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DBS Cashing In On Higher Profits

800px-DBSBank_DesVoeuxRoadBranch_HongKong The largest bank in Singapore as measured by assets, DBS Group Holdings (SGX: D05), announced its third quarter results this morning and delivered growth in both its top and bottom-line for the quarter.

The bank’s operations are focused on six key geographical markets: Singapore, Hong Kong, China, Taiwan, Indonesia, and India. In 2012, the bank’s 18,000 employees served 180,000 corporate clients and 5.3m retail customers in those key markets.

Some basic numbers

For the three months ended 30 Sep 2013, the bank’s Total Income (analogous to a company’s revenue) grew 7% year-on-year to S$2.15b. Profits, meanwhile, inched up 1% to S$862m.

DBS’ Total Income is made up of two components: Net Interest Income and Non-interest Income.

The former rose 6% year-on-year to a “record” S$1.41b. Loan volume expanded 19% to S$242b as trade loans, corporate borrowing and secured customer loans increased. This helped to offset a decline in net interest margins which fell from 1.67% a year ago to 1.6% due to lower loan spreads and yields on investment securities.

A falling net interest margin is a problem that is also plaguing the other two local banks, Oversea-Chinese Banking Corporation (SGX: O39) and United Overseas Bank (SGX: U11).  With a shrinking net interest margin, banks have to depend on increasing its loan volume to boost its Net Interest Income.

In such events, there’s always the risk of banks being willing to write poor-quality loans to drive sales growth. So investors have to watch out for any untoward developments in that area (more on that later).

Non-interest Income for DBS had grown 11% year-on-year to S$744m. The growth was led by Trading Income which jumped 45% to S$188m on the back of higher trading gains and cross-selling. Fee Income was another bright spot as it increased 9% to S$462m due to higher contributions from trade and services, wealth management, and cards.

Profits grew at a slower pace compared to Total Income as expenses rose 15% to S$1.1b. Staff cost was a major culprit as it rose 6% to S$511m from a year ago due to a higher headcount.

A huge 175% jump in credit and loss allowances from S$55m to S$155m was another big contributor to the increase in expenses. Credit and loss allowances are essentially reserves calculated by the bank where it estimates the amount of loan-losses that arise out of ‘bad debts’.

In the second quarter this year, DBS also reported a significant 135% jump to S$245m in credit and loss allowances. It seems that the bank’s seeing more bad loans: is that possibly a result of the bank’s chase for higher loan volumes?

Operational highlights and the balance sheet

DBS’ non-performing loan (NPL) ratio for the quarter fell from 1.3% a year ago to 1.2%. This is an important metric in assessing the quality of the bank’s loan portfolio. So, despite the increase in credit and loss allowances, it seems that the quality of DBS’ loan-portfolio has in fact improved a little.

The loan-to-deposit ratio (LDR) has increased from 84.3% to 89.5%. While there’s no hard ceiling on the LDR figure, it’s not always a good sign to see it ballooning as that could affect the bank’s liquidity in the future (especially in a situation where there’s a larger-than-normal amount of deposits being withdrawn), so it’s something for investors to note.

The importance of the health of a bank’s balance sheet cannot be overstated. On that front, DBS’ balance sheet seems to have taken a few steps backward compared to a year ago when looking at the ratio of its tangible book value to total assets, which has fallen from 7.1% to 6.9%.

In addition, DBS’ Capital Adequacy Ratios (CAR), which measures the amount of ‘cushion’ a bank has on its balance sheet to withstand losses, has also weakened.

DBS’ Tier 1 CAR has dropped from 13.4% a year ago to 13.3%. Meanwhile, its Total CAR has declined from 16.5% to 15.9%. It should be noted however, that despite a dip in those figures, DBS’ balance sheet is still strong as its Tier 1 and Total CARs are still well above the Monetary Authority of Singapore’s Basel III requirements of 6% and 10% respectively.

What’s next for DBS

Piyush Gupta, chief executive of the bank, commented that “DBS turned in yet another strong quarter despite the challenging market environment. Our portfolio is sound and asset quality remains healthy. We are well placed to navigate the market uncertainties ahead, and will be prudent and vigilant as we continue to grow our franchise across the region.”

Valuation

DBS, a stalwart within the Straits Times Index (SGX: ^STI), opened at S$16.70 a share for a 0.2% dip from Thursday’s close. At that price, the bank’s shares are valued at 1.26 times book value and 1.48 times tangible book value, and carry an annualised dividend yield of 3.4% based on its half-year pay-out of 28 cents.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chong Ser Jing doesn’t own shares in any companies mentioned.