• DBS (SGX:D05)'s management cautions for a 1-3bp NIM contraction in 2H19 on potential Fed rate cuts. We cut our FY19-21F estimates by 1-3bp to reflect falling rates.
• Delayed corporate drawdowns in 2H19 should sustain 4% loan growth target despite flattish mortgage growth. Credit costs still intact despite higher GPs.
• Maintain HOLD with a lower GGM-based Target Price of S$27.59 as we cut FY19-21F EPS by 1-3% to reflect lower NIMs and adjust full-year treasury income.

We Cut FY19-21F NIMs by 1-3bp to Factor in Potential Fed Rate Cuts

• The +3bp q-o-q NIM expansion in 2Q19 was aided by higher S$ and HK$ rates amid a release of expensive fixed deposits (-1.7% q-o-q). Tailwind repricing effects from the bank’s board-rate mortgages had also contributed to the increase.
• Management’s base case scenario is for 2 Fed rate cuts by end-2019, in which case DBS’s NIMs could contract up to 3bp in 2H19. We bake in these assumptions given tipping LIBOR, SOR and HIBOR rates since 2Q19, as well as elevated probabilities of 2 Fed fund futures cuts in FY19.
• While residual repricing effects of the bank’s fixed rate housing loans (25% of mortgages) could buffer some of the rate cut impact, pricing pressure from lower rates may weigh on asset yields nonetheless. We cut FY19-21F NIMs by 1-3bp to reflect this.

FY19 Net New Mortgages Expected to be Flattish (from S$1bn-1.5bn)

• In contrast to previous quarters, 2Q19 loan growth was led by trade assets (+5% q-o-q) instead of non-trade corporate loans (+0.3% q-o-q); we understand that the latter was due to delayed drawdowns by customers in view of macro uncertainty. We deem the pick-up in trade loans encouraging given its contraction over the past three quarters.
• As with the industry, 2Q19 mortgage growth was lacklustre but DBS expects a reversal of the S$1bn contraction in housing loans in 1H19 given a 60% rise in bookings. Although full-year net new mortgages could end up flattish (previous guidance S$1bn-1.5bn), we believe that delayed corporate drawdowns in 2H19 may still support our 4% y-o-y expectations.

2Q19 Credit Costs Were Pushed Higher by +7bp GPs for Weak Macro

• DBS recorded 28bp credit costs in 2Q19; 21bp specific provisions were below cycle average but the key surprise was the 7bp GPs (recall the 11bp writeback in 1Q19 GPs). The general provisions were attributable to management overlays on the ECL model in view of a weaker macro outlook and is expected to be one-off.
• Minimal provisions were taken for new NPAs attributable to an Indonesian steel exposure; the bank does not anticipate further impairments as a letter of support had been received. Going forward, the bank holds out for recoveries on its O&G portfolio but we are less optimistic.

Maintain HOLD; ROE Target Softened to "approaching 13%"

• We remain optimistic that non-II engines, such as wealth management and transaction-related income, should remain fairly resilient, buffering the impact from Fed rate cuts on ROE to just approach 13% (vs. 13% previously).
• Key downside risks are sharper Fed rate cuts than expected.
• DBS trades above mean at 1.3x FY19F P/BV (ROE: 12.5%)

Source: CGS-CIMB Research - 3 Aug 2019