No bank is getting through this cycle unscathed, and DBS Group (OTCPK:DBSDY) is no exception. Not only is DBS seeing significant spread compression from weakening loan yields, loan demand has moderated some. On the positive side, the company’s investments and efforts into building a stronger fee-generating business base are paying off, digitalization is helping reduce costs and maintain better business activity relative to less-digitalized peers, and the credit evolution has so far been pretty good.
These shares are down about 20% since my last update on this Singaporean money-center bank. That’s not the performance I expected in a pre-COVID-19 scenario, but it as at least better than the average American bank’s performance over that period, not to mention better than pretty much all of its peers, including United Overseas (OTCPK:UOVEY), Standard Chartered (OTCPK:SCBFY), Bank Rakyat (OTCPK:BKRKY), and Bangkok Bank (OTCPK:BKKLY), while it has basically been even with OCBC (OTCPK:OVCHY).
I continue to believe that DBS Group is a solid long-term holding to consider, as the bank has significantly improved itself over the last decade-plus. In addition to leveraging global trade growth, DBS is well-placed to benefit from the growth of retail banking in Southeast Asia, with a predominantly digital focus that keeps costs low and tends to attract younger, wealthier customers. With solid prospects for mid-single-digit core growth after the post-COVID-19 recovery, I believe DBS Group is undervalued below the $70’s.
Banking Is Banking … And Core Banking Is Under Stress
While DBS Group obviously has a different business mix than an American bank like Bank of America (BAC) or a European bank like ING (ING), the basic trends in spread lending are pretty universal these days. DBS saw weaker-than-expected net interest margin this quarter, but compensated for that with a bigger balance sheet, a little better performance in fees, and better costs, though higher provisioning ate away at the modest (4%) pre-provision profit outperformance.
Revenue was flat from the year-ago period and down 7% sequentially, with net interest income down 5% yoy and 7% qoq on a 29bp yoy / 24bp qoq decline in net interest margin driven by lower loan yields. Non-interest income was up 11% yoy and down 8% qoq, coming in a little better than expected.
While DBS has reduced some costs in the face of COVID-19, the bank is also starting to see some benefits from past investments in digital channels. Opex declined 4% yoy and 5% qoq this quarter, helping drive a better-than-expected pre-provision profit (down 4% yoy, up 9% qoq). Provision expense rose 232% yoy and declined 22% qoq, while net attributable profit fell 22% yoy and rose 7% qoq (in-line with expectations).
Mixed Balance Sheet Trends, Underlined By Healthy Credit And Capital
Loan growth has flagged some, with constant-currency net loans up 5% yoy and 2% qoq. Demand for loans in Chinese yuan remains quite strong, with loan balances up 24% yoy, and U.S. dollar loans also remain popular (not uncommon in times of greater stress/uncertainty), with 7% yoy growth. Loans denominated in Singapore and Hong Kong dollars grew less than average, up 3% and 4%, respectively.
Deposit growth flattened on a sequential basis, but was still up 14% on a year-over-year basis. Like most banks, DBS has seen a surge in deposits that it has struggled to effectively put to good use, and that’s part of what’s weighing on spreads.
Credit remains a major worry, but DBS management is really building up its credibility here. The non-performing loan ratio was stable this quarter at 1.51%, falling slightly from the year-ago period and the prior quarter. Consumer lending is looking particularly solid, with an NPL ratio of just 0.6%, while the institutional business is at 1.9%. The bank’s Singaporean loan book continues to have a higher NPL ratio (2.2%), due to the difference in the loan book (more “typical” bank loans versus the lower-risk trade finance loans that make up a lot of the non-Singaporean book), but it has been pretty stable.
Although some analysts and investors feared a surge in bad debts, and the COVID-19 cycle isn’t over yet, I think some of these folks haven’t really updated their views on how DBS manages its risk. The Asian Financial Crisis of 1997 did hit DBS hard, with double-digit NPLs in 1998 and 1999, but NPLs have steadily declined since then – the Global Financial Crisis roughly a decade later saw NPLs move from around 1.5% to just 2.9%, and quickly back down below 1.5%. To that end, when this crisis started I saw some analysts recommend selling DBS in favor of United Overseas because of the latter’s greater focus on “safer” Singapore, but while DBS has about 5% of its loans under moratorium, UOB is at 16% (and most of its regional peers are somewhere in the low-to-mid teens).
Things would have to get a lot worse for DBS to really struggle. Half of the loans under moratorium could go bad and it wouldn’t dent capital, and credit losses would have to rise to an almost unimaginable level before it would wipe out DBS’s above-regulatory-minimum capital buffer. I’d also note that DBS has more than 100% of its NPLs covered and the Monetary Authority of Singapore has required all Singaporean banks to limit dividends to 60% of 2019 levels to further preserve capital.
If there’s a downside to how DBS is weathering this crisis, it’s that there’s probably going to be a less dramatic rebound given that the declines haven’t been so severe. Core income is probably going to fall about 30% this year, which is steep, but I believe DBS will be back to 2019 levels of income in the second half of 2022 (on an annualized basis).
On the other hand, DBS could well emerge from this downturn in stronger shape than many peers, leaving it with a cleaner balance sheet and credit situation that lets it expand lending more quickly and gain share. Either way, I’m still bullish on the longer-term prospects for DBS in areas like wealth management (fee-generating) and gaining more digital banking business in markets like India, Indonesia, and eventually Vietnam. I also still believe a select acquisition or two could help the process along, but DBS has been very cost-conscious on deals, suggesting a high (and disciplined) threshold for returns on any such M&A.
While my long-term core earnings forecast drops to around 4%, that’s because of the steep 2019-2020 decline. Start with 2020 earnings and the long-term growth rate is closer to 8% (not much different than my prior outlook), and I expect long-term growth around 5% after the post-COVID19 normalization.
The Bottom Line
Between discounted core earnings and ROTE-driven P/BV, I believe DBS Group is undervalued below $70, and I can see more upside beyond that when Asian economies emerge from COVID-19. As a very well-run bank trading at a meaningful discount to fair value, I think this name is worth serious consideration.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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