such as Security Token Offerings, Digital Currency Exchange and Digital Custody Services. As part of its Security Token Offerings, it issues and allows trading of digital tokens backed by financial assets such as shares in unlisted companies, bonds and private equity funds. Besides, it also offers Cryptocurrency trading such as Bitcoin, Bitcoin Cash, Ether and XRP and offers exchange services between fiat currencies such as SGD, USD, HKD and JPY. On top of that, Digital Exchange offers an institution-grade digital custody solution to meet the increasing demand for secure custodial services tailored for digital assets. 

Digital Exchange had a great start in the first quarter with about $80 million of assets under custody from 120 clients. Trading volumes have gone up ten times to $30 million to $40 million and it has plans to expand operating hours to 24/7. Besides, it is also offering its first security token offering, a way to improve liquidity of illiquid assets in the second quarter. Demand for Digital Exchange has been strong with hundreds more clients interested to come on board. Furthermore, other exchanges are interested in DBS’ digital custody services in which it can monetise the service. Therefore, DBS is confident that Digital Exchange business will gain greater traction from the second half of the year with meaningful contribution starting from 2022.

Stake in Shenzhen Rural Commercial Bank 

DBS recently announced a 13% stake in Shenzhen Rural Commercial Bank, making it the largest shareholder of SZRCB. SZRCB was established in 2005, it is a privately owned commercial bank that operates one of the largest bank branch network in Shenzhen and the bank has been performing very well financially. Its net profit had a CAGR of 11% over the past five years, with a high ROE of about 17-18%. Besides, its NPL ratio is healthy and is also well capitalised.  

The rationale in investing in Shenzhen Rural Commercial Bank is that it helps increase its exposure to China,  accelerates DBS’ strategy of investing in its core markets and accelerates its expansion in the Greater Bay Area via Shenzhen.  The investment creates a mutually beneficial collaboration between SZRCB and DBS as it is a highly complementary strategic partnership where DBS can leverage on SZRCB’s local network to deepen and double down its GBA strategy while SZRCB can benefit from the digital transformation through DBS’ digital capabilities, allowing both banks to build and strengthen their own franchise. Furthermore, the investment generates attractive financial returns as it adds around $100 million to DBS’ bottom line immediately upon completion of acquisition.  

Partior

DBS recently announced a partnership with JP Morgan and Temasek to develop an open industry platform to accelerate value movements for payments, trade and foreign exchange settlement in a new digital era. The current cross-border payments and settlements model uses a hub-and-spoke process where a transaction is routed through the sender’s correspondent bank, then through the receiver’s correspondent bank, before going to the beneficiary. The problem in this model is that cross-border settlement can take up to two days as there will be multiple validations on payment details done by banks, thus creating massive inefficiencies and also costly and onerous post transaction activities. Patior looks to disrupt the traditional cross border payment model by creating a platform, leveraging blockchain technology, to change the way cross-border payments and settlements work more efficiently, where cross border payments can be executed in seconds. 

The blockchain allows money to be converted into digitised form that has been cleared, which can be sent across for settlement as quickly as a written message. Not only does this platform remove the latency of the process, it also allows users to program to include conditions before payments can be executed, making the platform very powerful. Furthermore, anyone on the platform can settle securities, FX and actual payments in real time without the need to have prior arrangements with counterparties, making the platform a game changer and making it a much better platform than current infrastructure such as Swift. 

Patior also has plans to develop wholesale payments rails based on digitised commercial bank money to enable instantaneous settlements of payments for various types of financial transactions, thus benefiting banks from the current standard sequential method of processing global payments. DBS also plans to monetise the platform by licensing the technology to third parties or to provide the platform as a software as a service to build revenue streams.

Dividends

DBS declared dividends of 18 cents for the quarter and will be the final quarter it will be doing so. MAS has yet to inform banks on whether there will be restriction of dividends going forward. DBS states that there is every likelihood that dividends will return to pre-covid level immediately if MAS removes all restrictions on dividend payment. However, if MAS only allows banks in Singapore to gradually raise its dividends back to pre-covid levels, banks have to follow those guidelines strictly. Nonetheless, DBS stressed that it has the capacity to pay more dividends than what it is paying for now. 

Outlook

In his presentation slides, DBS CEO shared that the latest economic data confirm that the global economic rebound has strengthened and this led to upgrades in consensus forecasts. Business momentum expected to remain strong for this year with upgrading of loan growth to mid-to-high single digits from mid-single digits. The upgrade in loan growth was mainly due to the momentum captured in the first quarter and the loan pipeline where corporate lending and trade pipelines are robust. However, mortgages loans could slow in the second half of the year as customers brought forward their housing purchases in the first half of the year. Full-year fee income growth is expected to grow at double digits after seeing strong performance in the first quarter. Furthermore, strong business momentum is also contributed by actions made to improve structures of certain fee activities and in Treasury Markets. 

In its earnings call, DBS shared the actions taken to improve the structures of certain fee activities and treasury markets. As Wealth Management fees can be volatile as it depends on market performance, DBS has been extending wealth management offerings to retail customers and retail customers now comprise 15-20% of Wealth Management income. Furthermore, DBS has been offering more annuity products to customers, which gives better resiliency to wealth management income. 

As for Treasury Markets income, DBS has been structurally improving its business by leveraging on digitalisation and technology. Firstly, DBS has been increasingly using digital channels to distribute its treasury products to its customers and it has helped volume growth. Secondly, DBS effectively uses its data collected from customers to perform data analytics and data mining for better targeting of its product offerings to its customers. Lastly, DBS has been using automated algorithms more frequently to manage its trading positions. These structural improvement actions have resulted in increasing its guidance by 11% from $225 million a quarter to $250 million a quarter.

Closing Thoughts

I will be using P/B ratio for valuation to answer my question of what to do with your own shares. DBS has returned close to 50% since the end of October last year. 

If one were to look at the P/B ratio compiled by CGS CIMB Research, you would be able to tell that DBS P/B has already breached the +1 Standard Deviation of 1.4x and onwards to its +2 Standard Deviation of 1.6x. The max P/B ratio ever recorded was 1.63x in 2018, the target price we should be looking at is $33.34, based on the current NAV of $20.46. This leaves us to an upside of about 13%. 

I do not think that DBS will be hitting $33 in the foreseeable future as recovery in economies and asset quality has already been baked into the share price rally since last year. I feel that the upside to share price will be the potential surprise to its delinquencies in loans under extended moratorium or in Hong Kong or the MAS announcement on dividends. Even if that is so, I think that the target P/B ratio that I am looking at is within the range of 1.5x to 1.55x. This gives us a target price of $30.69 to $31.71, or an upside of 4% to 7%. 

For existing shareholders, it is not wrong to partially sell your DBS to lock in profits as you might want to hold the remaining to see if DBS can emerge stronger after pandemic as its new businesses are promising especially the Digital Exchange and Partior. For new shareholders looking to buy DBS, I think you can get better returns elsewhere especially in US growth stocks where it got beaten down recently again. You may refer to this article where I reveal my Portfolio as a 21 year old teenager. 

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