DBS Group Offers Ongoing Excellence And Ongoing Opportunities

seekingalpha07-15

DBS Group has performed well with above-market loan growth, solid underwriting quality, and good execution on fee-generating operations like wealth management.Singapore offers modest loan growth ...

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GMT+8&nbsp;&nbsp;&nbsp;<a href=https://seekingalpha.com/article/4704008-dbs-group-offers-ongoing-excellence-and-ongoing-opportunities><strong>seekingalpha</strong></a>\n\n\n</h4>\n\n</header>\n<article>\n<div>\n<p>DBS Group has performed well with above-market loan growth, solid underwriting quality, and good execution on fee-generating operations like wealth management.Singapore offers modest loan growth ...</p>\n\n<a href=\"https://seekingalpha.com/article/4704008-dbs-group-offers-ongoing-excellence-and-ongoing-opportunities\">Source 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quite complimentary regarding the management of Singapore’s DBS Group Holdings (OTCPK:DBSDY) (OTCPK:DBSDF) for many years now, and the performance over the last 18 months or so since my last update has continued to support those feelings. Between decent loan growth and yield management, solid underwriting, and good execution on fee-generating operations like wealth management, the business has continued to perform well relative to expectations. Performance since my last update has been mixed. While the local shares have been among the best-performing banks in its peer group – up almost 20% versus about 17% for HSBC (HSBC), 16% for Oversea-Chinese Banking (or OCB) (OTCPK:OVCHF), 7% for United Overseas Bank (or UOB) (OTCPK:UOVEY), and 3% for Standard Chartered (OTCPK:SCBFY) – the ADRs have appreciated more modestly (about 6%), though dividends do improve that total return. Better-than-expected loan growth was a welcome development in the first quarter, and I like management’s commentary regarding loan demand trends and credit. While sluggish demand and minimal late leverage remain risks, growth in wealth management is a positive and I like the bank’s prospects for mid-teens long-term ROE, mid-single-digit core earnings growth, and double-digit growth in capital returns. Executing Well In A Sluggish Market This isn’t really an environment in which large banks are going to see robust underlying growth, but DBS is managing this period of higher rates and softening macro conditions rather well. Loans grew more than expected in the first quarter, up about 2% year over year as reported and about 1% in constant currency. DBS outgrew a basically stagnant Singapore market with healthier growth in corporate lending, and management also saw some strength in India and Indonesia. Net interest margin also did a little better than expected, climbing 2bp qoq to 2.77% for the commercial book and 1bp to 2.14% for the whole bank. DBS has done a good job of containing deposit/funding costs, while also benefiting from loan and security repricings. Management has actively turned down unattractively priced business and has been working to increase the duration of its securities book to make the asset base a little less asset sensitive (a reasonable move when rates are expected to fall). All told, net interest income exceeded expectations by about 5% in the first quarter and management expects a little bit of net interest income growth this year on the assumption of two rate cuts (previously they expected five) and modest low single-digit loan growth. DBS has been doing particularly well in some of its fee-based businesses, and this has helped offset slower core lending profit growth. While the inclusion of Citigroup’s (C) Taiwan business has boosted year-over-year comparisons, wealth management grew 45% sequentially (the Citi Taiwan deal closed in August 2023), offset by a modest 3% decline in card fees that was better than the year-ago 7% qoq decline (I believe there is a seasonal effect here). All told, wealth management and card fees are about 15% of the revenue base now, and management is actively looking to continue growing both businesses. Operating expenses remain well-controlled, with the efficiency ratio back under 40%. DBS Group has had to up its spending on IT in response to service issues that led to sanctions from the Monetary Authority of Singapore (basically Singapore’s Federal Reserve), and I expect further spending to support growth in fee-based businesses, but I believe operating costs are still well in hand. Credit has remained surprisingly benign, Non-performing assets were up about 6% yoy and down 2% in the first quarter, and the NPL ratio has stayed basically flat for a while now. Credit trends in the South/Southeast Asia business have been improving, while China/Hong Kong has been deteriorating. DBS Groups’ loan exposure to Hong Kong commercial real estate is manageable (3% of total loans), and management has stress-tested the portfolio with an assumed 50% drop in property values. Re-Acceleration Will Take Some Time I don’t think DBS is looking at an environment that’s going to support a rapid return to strong earnings growth. While loan growth should pick up in 2025, both DBS and UOB management have noted more competition for higher-quality loans and loan growth will be offset by lower yields. The Singapore mortgage market could get a little stronger later this year and into 2025 with new launches and the government offering up more land for development, but housing prices and transaction volume are really just crawling along near flat now. Commercial lending could pick up a little more, though, as Singapore’s 2nd quarter GDP surprised to the good (up 2.9%), but a lot depends on whether economic stimulus efforts in China pan out and whether the U.S. can avoid a more significant slowdown in the second half. I’m looking for loans to grow around 2% this year, 4% in 2025 and over 5% in 2026, but I believe loan yields could fall as much as a point next year around 125bp from 2024 to 2026, and I don’t expect funding costs to fall by a corresponding amount, so NIM is likely to fall below 2% again by the end of 2025. Provisioning has likely peaked, but I do think that loan losses are still likely to tick up a little from here, and DBS will continue to spend on opex, likely driving flattish pre-provision profit performance. Strategic Options Still In Play DBS Group exited the last quarter with a CET1 ratio of 14.7% that gives management a lot of strategic options. Management meaningfully raised the dividend in FY’23 (about 28%) and will likely raise it by a similar amount this year, but that will still leave the bank with ample capital. Management has been pretty clear that they’re not interested in large M&A, and even smaller-scale M&A still has to hit pretty stringent return targets – I think this is part of the reason why the bank wasn’t more active in buying Citi’s other Asian units. Likewise, management is a firm believer in the asset-light model they’re using in markets like India and Indonesia – operating enough physical locations to support the business, but really focusing on digital banking as the growth driver. As digital banking customers tend to be more affluent, it’s an approach that makes sense – getting large deposit share in markets like India and Indonesia isn’t nearly as valuable as getting profitable deposit share. If DBS does get more active on M&A, I expect it is likely to be more on the wealth management, payments, or fintech side. There is a clear goal in place to grow the wealth management business, as well as low-value cross-border payments, and I could see a strategic deal boosting this process. Likewise on the fintech side, as fintech is likely to be an important part of maximizing the value in markets like India, Indonesia, and Vietnam over time. The Outlook Moving along with the top-line views I discussed a few paragraphs ago, I do expect the “higher for longer” rate environment to have a modestly negative impact on earnings in 2024 and 2025, and I’ve lowered my core earnings expectations slightly (2023 results were within 2% of my expectations). I’m looking for around 5% growth this year, a roughly 2% decline in 2025, and growth of around 4% to 5% in core earnings over the next five and 10 years. Discounting those earnings back, I believe the shares are about 10% undervalued today. I get a similar result with a P/E approach (7% undervalued using an 11x multiple on my FY’24 EPS estimate) and a ROTCE-driven P/TBV approach (about 15% undervalued assuming an ROTCE in the 15%’s for FY’25). The Bottom Line I don’t really have many concerns about DBS at this point; yes there is some risk in the China / Hong Kong loan book, particularly in HK real estate, but DBS typically sticks to very high-grade credits in these markets. I’m also a little concerned about the macro environment, but I think DBS can leverage advantageous customer relationships and funding costs to offset possible weakness in loan demand. The only real issue I have now is valuation. I definitely think it’s fine to own a good business trading at a reasonable price, but 10% or so upside may not be enough for some investors given the higher risk profile of this bank (even if that’s more in risk perception than risk reality). I still think this is a bank worth buying and owning, but a pullback would be a welcome opportunity.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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