SCBFY - DBS Group Continues To Excel But Growth Will Slow

Summary

• DBS Group's fourth quarter results came in a little soft, with weaker spread income and fee-based income, as loan growth decelerated and deposit costs rose.
• Credit quality remains fine and management is looking for mid-single-digit loan growth in FY'23, but with a lower peak NIM due to deposit cost pressure.
• DBS Group continues to execute well through all phases of the cycle, and the shares are still priced to offer a worthwhile long-term return.

Singapore’s DBS Group ( DBSDF ) ( DBSDY ) continues to perform at an exceptional level, with another year of beat-and-raise performance in the books. I can quibble with the bank’s capital return policies and I do see some risks to growth and credit in the near future, but the shares have performed solidly since my last update – rising about 13%, not only exceeding the performance of large U.S. banks (as a group), but also beating local rivals like OCBC ( OVCHF ) and United Overseas Bank ( UOVEY ), though Standard Chartered ( SCBFY ) did outperform them all over the last six months.

With the end of the rate cycle in sight, net interest margin will peak in 2023, and peak at a lower level than management expected, while credit costs will likely go up. China is a harder call now, as the removal of COVID-19 restrictions should boost the economy, but the property sector is still a mess. I could see DBS possibly getting active in M&A again, though there’s plenty the bank can do organically, and while I do expect below-trend core earnings growth in FY’23 and FY’24, the long-term trend remains healthy and I still see these shares as worth owning.

Closing Results For 2022 Were More Mixed

After a strong third quarter, DBS Group’s fourth quarter results were a somewhat disappointing close to the year. The misses at key lines weren’t large, and could be attributed in part to analysts getting ahead of themselves, but it’s still not the best note on which to close.

Revenue rose 41% year over year and 2% quarter over quarter in the fourth quarter, missing by 2%. Net interest income rose 53% yoy and 9% qoq, but missed by 2%, with net interest margin rising 62bp yoy and 15bp qoq to 2.05%. Core commercial book NIM rose 31bp qoq to 2.61%.

Non-interest income was a strong contributor in the third quarter, but cut the other way this quarter, growing 18% yoy but declining 11% qoq and missing by 2%. While card fees were strong (up 20% qoq), wealth management was weaker (down 21%), as was treasury (down 24%).

Operating expenses rose 17% yoy and 8% qoq, missing by 3%, though that miss can be largely attributed to costs tied to the acquisition of Citigroup ’s ( C ) Taiwan operations. Excluding those costs, the company would have slightly outperformed on costs.

Pre-provision profits rose 68% yoy and 5% qoq, but missed by 5%. Here again, adding back those unusual costs would have driven a small beat. Net attributable profit did beat by 3%, but that was driven by provisioning.

A Familiar Story As The Cycle Slows

Readers who’ve seen my other commentaries on U.S. banks will recognize a lot of familiar themes in the underlying balance sheet performance at DBS Group – weakening loan growth, rising deposit costs, and a less favorable outlook for spreads and growth in 2023 and beyond.

Loans rose 4% yoy and were down slightly sequentially in constant currency, as activity continues to slow. An uptick in housing loans (up 2.3% in the second half) was welcome, but wealth management loans were down and commercial lending (down 11%) and manufacturing (down 10%) were both soft, and suggest to me more meaningful underlying weakness in the global macro in the face of rising rates and slowing demand.

Deposits did rise 2% qoq in constant currency, but deposit cost rose 81bp yoy and 74 bp qoq to 1.04% in the second half. Like practically every bank, DBS Group is seeing low-cost deposits leave in pursuit of better rates elsewhere (like U.S. Treasuries). With a higher than expected deposit beta (a common theme among banks, and something I predicted throughout 2022), DBS Group management has trimmed back its expectations for peak NIM in 2023 from 2.25% to 2.18% to 2.20%.

Credit remains surprisingly good, though it seems like the sell-side is always (or at least often) overstating DBS Group’s credit risk and giving management too little credit for its risk management. The non-performing loan ratio improved 10bp sequentially (to 1.1%), and new formation was low, with stage 3 expected credit losses down 15% half-over-half and stage 1 and 2 ECL flat.

Coverage levels remain high and DBS Group’s exposure to Chinese commercial real estate is under 4% of the total loan book. Of that amount, more than half is to state-owned enterprises. I do expect credit costs to rise from here, but I don’t see anything in the reported financials suggesting meaningful issues and the bank looks well-reserved.

The Outlook

DBS Group ended the year overcapitalized with a CET1 ratio of 14.6%. Even allowing for the impact of the dividend hike, the special dividend, and the acquisition of Citi’s Taiwan assets, the adjusted CET1 is still about 13.2%, which is more capital than the bank needs.

I understand conservatism, but I also wonder if management may be looking to keep its options open. If management thought bigger credit issues were on the way, they’d sock more into reserves, so I wonder if they’re considering the possibility of M&A as a use for some of that surplus capital. I’ve criticized the bank in the past for being too stingy about paying up for growth opportunities in other Asian countries (Indonesia, Thailand, et al), but valuations are a lot more attractive now. I don’t expect a deal, but it wouldn’t shock me. Should one not materialize, and the macro situation doesn’t pan out much worse than expected, a larger special dividend could be on the table next year.

Given DBS Group’s rate sensitivity and the strength of the rate hike cycle, DBS Group outperformed my initial 2022 expectations by around 7%, and my estimates for 2023 and 2024 are about 10% to 15% higher as the company coasts on those tailwinds. I do expect more sluggish growth from 2023-2025 as the cycle reverses, but I’m still looking for long-term core earnings growth of over 6%.

Between discounted core earnings, ROTE-driven P/TBV, and P/E, I believe DBS Group shares are about 10% to 20% undervalued today.

The Bottom Line

DBS Group has enjoyed a great run from its pandemic lows, basically doubling since April of 2020. I can understand if investors want to hold back in the hope of a pullback before buying, as 10%-20% pullbacks aren’t that rare, but I continue to believe this is a very well-run bank with good growth and good quality and a name that can be considered as a core holding.

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