Yesterday, Macquarie Equity Research (MER) published a research report that downgraded DBS from “Outperform” to “Neutral”. The downgrade comes on the back of am MER analysis of the impact of falling commodity prices on Asia’s multinational bank. MER believes the commodity finance exposure of DBS accounts for 9% of total loans and that S$1.8bn of commodity-related losses are possible based on MER’s stress test…

 
Quantifying the commodity finance exposure – DBS has commodity finance exposure (including off balance sheet and derivatives) of S$28bn, which is about 0.9x of tangible book value, based on MER estimates.
 
Stressing the commodity finance exposure – Based on MER’s assumptions of (i) 10% defaults in the commodity finance related exposure and 60% specific impairments and (ii) S$112m revenue losses on these defaults, MER estimates S$1.8bn total pre-tax losses in their stress test. This compares to 34% of pre-tax profit estimate for 2015.
 
Lower probability of stress test losses occurring – In MER’s valuation, they discounted for a 50% probability that these losses will occur. A large proportion of DBS’s Commodity Finance exposure relates to trade finance, which is of relatively low risk in MER’s view. At the moment MER is more worried about revenue headwinds (in trade finance) from falling commodity prices for DBS.
 
Earnings and target price revision
Yesterday, MER changed their earnings per share estimates marginally. DBS’ target price is now reduced to S$21.00 from S$22.00 by discounting for potential commodity finance related losses.

Action and Recommendation
MER downgraded their recommendation on DBS to Neutral and cut their Target Price to S$21.00.
 
MER still believes DBS is in a good strategic position to take market share from the struggling multinational banks. However, after the relative share price outperformance over the past six months, MER thinks it is time to take a break.
 
DBS is a consensus buy (85% buy and no sell rating on Bloomberg) and MER believes the market is too optimistic on the impact of rising US rates for DBS.
 
Revenue growth headwinds from falling commodity prices, renewed margin pressure in trade finance, a more uncertain outlook for financial market-related income and moderating loan demand will make it challenging for DBS to meet the 10% YoY top-line growth expectation by the market in 2015.

The commodity finance exposure of DBS is more of a risk for revenue growth outlook for DBS and MER is less worried about immediate asset quality deterioration at this stage.

Source: Macquarie Research - 28 Jan 2015