DBS just released its Q1 2020 results and held its AGM online for the first time. Here is a summary of the outlook for DBS in 2020. Do check up the previous post on the guide to analysing banking stocks part 1 and part 2. There might be a lot of banking jargons here.
DBS’s CEO, Piyush Gupta, started off reiterating how DBS has recorded a Y-o-Y double-digit growth rate in 2019 for total income, operating profits and net profits. Earnings and ROE were consistently going up over the past decade. They also managed to hit the target ROE of 13% for FY 2019. In short, DBS’s financial performance has performed really well from 2009 to 2019.
DBS’s Q1 2020 Results
Fast forward to today, how has DBS’s Q1 results been?
Total income for the first quarter came in at $4 billion, 13% higher than the prior year. Profit before allowances was $2.47 billion, 20% higher than the previous year. Net profit was $1.16 billion, 29% lower compared to the prior year. The fall in net profit is due to an increase in allowance to $1.1 billion.
There was an increase in allowance because non-performing assets were up 14%. When you have non-performing assets, it means that payments are overdue for more than 90 days. And because of that, the bank has to make an allowance and estimate the bad debts.
This $1.1 billion allowance is further categorised into $703 million of general allowance and $383 million of specific allowance. Note that the specific allowance of $383 million is at stage 3 of the ECL. This means that it has been credit-impaired with objective evidence of default. It is likely to be write-off soon.
Their allowance coverage is at 92% or 173% after taking collateral into account. This allowance coverage is the ratio of provisions for bad debt against non-performing loans. So you can say it is pretty much covered.
What’s Coming Next for DBS?
DBS’s quarter 1 results are pretty okay because the economic impacts of Covid-19 were not felt only until March and April. So it is still business as usual for the month of January and Febauary in 2020. That’s the reason why revenue and operating profits are up.
But moving forward into the next three quarters in 2020, the results are likely going to be worse. Piyush mentioned that it is lucky that their Q1 results are strong. That is because Q1 results can offset the weak earnings for the subsequent months.
The biggest pressure point he brought up was not so much about the economic impacts of Covid-19, but it is interest rates. Fed has gone all out to cut rates down to 0% in March. Because LIBOR & SIBOR rates always lag behind the fed rates, Q1 results have not factored in the rate cuts.
NIM is likely to contract further in the coming months and DBS’s earnings would come under downward pressure very soon. The impact on interest rate cut is estimated to be about $500 million to $600 million.
The business volume for Q1 is decent. Businesses are still borrowing and there is a healthy pipeline of non-trade corporate loans from top-end customers.
However, trade-related loans are soft. This is because the global trade volume has practically come to a halt due to Covid-19. Fortunately, losses from lower trade loans volume are likely to be mitigated because trade margins are quite thin.
Housing and consumer loans like credit cards are expected to slow, but it won’t be drastically affected. So loan growth from these areas could potentially cover the shortfall from lower NIM.
Positives of DBS
The upside for DBS comes from non-interest income. Even though wealth management has started to slow in April, volumes are picking up from hedging activities and bond issuance programs.
In uncertain times, businesses are going to come out and hedge contract prices to mitigate volatility. This is positive for DBS as they earn fees from helping customers to engage in all these stuff.
Secondly, businesses need cashflow and money to stay afloat. They will come out to issue bonds or do rights issue. Again, DBS is there as an intermediary to facilitate all these stuff.
Thirdly, have you noticed everyone around you suddenly wants to open a brokerage account and start investing lately? The volume of business is so high that their server keeps crashing. DBS earns commission fees from trading volume whether you buy or sell.
Fourth, DBS themselves also invests like us. They hold a large pool of investment securities. When interest rates fall, the valuation of these assets rises as the discount rate becomes lower. They can sell and realise some of these profits to offset the fall in NIM also.
Lastly, there would be a flight to safety mindset as everyone deposits their cash into banks. For the first quarter in 2020, there is an additional $35 billions of deposits coming from companies and customers. The more deposits they have, the stronger their balance sheet would be.
All in all, the positives are likely to mitigate the losses from credit allowances, slower growth in loans and NIM compression. Expenses would also come down as they have cut discretionary non-staff costs and variable bonuses are aligned with earnings.
Since revenue is flat, expenses are also flat, Piyush expects FY 2020 earnings to be flat. But of course, all these are just management guidance and no one really knows the extent of the economic impact.
Credit Outlook for DBS
This pie chart represents DBS’s total loan composition.
In the consumer segment, most of it is housing and credit cards. Housing portfolio is held steady at $75 billion. The risks of defaulting on housing mortgages are very low in Singapore as MAS has a stringent policy on borrowing.
There is the Total Debt Servicing Ratio (TDSR), Loan-to-Value (LTV) ratio and Mortgage Servicing Ratio (MSR). All these stuff look at your income ability to pay off housing loans and they are really conservative.
Also, most of the borrowers are actually house owners rather than investors. So the risk here is very low.
Their credit card loans make up about $11 billion of the consumer segment. This is in comparison to the American banks where credit card loans form the bulk of their consumer loan portfolio. For DBS, it is just 3% of the total group loans. Borrowing limits have also been tightened with more stringent regulations since 2015.
All in all, losses from consumer loans are likely to be minimal based on the prudent measures set up by MAS.
DBS’s loan size to SME is about $39 billion, 10% of the total group loans. Almost 90% of these SME loans are from Singapore and Hong Kong. The good thing about these loans is they have collateral such as properties. So in the event of defaults, DBS still can sell the properties and cover back the losses. However, if the valuation of properties plunges 50%, it is going to be a 08 repeat again.
10% of SME loans are towards the impacted industries like hotels, retailers and F&B companies. For Hong Kong, their portfolio has already been through prolonged stress. Not sure if that meant the negatives are priced in. There was very little mention of Hong Kong.
Lastly, corporate loans are worth $221 billion. The management did some stress test and assumptions to identify how much of this $221 billion loans are at risk of defaulting.
Some of it includes airlines making 0% revenue for 12 months, oil prices staying at $15, occupancy rates falling by 50% and etc. The eight industries that have the biggest impact are oil and gas, aviation, hotel, tourism, gaming/cruise, retail, food and beverage and shipping.
It was estimated that these eight industries make up $46 billion of their total corporate loans. And out of this $46 billion, oil and gas makes up the biggest sector of $23 billion. So the oil and gas sector accounts for about 10% of total corporate loans.
Management has identified about 20% for close monitoring. This means that 20%, out of this $46 billion, or $9.2 billion of corporate loans are in a dangerous situation.
The management guidance for credit losses is around $3 billion to $5 billion over 2 years. They said 2 years because if things go sour, loans for this year would only turn non-performing in the second year.
Assuming DBS’s revenue for 2020 stays the same as 2019 at $14 billion, and drops to $12 billion in 2021 to be conservative. Total revenue over 2 years would already be $26 billion. Let’s say credit loss is realised at $5 billion for the worst-case scenario, that equates to a 20% drop in earnings or 10% each year.
Balance Sheet Stability
Lastly, Piyush gave the assurance that DBS entered into these uncertain times with a strong balance sheet.
CET-1 is 13.9%, higher than MAS’s regulatory requirement of 9%. Tier-1 capital is 15.1%, higher than MAS’s requirement of 10.5%. And Total capital is 16.8%, higher than MAS’s requirement of 12%.
Most people look at CET-1 as that is the bank’s core capital and it is the highest-rated. DBS’s CET-1 of 13.9% is in line with their FY 19 target of 13% +/- 0.5%. In 2020, they are targeting a range of between 12.5% – 13.5%.
The leverage ratio has fallen by 0.1% to 6.9% from 7%. MAS’s requirement for LCR is 3%. Leverage ratio is a measure of how much the bank has loaned out in proportion to the deposits it has in CET-1.
In my opinion, I think the consumer segment is fairly safe as we Asians are more of savers. It is not like in the US where consumers are spending aggressively more than what they can afford. Furthermore, MAS regulations have provided banks with a good buffer and it has significantly reduced the risk of defaults.
The biggest risk comes from two angles. One is NIM compression and the second is that 20% of corporate loans that DBS is “monitoring closely”. DBS has $46 billion worth of loans that are in the impacted industries and that makes up about 12.2% of total loans. So you can say that 12% of DBS’s revenue is at risk and 20% of this 12% is at a high-risk.
These two headwinds would cause earnings to fall. However, lower operating expenses and a boost in non-interest income should help offset some of these falls.
We are really in uncertain and volatile times now. It could be the economy is back to business by 2H 2020 and all the allowances reverse to profits. Or it could be that the global economy remained shut for the whole year of 2020. Nobody really knows but I believe DBS can weather through this crisis. In the meantime, just keep calm and collect dividends.