• We forecast DBS Group (SGX:D05) to report net profit of S$1,079m for 2Q20, down 32.7% y-o-y and 7.4% q-o-q. Operationally, total income receded 15.8% q-o-q, partially mitigated by a reduction in operating expenses and credit costs (DBS affected by huge general provision of S$703m and S$415m exposure to Hin Leong in 1Q20).
• We foresee DBS adopting a conservative stance to trim dividends by 9.1% to 30 S cents per quarter, while reactivating its scrip dividend scheme.
• Maintain BUY. Target price: S$24.80.

Growth in Non-trade Corporate Loans

• We expect DBS to report moderate loan growth at 4.2% y-o-y and 0.5% q-o-q in 2Q20, driven by non-trade corporate loans. Trade loans are expected to be flat, while consumer loans should have contracted slightly.

Experienced Severe NIM Compression

• We expect NIM to have compressed by a massive 16bp y-o-y and 11bp q-o-q to 1.75% in 2Q20. FED Funds Rate dropped by a total of 150bp in March. 3-month SIBOR and SOR continued to fall in 2Q20, dropping 44bp and 72bp respectively to 0.56% and 0.20%.
• 3-month LIBOR fell by a massive 115bp to 0.30%. The fall of these benchmark interest rates have caused significant compression of loan yields, especially for S$-denominated loans.
• High CASA ratio of 88% for S$-denominated deposits means that DBS has limited room to reduce its cost of deposits. This was further exacerbated by strong inflow of deposits.

Fees Pulled Back From Record Levels in 1Q20

• We expect contributions from DBS' Wealth Management to have declined by 10% y-o-y as high net worth clients adopted a risk-off approach amid the COVID-19 pandemic. We expect a decline in contributions from cards of 24% y-o-y, hampered by curbs on overseas travel. Contributions from trade and loans-related fees were flat.
• We expect DBS’ fee income to have declined 11% y-o-y and 18% q-o-q to S$684m in 2Q20 (DBS achieved record fee income of S$832m in 1Q20).
• We expect net trading income to be seasonally strong at S$300m, supported by healthy customer flows driven by active hedging of forex and interest rate risks.

Cut Operating Expenses

• We expect operating expenses to have decreased 3.4% y-o-y.
• We estimate cost-to-income ratio at 44% in 2Q20 (1Q20: 38.6%).

Moderation in Credit Costs

• We expect DBS to report general provisions of S$167m caused by recalibration of macroeconomic variables due to a COVID-19 induced recession in 2020 (Ministry of Trade & Industry has lowered GDP forecast from contraction of 1-4% to 4-7%). We expect specific provisions of S$450m.
• Overall, we expect credit costs to hit 67bp in 2Q20 (2Q19: 28bp, 1Q20: 119bp).

Weathering the COVID-19 Pandemic

• We forecast DBS to report net profit of S$1,079m for 2Q20, down 32.7% y-o-y and down 7.4% q-o-q. Operationally, total income receded 15.8% q-o-q from a record S$4,026m in 1Q20. This was partially mitigated by a reduction in operating expenses and moderations in credit costs (1Q20 affected by huge general provision of S$703m and exposure to Hin Leong of US$290m or S$415m).

Two Years of Elevated Credit Costs

• Management expects credit costs to rise to between S$3b-5b (80-130bp) cumulatively over two years. Management guided credit costs at 65bp each for 2020 and 2021. The new guidance factors in a deep and prolonged economic impact from the COVID-19 pandemic.

Earnings Revision

• We trimmed our DBS' 2020 net profit forecast for marginally by 1.5% due to NIM compression and decline in fee income in 2Q20.
• We expect interim dividend for 2Q20 to be reduced by 9.1% from 33 S cents to 30 S cents. We expect full-year DPS for 2020 to be S$1.23.
• We assume that DBS will turn on its scrip dividend schemes for two years in 2020 and 2021 with issue price for new shares set at 5% discount to today’s closing prices, which is S$21.38. We assume acceptance for scrip dividend at 70%.

Recommendation

• Valuation is attractive with 2020 P/B at 1.1x and dividend yield at 5.8%.
• Maintain BUY on DBS. Our target price of S$24.80 is based on 1.24x 2021F P/B, derived from the Gordon Growth model (ROE: 9.1%, COE: 7.75% (beta: 1.15x), Growth: 2.0%).
• DBS share price catalysts:
  • Gradual easing of NPL formation due to progressive reopening of the economy post Circuit Breaker.
  • Aggressive cuts in opex.
• DBS to announce 1H20 earnings on 29 Jul; OCBC to announce 1H20 earnings on 7 Aug; UOB to announce 1H20 earnings on 6 Aug.

Source: UOB Kay Hian Research - 20 Jul 2020