DBS posted a 2Q09 net profit of $552m (+21%qoq, -15%yoy), above market expectations. The earnings out-performance was mainly due to cost discipline (expense ratio at its best levels of 35%), better net interest margins, as well as strong trading and investment gains. A dividend of 14 cents/share was declared, unchanged from the previous quarter.

While loans growth declined 2% in pace with the industry, the group is seeing a strong loans pipeline. While it has been competitive in consumer lending, the group assured that it will exercise discipline to ensure meaningful returns. Net interest margin benefited from improved credit spreads and is expected to be sustainable at the current interest rate environment.

NPLs spiked up by 25% primarily due to lumpy accounts from shipping and the Middle East. Unlike its peers, specific allowances were still rising, up 21% qoq to $273m. However, based on stringent assessment, the management is comfortable with their coverage ratios, at 81% on NPAs and 119% on unsecured NPAs. With rising business confidence, they observed improving NPL trend in core markets.

Its Hong Kong earnings have reversed up from a loss of $35m in 1H08 to a profit of $193m due to margin improvement, cost reduction and lower allowances. With buoyant activities in financial markets regionally and easing provision charges, we expect good earnings potential from Hong Kong and its other fast growing markets in China and Indonesia.

We have raised our earnings estimates by 2% on the good results. Our target price is increased to $15.30, rolled forward to 1.3x FY10 PBV. We applied a discounted PBV multiple to DBS on the back of lingering concerns on its NPLs. However, valuation is still attractive along with an improved economic outlook. Near-term catalysts could arise from the utilisation of its $4bn rights issue proceeds for strategic investment for future growth. Maintain BUY.