DBS Group Holdings’ management gave two interesting messages on Feb 13 which got drowned out in its exposure to the crisis at India’s Adani Group.
One of them is the potential for DBS to hit $10 billion in net profit for FY2023 although no analyst has yet made that forecast. That would be an all-time high for a local bank. Already DBS’s earnings have surpassed that of Standard Chartered Bank.
The second message is good news for shareholders. The more profit DBS earns, the more shareholders will get in dividends. In addition, DBS has excess capital. Its common equity tier 1 (CET1) ratio was 14.6% as at Dec 31, 2022. This will increase by 2 percentage points (ppt) when Basel IV is implemented, enabling DBS to redeem more expensive additional tier 1 (ATI) capital and subordinated debt classified as tier 2 capital (CET2), lowering its funding costs.
On Feb 13, Group CEO Piyush Gupta acknowledged DBS’s exposure to the financing of the sale of Ambuja Cement to the Adani Group by Holcim but reiterated that the amount of the $1 billion loan was supported by Ambuja’s cash flows. Although Ambuja missed its earnings estimates in FY2022, it is still one of the most profitable entities in the Adani stable.
Uncertainty in environment
For those with long memories, $10 billion was the amount that DBS paid for Dao Heng Bank back in 2001–2002. Some 20 years on, DBS has the potential to earn $10 billion in a year. In FY2022, DBS’s net profit was $8.19 billion, up 20% y-o-y.
When asked about the probability of getting to $10 billion this year, Gupta says: “The bottom line depends on some of the moving parts. There’s a lot of uncertainty in the environment if you look at our projections on net interest margins (NIM), costs and specific provisions (SP).” However, the guidance given by DBS’s management is often on the conservative side.
“But some of those moving parts also depend on how strong the Singapore dollar gets because the translation impact of our income from our overseas activities into Singapore is also material. The stronger the Singapore dollar is, the less those overseas revenue streams convert into Singapore dollars as well. So it’s hard to say whether we hit that number, but I think we have a shot at it this year,” Gupta adds.
During DBS’s results briefing on Feb 13, Gupta guided for mid-single-digit loan growth and double-digit fee income growth for FY2023. He indicated that NIMs are likely to be in the 2.10%–2.20% range rather than the 2.25% range that was indicated during DBS’s 3QFY2022 results guidance. In addition, a weak Singapore dollar is usually the background for almost all of the “pass-through” from US interest rates to domestic interest rates but this is less so with a stronger Singapore dollar. The US Federal Reserve has indicated that the Federal Funds Rate would peak at 5% or 5.25%.
Local banks are funded mainly by deposits and a small portion of wholesale funding. In 4QFY2022, DBS’s total funding was $574 billion. Of this, low-cost Casa (current account savings account) was $318 billion or down $60 billion y-o-y, higher-cost fixed deposits were $209 billion or up $88 billion y-o-y, while other sources — mainly wholesale funding — were at $47 billion, down $6 billion y-o-y.
See also: Banks in Singapore can withstand multiple shocks: MAS
DBS has indicated that it will tap the covered bond market to access cheaper funding. Covered bonds are those with coupons secured by the bank’s mortgage book and hence cost a lot less than senior debt.
On the cost front, operating expenses could increase by 9% to 10%, while the cost-to-income ratio (CIR) is likely to dip below 40%. In 4Q2022, CIR rose q-o-q from 40.6% in 3QFY2022 but fell dramatically from 51.4% in 4QFY2021 to 42.8%. The 4QFY2022 figure included a one-off charge for the acquisition of Citi’s Taiwan retail business.
On the credit-cost front, Gupta guided for specific provisions of 10 bps–15 bps (2021: 12bps, 2022: 8bps). DBS has built up ample general allowance. As at Dec 31, 2022, DBS’s allowance coverage was 122% and 215% after considering collateral. Total allowance reserves were $6.24 billion with a management overlay of around $2 billion.
In 4QFY2022, DBS’s ROE was 17%. Annualised, this would have helped DBS achieve some $9.67 billion in net profit. Based on Bloomberg’s poll up to Feb 12, the average earnings estimate by the Street for DBS was $9.883 billion for this year, rising to $10.38 billion for FY2024.
For FY2023, DBS could squeeze a bit more earnings through lower costs, a tad higher NIM and better fee income — which is possible if policy rates and interest rates in general reach a plateau as this would trigger a rebound in wealth management income and fees.
Gupta cites a positive outlook for wealth management following a tepid FY2022. Because of rising interest rates, private banking clients did not do much and “animal spirits were low”.
“Nevertheless, our net new money was the highest we’ve ever had, we got $24 billion for 2022 and $9 billion-plus in the fourth quarter alone. And a lot of this money is out there for dry powder, it’s waiting on the sidelines, waiting to be invested. We’re already beginning to see green shoots on the back of that,” Gupta says.
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Outlook for dividends
The relationship between earnings, dividends and capital is simple. The more cash earnings (excluding mark-to-market gains and losses) that are announced, the more shareholders' funds build up — hopefully after dividend payouts. In 4QFY2022, DBS announced an ordinary dividend of 42 cents and a special dividend of 50 cents. In total, DBS will pay shareholders $2 per share.
In terms of total payout including the special dividend, DBS is paying out $5.14 billion compared to a net profit of $8.19 billion. DBS paid out $3.86 billion in ordinary dividends, translating into a payout ratio of 47%. The additional $1.29 billion in special dividends takes the total payout ratio to 62%.
The other part of dividend payouts is managing capital. For banks this is CET1. DBS has a stated policy of keeping its CET1 ratio in the 12.5%–13.5% range — which is lower than 4QFY2022’s 14.6%.
“The special dividend was well anticipated (although expectations on the quantum varied) and is worth around $1.29 billion, implying that it would only lower the CET1 to around 14.2%, this is still above management’s comfortable range of 12.5%–13.5%,” notes Credit Suisse in an update.
Accounting for the combined impact of the Citi Taiwan acquisition (–0.6 ppt to –0.7ppt) and eventual reversal of additional capital requirements from digital bank outage (+0.4 ppt) would still imply a CET1 of about 13.9%, Credit Suisse estimates.
Interestingly, if DBS’s net profit rose to $10 billion, shareholders would benefit from higher ordinary dividends based on a 50% payout ratio.
“We note that if we assume a sustainable ROE of 15% and loan growth of 5%, the payout ratio would have to be 70% for DBS to stop accreting capital. This suggests substantial upside to the current quarterly dividend, which only implies a payout ratio of only 45% (based on FY2023 net profit),” Credit Suisse calculates.
Basel IV impact
The Monetary Authority of Singapore is expected to announce the final rules on Basel IV in July this year with banks starting their implementation on Jan 1, 2024, the start of a five-year transitional period.
“We expect that the transitional CAR (capital adequacy ratio) will be lifted by some two percentage points. In the first instance, we have [plans] to redeem additional tier one (ATI) instruments and tier two instruments in the next three years, amounting to some $5 billion and they will not need to be refinanced.
Therefore, that will have beneficial impacts, both to our bottom line and to tier one capital,” explains Chng Sok Hui, DBS’s group CFO.
“Over the five-year transition period, we expect that our final CAR ratio should be neutral. Over time, as the capital floors kick in after five years, then we are back to the sort of CET1 that you see today,” she adds.
ATI and tier 2 capital carry higher coupons with ATI — usually perpetual securities — being the most expensive.
All in then, lower cost of funds, higher fee income, and continued elevated NIM on the back of modest loan growth may help to tip DBS past $10 billion.
