Aozora Bank Ltd

TSE:8304

Earnings Call Analysis

Earnings Call Transcript 2023-Q4

[Operator]

Welcome to Aozora's Fiscal Year 2022 Financial Results Conference Call. Before we go further, I'd like to review the safe harbor statement. Some of the matters that we will discuss today are forward-looking statements. These statements are based on current plans, estimates and expectations. Forward-looking statements involve inherent risks and uncertainties. In a number of factors could cause actual results to differ materially from those contained in the forward-looking statements. Forward-looking statements are valid only on the date on which they are made and Aozora Bank undertakes no obligation to update publicly or revise any forward-looking statement, whether as a result of new information, future developments or otherwise. Please note that this presentation is not an offering of any securities of the bank and should not be so construed in any jurisdiction or for any purpose.

Masaharu Matsuura, General Manager, Corporate Communication Division, will now provide you with a view of the fiscal year 2022 financial results. Matsuura?

[Masaharu Matsuura, executive]

I want to thank everyone for joining us today for our fiscal year 2022 Financial Results Teleconference. I'd also like to thank all of Aozora shareholders and analysts for their continued interest and support.

Let me now turn to Page 3 of today's financial results overview to review the highlights for fiscal year 2022. Net revenue was JPY 59.5 billion and profit attributable to owners of parent was JPY 8.7 billion, both of which were almost in line with the revised forecast announced in January 2023. Net revenue from customer-related business, mainly driven by Aozora's strategic investment business was strong with JPY 0.3 billion, increased year-on-year. [indiscernible] domestic real estate nonrecourse loans and business recovery finance performed well.

With regards to our financial market-related business, we continued risk-reduction operations on the securities portfolio throughout the fiscal year and implemented a loss cut to a portion of the unrealized losses. Unrealized losses in the securities portfolio on a consolidated basis were JPY 63.8 billion as of March 31, 2023, with an improvement from December 31, 2022. Full year credit-related expenses in fiscal year 2022 were JPY 1.7 billion. Within the range of our initial forecast, while Q4 saw a net expense due to the provisions made mainly for overseas real estate nonrecourse loans, in light of recent market conditions in the U.S.

For our dividend, we declared our fourth quarter dividend of JPY 40. Therefore, the full year dividend will be JPY 154 per common share. Since our customer-related business has been strong, mainly driven by Aozora Strategic Investments business, and our capital adequacy ratio remains adequate at 9.43%. We have approved our full year dividend of JPY 154, in line with our initial forecast.

I will now turn to the fiscal year 2023 earnings and dividend forecast contained on Page 4 of today's presentation materials. Our forecast for fiscal year 2023 net revenue is JPY 86 billion and profit attributable to owners of parent is JPY 24 billion. These forecasts are based on our continued growth trend in customer-related business, including buyout finance and business recovery finance.

In addition to the expected further growth in customer-related business that I have just mentioned, we've also factored in recovery in our financial market-related business, including both our further loss cut to unrealized losses and rebuilding our securities portfolio. Also factored in is GMO Aozora Net Bank's growth in line with the new midterm plan. The fiscal year 2023 dividend forecast is JPY 154 per share based on our policy of stable shareholder returns while maintaining financial strength. This dividend forecast for fiscal year 2023 is set taking into consideration the earnings target level for fiscal year 2025, under the new midterm plan, which will be discussed in a moment.

We expect that the 3 years covered by our new midterm plan, Aozora 2025 will be a period of historic change in the environment. The new midterm plan was developed to drive our growth over the next 3 years by evolving Aozora strategic investment business under the 3 key concepts fostering, change and recovery for customers. With respect to the financial targets, we have set new key performance indicators or KPIs, which are ROE of 8% on capital adequacy ratio of 9% or higher Business-related profit per employee of JPY 20 million, business-related return on risk assets of 1.3% and profit attributable to owners of parent of JPY 37 billion, which are to all be achieved by the final year of the plan.

In terms of our capital policy, we will maintain a proper balance among stable shareholder returns, strategic investments and financial strength. Regarding our shareholder returns, we'll aim to increase the annual dividend to JPY 158 per common share with a payout ratio of 50% by achieving the earnings target for fiscal year 2025 in the final year of the new midterm plan. We'll continue with our dividend payments on a quarterly basis.

Now we'd like to go into the detailed discussion of our financial results for fiscal year 2022 by reviewing the breakdown of revenue and expenses included on Page 5 of today's materials. Full year net revenue was JPY 59.5 billion. As you can see in the table at the bottom of the page, net revenue, excluding financial market-related and retail businesses increased slightly year-on-year. However, due to the decline in revenues from our retail and financial market-related businesses, overall net revenue was significantly lower than the prior year. General and administrative expenses increased by JPY 1.5 billion compared to the previous year, mainly due to increased personnel costs. However, overall expenses were within the original budget as we maintained our focus on cost control.

Profit attributable to owners of parent was a net loss of JPY 6.9 billion in the fourth quarter, mainly due to losses in our financial market-related business as well as provision made for the overseas real estate portfolio based on our conservative evaluation. Full year net earnings were JPY 8.7 billion, in line with the revised forecast announced in January 2023. Next, let me touch upon several of the more significant items included in today's materials.

Please now turn to Page 6. Net interest income was JPY 51 billion. Net interest income on loans increased by approximately JPY 10 billion year-on-year due to the increase in both loan outstandings and net interest margins. Net interest income on securities decreased by approximately JPY 8 billion due to a decline in interest margins. As a result, net interest income was almost flat year-on-year. If you can look at the table and the graph on the right, you can see that net interest margin declined due to the lower securities margins, as I've just mentioned. You also see that the lending margin increased due to the increased margin on overseas loans. The lending margin is on an upward trend, and it was 1.37% in the fourth quarter.

Please now turn to Page 7. Noninterest income was JPY 8.4 billion, a decrease of JPY 42.9 billion from the previous year. As you can see in the bar graph on the right, while retail and the financial market-related businesses both faced difficult conditions. Noninterest income from customer-related business remained steady at JPY 27.4 billion. Aozora continues to implement a loss cut to a portion of unrealized losses in the securities portfolio. And as a result, gains and losses on bond transactions were a net loss of JPY 11.1 billion.

For our breakdown of noninterest income, please now turn to Page 8. Net fees and commissions were JPY 13.3 billion. While loan-related fee income decreased due to the delay in the closing of several large sites transactions to the first quarter of fiscal year 2023. Fees, including investment trust fee income increased. As a result, overall fees and commissions were flat compared to the previous year. Net trading revenues were a net gain of JPY 4.1 billion, a decrease of JPY 12.4 billion due to a lower level of earnings from the sale of structured bonds and trading income.

Please turn to Page 9. Gains/losses on bond transactions were a net loss of JPY 11.1 billion due to the loss cut to a portion of the securities portfolio, mainly foreign government bonds and domestic municipal bonds. As you can see at the bottom of the table, the overall losses related to the risk reduction operations in the securities portfolio which includes the total gains, losses on bond transactions, gains losses on financial derivatives and gains losses on equity derivatives were a net loss of JPY 11.2 billion for the full year and net loss of JPY 7.5 billion for the fourth quarter. Gains from limited partnerships were JPY 4.6 billion, a JPY 4.5 billion decrease compared to the previous year. While real estate related gains and distressed loan-related gains were strong, an allowance for investment losses of JPY 2.6 billion was provided on certain transactions classified as [ buyout ] venture and other in the fourth quarter.

Please now turn to Page 10. Gains/losses on equity method investments were a net gain of JPY 2.3 billion. Net earnings of OCB in Vietnam during the January, December 2022 period decreased compared to the previous year, mainly due to losses recorded on the sale of bonds in response to increased interest rates in Vietnam. OCB's net profit for January to March 2023 period was JPY 4.4 billion, an increase from the previous year. Gains/losses on stock transactions were a gain of JPY 8.4 billion. Gains in the fourth quarter were JPY 3.7 billion due to equity investment exit transactions related to Aozora's strategic investment business.

Please now turn to Page 11. This page shows the status of equity investments and the Aozora strategic investment business. The outstanding balance of investments as of March 31, 2023, was approximately JPY 290 billion and capital gains for the full year were JPY 9.7 billion. In the fourth quarter, the balance of our investments in business recovery claims increased due to continued purchases, while a net gain of JPY 1.1 billion was recorded due to collections. Real estate-related equities recognized a net gain of JPY 1.7 billion due to a large sized edit transaction, while balances declined as a result of sale. Domestic overseas equity investments recognized a net gain of JPY 4 billion in the fourth quarter. Well, as I touched upon a minute ago, [ buyout ] venture and other were a net loss of JPY 3.8 billion, including provisions of an allowance for investment losses.

Please now turn to Page 12. This graph shows the business revenue by segment. Structured Finance Group and International Business Group which are the core business groups of Aozora Strategic Investment Business were strong and the business revenue increased were maintained compared to the previous year, while business revenue declined in the market and retail banking groups.

Please now turn to Page 13. General and administrative expenses were JPY 59.3 billion, an increase of JPY 1.5 billion from the previous year. We maintained our focus on cost control while making necessary personnel and IT-related investments. Overall, G&A expenses were within our original budget of JPY 60 billion.

Please now turn to Page 14. Credit-related expenses were a net expense of JPY 1.7 billion, an improvement of JPY 2 billion compared to the previous year and within the range of our initial forecast. Credit-related expenses in the fourth quarter were a net expense of JPY 3.9 billion. This was due to the provisions made for overseas real estate nonrecourse loans, particularly office loans based on the conservative evaluations. We continued rebalancing our overseas corporate loan portfolio and recorded losses on loan dispositions of JPY 1.2 billion in the fourth quarter. The ratio of loan loss reserves to total loans was 1.13% as of March 31, 2023. The ratio of loan loss reserves to overseas loans was approximately 2%. For overseas real estate nonrecourse loans, the ratio of loan worth reserves was approximately 4.7%.

Please now turn to Page 15. The nonperforming loans based on the FRA was JPY 39.1 billion as of March 31, 2023, an increase of JPY 17.7 billion from March 31, 2022, an increase of JPY 19.2 billion from December 31, 2022. The ratio of NPLs to total claims was 0.99%. This was mainly due to changes in obligor classification, mainly in overseas real estate nonrecourse loans. The coverage ratio was 93%, an increase from 77% as of December 31, 2022.

I'll now share some balance sheet highlights, starting on Page 16, which contains our general overview. Please now turn to Page 17. Total loans increased by JPY 564.2 billion compared to March 31, 2022. Domestic loans increased by JPY 382.6 billion due to an increase in environmental finance and loans to the borrowers with strong credit ratings, such as government, domestic REITS and leasing.

Please now turn to Page 18 for our breakdown of our overseas loans. Overseas loans were USD 10.3 billion, an increase of [ USD 550 ] million. On a yen basis, the outstanding balance was JPY 1.37 trillion and represented 35.3% of total loans. As you can see on the graph at the top right corner of the slide, the loan spread was flat compared to the last year.

Please turn to Page 19 for more information on our North American corporate loan exposure. Our North American corporate loan outstandings decreased by $40 million. In light of the uncertain financial environment in the U.S., we've maintained portfolio quality through selective loan originations and flexible rebalancing. As a result, our loan portfolio continued to outperform the market index as shown in the graph at the bottom of the page.

Page 20 contains the information about our overseas real estate nonrecourse loan portfolio. The majority of our overseas real estate nonrecourse loans are located in the U.S. In the U.S., weak office demand and rising interest rates have raised market concerns about U.S. commercial real estate, particularly office loans. But our experienced team in Tokyo and New York are closely monitoring the portfolio, and we are controlling risk by making necessary provisions in the fourth quarter based on conservative evaluations.

With regard to the status of our loan portfolio, we will continue with a cautious approach based on the conservative credit analysis, and we make only senior secured loans while we don't provide ADC loans. All underlying properties are with positive cash flows. We only participate in syndicated loans consisting of major lenders in the real estate market, property owners who are quality sponsors with a long-term investment horizon and ranges who are established financial institutions with proven track records.

In terms of the status of our office loan portfolio, the majority of high-quality offices located in major metropolitan areas and 85% of the offices are Class A buildings. As you can see on Page 21, locations are geographically diversified with New York being the largest accounting for 37% of the total. While office demand remains weak across the U.S. The flight to quality has made New York an area of prime real estate with high occupancy rates. On the other hand, San Francisco remains an area of concern due to rising vacancy rates, but the exposure is limited to 4% of total CRE loans. As I mentioned earlier, nonperforming loans increased due to the conservative evaluation of the overseas real estate nonrecourse loans in the fourth quarter.

In terms of office loans, we classified USD 145 million, which is equivalent to 7% of the total overseas nonrecourse loans as NPLs based on the FRA. And the ratio of the loan growth results to the U.S. office loans increased to an adequate level of approximately 4.7%. Currently, the real estate financial market is not very liquid and the market for real estate sales is quite limited. During the workout process, Aozora plans to maximize the collections by carefully assessing trends in the real estate market.

Please turn to Page 22. Our domestic real estate nonrecourse loans were JPY 428 billion, an increase of JPY 47.1 billion compared to March 31, 2022. When compared to December 31, 2022, loans increased by JPY 7.6 billion, which was mainly due to an increase in loans to borrowers with strong credit ratings, such as domestic REIT. We continued a selective origination and therefore, the majority of the transactions in the portfolio have low LTVs.

For a review of our securities portfolio, please now turn to Page 23. Securities were JPY 1.28 trillion. We continued to perform risk-reduction operations on the securities portfolio and the balance of JGBs and municipal bonds as well as the foreign government bonds decreased. Investment trust increased as a result of investing in their funds for risk control operations in the future. Unrealized gains losses including unrealized gain losses on hedging instruments were a net loss of JPY 63.8 billion, an improvement of JPY 6.3 billion from December 31, 2022.

Please now turn to Page 24 as I'll discuss a bit more about the risk reduction measures we took on our securities portfolio during the year. We further reduced our level of risk in the fourth quarter, and our value at risk was reduced to JPY 2.2 billion as of March 31, 2023. All of our U.S. and European government bonds, 90% of mortgage-backed securities as well as 80% of our ETFs were hedged as of March 31, 2023. We are continuing to work on the loss cut, mainly in the foreign government bonds from April onward.

Please now turn to Page 25. Total core funding was JPY 5,645.1 billion, an increase of approximately JPY 120 billion from December 31, 2022. Our retail funding ratio was 66%, and the balance was approximately JPY 3.7 trillion. Liquidity reserves, which a surplus fund at hand for cash management purposes operated with high liquidity method were at an adequate level of JPY 1.36 trillion. In terms of our foreign currency balance sheet, the breakdown of investments and funding are as shown in the graph at the right bottom. The medium- to long-term funding, bonds and deposit fund our overseas loans.

Please now turn to Page 26. On a preliminary basis, our consolidated capital adequacy ratio was 9.43%. Although we are subject to the Japanese domestic standards. For reference purpose, we also disclose our CET1 ratio, which is based on international standards. Our CET1 ratio was approximately 7.4%.

Please now turn to Page 27. We announced a fourth quarter dividend of JPY 40 per common share. The full year dividend is JPY 154, the same level as the initial dividend forecast. We maintained a dividend as our customer-related business continued to perform strong and the capital adequacy ratio was maintained at the adequate level of 9.43%.

Please now turn to Page 28 for the status of GMO Aozora Net Bank, GANB for short. GANB's business, including domestic transfer transactions, debit costs and corporate loans performed well, with net revenue exceeding and business profit in line with the plan for fiscal year 2022. The number of corporate accounts grew to approximately 77,000 and the number of simple embedded finance service contract has progressed almost as planned.

Please now turn to Page 30. This page shows the review of the previous midterm plan, Aozora 2022, we forecast on Aozora strategic investment business and the customer-related business performed strongly. In fiscal year 2022, earnings significantly declined mainly due to the loss cuts taken on a portion of unrealized losses in the securities portfolio in our financial market-related business and review of the sales policy of structured bonds in retail. Going forward, Aozora will continue to expand its customer-related business forecast on our Aozora's strategic investment business as well as restructure our securities portfolio in the financial market-related business and transform the structure of our retail business. Today, we also announced our new midterm plan, Aozora 2025, which addresses the key challenges I have just mentioned. We hope that you take a moment to review our new plan.

In conclusion, we'd like to thank each of you for setting aside some time for us today and for your ongoing interest in Aozora Bank. As always, our management team remains committed to delivering products and services that meet the needs of our customers and achieving our financial targets while maintaining our ongoing focus on disciplined risk management. Your continued interest and support is greatly appreciated. Thank you for your time today.