China Exposure Evokes Doom & Gloom. Is It Justified?

• North Asia delivers a third of DBS GROUP HOLDINGS LTD (SGX:D05)’s income. Intensifying US-China trade tensions have created operating and news-flow risks. Nevertheless, DBS has been delivering North Asian ROAs that are significantly above its long-term mean since the trade war began in 1Q18. Asset quality is also much better than at home.
• In North Asia, DBS is mostly exposed to high-quality corporates and FIs, funded by a large, low-cost CASA base. This puts it in a stronger position to deal with trade-war volatility than regional peers, we believe.
• Importantly, its Singapore earnings should be more than sufficient to back guided dividend payments. See DBS dividends history.
• Maintain BUY with multi-stage DDM (10.3% COE, 3% terminal) based Target Price of SGD29.46.

Exposed to Right Segments

• According to management, 85% of DBS’s North Asian loans are made to mostly large corporates and FIs in HK and China. Direct CNY loans make up just 3.7% of its book vs 43% for USD & HKD loans. This level of wholesale exposure lowers its portfolio risks compared with a retail-and SME-heavy book, which may be hurt more by trade wars.
• Additionally, 57% of DBS’s North Asia lending is funded by low-cost CASA. This provides a margin advantage. DBS has been delivering ROAs that are 30bps above its long-term 0.9% since the trade war began, pointing its franchise strength.

Balance Sheet to Manage Volatility

• North Asian credit charges have been materially lower than elsewhere for the bank since the trade war began. 1Q19 NPLs here were 0.8% vs 2.0% for the group. This underscores the quality of its portfolio, in our view. DBS has a 14.1% CET. Provisions will need to double to take this down to 13.5%: management’s minimum comfort level. Even then, it would be 5.1% higher than the MAS minimum.
• The last time this played out was in 2009 during the GFC, when DBS was structurally different with a higher dependence on trading income.

Dividends Secure

• All else being equal, we estimate that its minimum-dividend guidance of SGD1.20 for prospective 4.6% yields can be funded just by earnings from Singapore. Domestically, DBS should benefit from rising NIMs from mortgage re-pricing and its low-cost funding base.
• While trade-war news may affect short-term sentiment, we believe DBS is structurally well-placed to weather the volatility. BUY.

Defying Volatility With Its Returns

• DBS has been delivering ROAs that are 30bps above its long-term run rates of 0.9% since the trade war began, pointing to the strength of its franchise in North Asia.
• Nearly a third of DBS’s earnings is derived from North Asia – the highest proportion among domestic banks. However, according to management, 85% of DBS’s lending is made to corporates, mostly large ones, and FIs in HK and China. Direct CNY loans make up just 3.7% of its book, whereas USD & HKD loans are 43%. This level of wholesale exposure lowers its portfolio risks compared to a retail-and SME-heavy book in a trade war, in our view.
• Additionally, 57% of DBS’s North Asian loans is funded by CASA, which provides it with a margin advantage.

Strong Balance Sheet to Manage Volatility

• North Asian credit charges have been materially lower than elsewhere in its operations since Trump fired his first trade-war salvo.
• NPLs in North Asia were 0.8% in 1Q19 vs 2% for the group. This underscores the quality of its portfolio, in our view. With lower exposure to the retail and SME sectors, which should feel the pinch of the trade war sooner and harder than large corporates with scale and diversification, DBS should be better positioned than its regional peers in North Asia, we believe.
• DBS has a 14.1% CET. Provisions will need to double from here to take this down to 13.5%, management’s minimum comfort level. This would still be 5.1% higher than the MAS minimum. The last time this played out was in 2009 during the GFC. At that time, DBS was structurally different with a much larger dependence on trading income and higher-risk financial instruments.

Dividends Secure

• All else being equal, DBS’ minimum guided dividend of SGD1.20 for a 4.6% prospective yield should be deliverable just from its 2018 Singapore earnings.
• We forecast yields of 5.3% for FY19E, a payout that we believe its ex-North Asian operations can comfortably support.
• So while trade-war news flow may affect short-term sentiment, we think DBS is structurally well-placed to weather the volatility.
• BUY.

Source: Maybank Kim Eng Research - 21 May 2019