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3 Looming Risks for DBS Bank

3 Looming Risks for DBS Bank

When evaluating any company, you should not only focus on the upside but the downside as well.

Some risks may be fairly obvious, while others may crop up over time and as the business environment evolves.

These risks, if left unchecked, may break a strong investment thesis.

DBS Group Holdings Ltd (SGX: D05) is sailing into stormy seas caused by the COVID-19 pandemic that has wreaked havoc on economies and businesses.

Although Singapore’s largest bank has been growing steadily and consistently since the challenging days of the Global Financial Crisis back in 2008-2009, we cannot rule out any rough patches that may be just around the corner.

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Today, we take a look at three looming risks for the bank, and what it means for its growth prospects.

Lower net interest margin

DBS released its earnings report for the first quarter of 2020 (1Q 2020) back in May.

The bank flagged out lower global interest rates as a key pressure on earnings.

The bank’s core business relies on accepting deposits from the public and lending out these monies to individuals and corporations, earning a spread on the difference in rates between its deposits and loans.

This spread is known as the net interest margin (NIM), and the revenue obtained is called net interest income.

Though 1Q 2020 saw net interest income rising 7% year on year to S$2.48 billion, this rise may moderate moving forward as interest rates tumble globally.

NIM stood at 1.86% for 1Q 2020, but CEO Piyush Gupta believes that the current margin does not reflect the impact of recent rate cuts.

The full impact will be felt in the second quarter as NIM comes under pressure.

Unless loan growth can offset the decline in NIM, investors may see net interest income declining on a year on year basis.

Higher non-performing loans

The non-performing loans (NPL) ratio of a bank reflects the level of bad loans it expects to have in any given period.

For DBS, its NPL ratio stood at 1.6% at the end of the first quarter, notably higher than the 1.5% it reported during the same period last year.

The rise was due to a higher level of allowances made for bad loans due to COVID-19.

Total allowances came up to S$1.09 billion, up significantly from just S$76 million in the first quarter of 2019.

The pandemic is set to trigger Singapore’s worst economic contraction since independence, and many businesses in the tourism, hospitality, oil and gas and airline industries have been hard hit.

Although DBS has bumped up its level of allowances to account for potential bad loans, if more businesses go belly up, its NPL ratio could increase and the bank’s earnings could be further impacted.

Digital banks

A third risk comes from digital banks.

Last year, the Monetary Authority of Singapore (MAS) had invited applications for digital full bank (DFB) and digital wholesale bank (DWB) licences last year.

A total of seven applicants submitted applications for the DFB, while 14 applicants threw their hat in for the DWB.

The list of applicants includes reputable names such as Singtel (SGX: Z74), in partnership with Grab, Razer Inc (SEHK: 1337), and Sea Ltd (NYSE: SE).

Other contenders include iFAST Corporation Ltd (SGX: AIY), Sheng Ye Capital (SEHK: 6069) and Ant Financial, owned by Alibaba Group Holdings Ltd (SEHK: 9988).

MAS expects to award the licences by the end of 2020.

These digital banks will not have a physical presence, thus significantly lowering their operating cost structure.

As each bank, including the newbies, seek to build up market share and attract deposits, a price war may break out.

DBS may end up facing stiff competition from the digital banks as they vie for deposits from the same pool of potential customers.

With digital banks being a permanent and structural change to the banking industry, DBS needs to be nimble and navigate its way around the competition.

The digital banks may likely steal some market share away from DBS and the other local incumbent banks.

It remains to be seen as to how disruptive digital banks can be, and what steps DBS may take to mitigate the negative impact of this competitive threat.

Get Smart: Risks are part and parcel of investing

These risks may seem daunting, but investors need to remember that they are a normal part of investing.

If DBS is a well-run business with astute management, it should be able to overcome these challenges and still emerge strong.

Investors need to monitor these three risks closely to see how the bank reacts to them in the coming quarters.

With share prices battered to multi-year lows, many attractive investment opportunities have emerged. In a special FREE report, we show you 3 stocks that we think will be suitable for our portfolio. Simply click here to scoop up your FREE copy… before the next stock market rally.

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Disclaimer: Royston Yang owns shares in DBS Group Holdings Ltd and iFAST Corporation Ltd.

The post 3 Looming Risks for DBS Bank appeared first on The Smart Investor.