But results mediocre when compared to peers, UOB and OCBC both saw margins widening

SYNOPSIS: Only 90% of its ABS CDO is provided for. Default risk on SME loans also higher due to late entry into the market segment. Stock offers only 6% upside to our fair price target of S$20. Maintain SELL.

CDO EXPOSURE UPDATE

No further provisions were made in 2Q08 for its ABS CDO exposure, ie only 90% provided for compared to 100% for both UOB and OCBC. Of the remaining S$859m non-ABS book, only S$50m or 6% has been provided (no change from 1Q08) as 94% of these are rated A and above. These appear sufficient for the moment unless those rated A and above slips into non-investment grade. Note that only 83% of OCBC’s and 56% of UOB’s corporate CDOs are rated A and above, the latter two have about 6.3% and 50% of their respective corporate CDOs provided for in their interim results.

RESULTS ANALYSIS

1. DBS reported a 11% q-o-q rise in net profit (excluding one-time charges) to S$668m for 2Q08. Compared to the same period last year, the earnings were almost flat in the second quarter. Group net profit for the first six months of the year totaled S$1.27bn, down 1% compared to same period last year. The results were in line with our full year net profit forecast of S$2.37 bn.

2. Net Interest Income in 2Q08 was driven mainly by asset growth. Gross customer loans grew by 4% q-o-q and 20% y-o-y. Excluding the S$2.3bn loans from Bowa Commercial Bank of Taiwan which was consolidated from 24 May 2008, loans growth would have been a slower 2% q-o-q and 17.5% y-o-y (similar y-o-y growth as UOB but lower q-o-q).

Loans growth was driven mainly by personal and housing, building & construction and manufacturing loans. Similar to UOB, loans to individuals were growing above industry rate, implying a gain in market share in this loan segment where margins are more lucrative than housing loans. However, it appears to be losing market share on its housing loans, the latter grew by only 2% y-o-y and 0.3% q-o-q, the least growth amongst the three local banks.

3. Net Interest Margin slipped further. Overall net interest margin slipped further by 5bp from 1Q08 to 2.04%. This is 17bp lower when compared to a year ago. The margin decline (as opposed to margin improvement for UOB) is expected for DBS, which has the lowest loan-to-deposit ratio of only 75% compared to near 90% for UOB. The ratio implies more excess funds parked in the interbank market where rates have fallen substantially.

4. Fees & commission declined 8% y-o-y and 3% q-o-q, dragged down by sharp falls in stockmarket-related activities. Fees from stockbroking, investment banking, wealth management and funds management fell by more than 30% y-o-y. These were partially offset by 50% or more jump in fees from loans and guarantees. Compared to 1Q08, fees & commission income was lower by only 3%.

5. Other non-interest income rose 30% y-o-y and q-o-q to S$199m. Net trading income rose 14% y-o-y to S$111m.This compared favourably to the S$161m trading losses registered in 1Q08. However, gains from sale of financial investments were only a quarter of that recorded in 1Q08. Cost-to-income inched up slightly to 43%, from 42% in 1Q but little change from a year ago. The inclusion of NPLs from Bowa pushed DBS’ group’s NPL rate up marginally from 1% to 1.4%. Except for Singapore and SE Asia which inched up by 0.1%, NPL rates for the rest of the countries were unchanged from 1Q08.

6. Hong Kong: Net Interest income was lower than the previous year as margin declines more than offset the asset growth. Compared to 1Q08, NII fell due to a fall in interbank assets.

7. Proposed 20 cents interim dividends (Tax-exempt), bringing total dividends payout at half-time to 40 cents.

CONCLUSION

We are maintaining our full year net profit forecast at S$2.37bn. Unlike UOB, DBS’ net interest margins are likely to continue to fall as long as the interbank rates remain soft. This leaves DBS with little choice but to grow its asset base more aggressively than its competitors in order to shore up its net interest income line as it had done in the past few quarters. However, with the domestic and regional economy expected to slow down more significantly in the coming quarters due to high inflationary pressure and the weaker US economy, there is limited room for DBS to expand its loan portfolio. We are also wary of DBS’ aggressive entry into the SME market in the past 3 years. DBS is at greater risk of defaults from these SMEs should the congruence of high oil prices, high food prices and possible US recession take their toll on the smaller SMEs. Maintain SELL on DBS.