Daiwa Securities Group Inc

TSE:8601

Earnings Call Transcript 2019-Q3

[Mikita Komatsu, executive]

I am Komatsu from Daiwa Securities Group Inc. Thank you very much for taking time out of your busy schedule to join our telephone

conference today.

I would like to explain the results of the third quarter of FY 2018, which we have just announced today, along with the presentation material we have uploaded on our homepage.

Please turn to Page 4. Let me first take you through the summary of the consolidated results. Increase and decrease shown in this material are versus the second quarter of FY 2018.

Net operating revenues of the third quarter in 2018 were JPY 110.3 billion, up 2.3%.

In the Retail Division, revenues were down, as stock investment trust sales and trading value of foreign equities dropped during the correction phase towards the end of that year, partially offset by the net asset inflow and net account openings associated with the global IPO of SoftBank. In the Wholesale Division, revenues in Global Investment Banking were record high on the quarterly basis, since 2010, driven by a large growth in underwriting offering commissions and M&A-related commissions, although equity and FICC revenues were down in global markets.

Ordinary income was JPY 19.4 billion, down 3.3%.

SG&A was JPY 94.1 billion, up 1.9% on the back of higher advertising and promotion expenses related to sales promotions and increase in earnings-linked bonuses overseas.

Profit attributable to owners of the parent company was JPY 14.1 billion, down 20.5%. Annualized ROE was 4.5%, and BPS was JPY 782.06.

Please turn to Page 10. Let me explain the P/L summary.

Commission received was JPY 78.3 billion, up 18.3%. We are disclosing the breakdown of commission received in details on Page 23, but briefly: Brokerage commission was JPY 14.5 billion, down 1.8% due to a drop in foreign equity trading volume. Underwriting and secondary offering commission was JPY 17.9 billion, significantly up by 188.9% attributable to the global IPO of SoftBank. Distribution commission was JPY 5.5 billion, down 25% due to lower stock investment trust sales.

Net trading income was down on the back of the decline in customer order flows of foreign equities and FICCs. Nonoperating income was down due to a decline in dividend received. We posted a gain on sales of investment securities for strategic purpose in the extraordinary income line.

Please turn to Page 11. Let me explain the breakdown of SG&A. Trading-related expenses were up due to high advertising and promotion expenses related to sales promotions. Personnel expenses were up, as bonus linked to earnings increased in DCA which is the company we acquired in Europe, although it remained flat in Japan. Office cost was up due to outsourcing expense related to IT systems. Depreciation increased as system which was under development began operation.

Please turn to Page 13. Next, I would like to explain ordinary income of overseas operations. Ordinary income of overseas operation in total was JPY 0.3 billion, which marked a positive ordinary income for 11 quarters in a row.

Now let's look at by regions, starting with Europe. Revenue from equity business was down as well as FICCs, influenced by credit spread widening. Asia, Oceania posted a small increase in income, thanks to contribution from SSI securities, while revenues of both equities and FICCs decreased. Income in the Americas was higher, thanks to higher equity revenues, including CB, in addition to lower expenses such as goodwill amortization expense related to DCS.

Let me explain details in each segment. Please turn to Page 14.

First, the performance of the Retail Division. The net operating revenue was JPY 46.3 billion, down by 2%; ordinary income JPY 6.1 billion, minus 9%. Both declined. Equity revenues increased. Foreign equities dropped due to the global IPO of SoftBank. Agency fee for equities increased. Fixed income revenues declined mainly due to the decline in sales of structured bonds. As the market environment deteriorated, sales of equity investment trust declined. That led to a decline in distribution commission for investment trust. Agency fee for investment trust declined due to the decline of the average balance during the term. In others, wrap-related revenues increased.

Please turn to Page 15. In the Retail Division, here is the sales and distribution amount of this quarter. In equities, due to the contribution of the global IPO of SoftBank, the sales increased drastically. That contributed to new account openings and new assets. Wrap account service steadily increased the net value, though valuations declined.

Please turn to Page 16. The next one is Wholesale Division. First, Global Markets net operating revenues JPY 19.5 billion, minus 37.2%. The ordinary income was JPY 3.1 billion in deficit. In equities, customer activities in Japanese equities were stable. However, foreign equities declined as the overseas markets became weaker. The trading income declined as well. In fixed income, as the interest rate goes down, to avoid risks, customer activities declined towards the end of the term. The trading position weakened and the revenue declined.

Page 18, please. Global Investment Banking. The net operating revenues JPY 17.5 billion, up 113.3%. The ordinary income was JPY 6.3 billion. In equity, as of writing, we were the lead manager of the SoftBank IPO. And our experiences of being the lead manager in multiple deals significantly contributed to the increase. In debt underwriting, we were the lead managers in straight bonds and subordinated bonds. And we have multiple benchmark bonds experiences, and in M&As we completed a lot of overseas and cross-border deals.

Page 19. This is the Asset Management. Net operating revenue was JPY 12.1 billion, plus 0.3%; ordinary revenue JPY 6.9 billion, minus 5.7%. In Daiwa Asset Management, the average balance of equity funds declined towards the end of the term due to market factors. Both the net operating revenues and ordinary income declined. Real estate asset management: Daiwa Real Estate Asset Management, the REIT company, acquired properties. The AUM became record high.

Page 21, please. The Investment Division. The net operating income was JPY 1.5 billion. The ordinary income was JPY 600 million.

With this, I would like to complete my presentation about Q3 result FY 2018.

[Unknown Executive]

Now we'd like to receive questions from the participants. You can ask questions in English through the simultaneous translation, but first we'd like to receive questions in Japanese first, followed by questions in English. And please follow the explanation of the operator.[Audio Gap]

[Masao Muraki, analyst]

And for the past 3 months, what has happened for both subsegments? And what is the outlook for the future? Do you expect the recovery from the third quarter going forward? And the reason why I am asking is because for the equity subsegment half of the foreign equities of sales are dropping by about half. I think half of this drop is explained by the falling equities. For the FICC business, structured bonds and position management were down. That resulted in these results. I think the majority of the decline of the FICC business is explained by those factors. Am I right? And the second question is related to IPO of SoftBank. Due to this IPO of SoftBank, underwriting acquisition increased by more than JPY 10 billion in total, but other than that, for example, was there any impact on our other business-as-usual, like marketing activities? And what was the impact on the sentiment of retail investors after IPO of SoftBank? I think it's difficult to quantify those factors, but what is the impact from the global IPO of SoftBank?

[Unknown Executive]

Muraki-san, thank you so much for your questions. Your first question was about trading income. As Mr. Muraki analyzed correctly, first, for the equity business, yes, that's due to the significant drop of the trading volume of foreign equities. And as a matter of course, market sentiment was not great, so trading profits are low and deteriorated, because of the market sentiment. For the FICC business, as you mentioned correctly, structured bond sales were stagnant. In addition, position management did not work very well. Going forward, do I expect a recovery in the future? I think we are out of the bottom in December, but first, for the equity business, the trading of foreign equities is not easy yet. Especially, these days, [indiscernible], Amazon, depending upon the name of the [ stock stakes pegs ], those names are not really performing well. The volatility of those names is higher than we expected. So it's not just a linear pace of increase that we experienced in the past. So the trading volume has not come back to the previous level, yet at this point, for the FICC business, deals with structured bonds are recovering only a little bit, but I am not seeing a dramatic recovery in Japan. There is absolutely no [indiscernible] of the interest rates in the Japanese market. The position management is not [ eating ] this environment. We have to always hold certain stock level, but trading for FICC business is still in a very difficult situation. In the future, when the market improves, then I think income from that business will, should improve, but at the moment it's hard for me to say that is improving visibly. Let me address the second question, related to the IPO of SoftBank. How large was the impact? The underwriting commission increased by more than JPY 10 billion, but your question was, are there impact on other businesses? Or business as usual. In the Retail Division, the time we devoted was in the parallel relationship with the return that we received. For SoftBank, this IPO was the record large type, and we really tried to distribute this IPO win very carefully. So roughly speaking, 25% to 30% of the time was devoted to this deal, to this mandate in this environment where we have not really increased the time in total for marketing. So the time that we can share and spare for other products decreased. So that impacted directly to the sales amount of other products. And SoftBank IPO price was about JPY 1,500, whereas the IPOs, there was a significant slowdown. And it's still a little bit over JPY 1,400 we have never recovered to the IPO price since the IPO. So the customer sentiment is somewhat down. I cannot say sentiment is stronger. So I think there is some impact on the customer sentiment, but there are other names other than SoftBank. Obviously, sentiment is influenced by the overall market situation, not only SoftBank, but there are good news. For example, relating to IPO of SoftBank, in the Retail Division 70% was new money. That means we had new -- capital flow of more than JPY 300 billion. And customer driven, we sold half of -- more than half of the customers driven, we sold. SoftBank IPO was new or dormant customers. We called it non-actives. So more than half was non-active customers. So we were able to scale or reach a wide range of customers because or thanks to this SoftBank IPO, but the share price of Softbank has never recovered to the IPO price yet. So there's an impact from that.

[Operator]

[indiscernible], Morgan Stanley.

[Unknown Analyst]

I have 2 questions, the current environment and costs. Right now the foreign exchange-evaluated sales is severe. And looking forward for the next year and 1.5 years, I cannot really negotiate. And the allocation has been already completed. And as you have mentioned before, some non-active customers came back and that you have established new communications with those customers. So you can change your sales methods, but have they taken effect? And could you please elaborate on that part? And one more question, if you could detail. According to the presentation, Q-o-Q, 39%, a decline in accordance with statistics, except for ETFs, the investment trust sales. But 13% declined Q-o-Q, so there is a great difference. And according to Nikkei statistics, Q-on-Q, 13% decline. And the company experienced minus 36% of the distribution commission for investment trust. And why do you have 36% decline and 39% decline in sales? However, as the commission was minus 25%, is that because of the bull-bear situation?

[Audio Gap]

[Unknown Executive]

The second one is the minus 39% of the sales of stocks. In our company, as I mentioned before, 25% to 30% of the time was allocated to SoftBank IPO. So compared to the sales of investment trust, we allocated more to -- time and money to SoftBank IPO. And the end of September, the basic price of investment trust became very high, but after that it started to decline. In that situation, we struggled to sell investment trust. And the customers were not really active. That was a main reason; and also the structured portfolio of the products, where in this quarter we didn't have any hit products. So we have a lot of factors. I'm not going to talk about all of them, but we don't sell balanced fund. And in this industry, such index funds are selling well, and that is why we declined more. And we provide, we offer funds wrapped to those customers. So I hope you don't only look at investment trust sales to make a judgment. Well, some additional things about investment trust sales: The sales and also commissions, when I look at that, I see the bull-bear situation. More than a year ago, for example, it was different, but it was more than 1.5x [indiscernible]. And the highest was 2%, and recently it has been declining. 1.5% is the level currently.

[Unknown Analyst]

And do you have any views toward the future? And so -- and non-active customers are increasing. They are coming back, and they might be affluent. They should have a lot of capitals. And so maybe you can talk about allocation of assets at your customers, those customers? Is that what you're thinking about doing?

[Unknown Executive]

Well, there is not so much difference in terms of the distribution commission. Well, about 2% and lower is the average. Well, closer to 1.5%. That is because of the switching portion that is larger, and overall it becomes lower. So we do not intend to lower the commissions. We do not intend to change our policies in that regard. So probably a little bit less than 2% should be our appropriate level of commissions. Yes, it becomes less than 1.5% or 1%. Well, I -- we don't really think about that situation.

[Operator]

Next questions are from Otsuka-san from JPMorgan.

[Wataru Otsuka, analyst]

My name is Otsuka from JPMorgan. I have 2 questions. First question, for these 3 months in the third quarter, the ordinary income level which is JPY 19.5 billion. So what is your take on this level of the ordinary income in the third quarter which is JPY 19.5 billion, which is almost the same as the second quarter? And there was a bit increase from the SoftBank mandate, but were there any factors behind that you could have made more money and which are income -- was limited to this level? Second question, the KPI, Daiwa's BPS. You are going to continue to use customer-driven KPI, but in the medium-term management plan, you have managerial KPI ordinary income by 2020. You are aiming at more than JPY 200 billion. As far as I see, for the first 9 months of this year, I think you are a bit behind. The external environment that you made this midterm plan and the current external environment, are they different?

[Unknown Executive]

Otsuka-san, thank you so much for your questions. So your first question, about the level of the ordinary income, JPY 19.5 billion for the 3 months in Q3, which is about the same as the level in the second quarter. Actually, income ins and outs are totally different, although the total number is the same. In the second quarter, in the Investment Division there was a large loss. So without the large loss, the difference between the 2 quarters would have been higher. And in addition, as I explained before, the mandate of SoftBank deal -- and there was a large contribution from SoftBank mandate, but still income was down. So from the management point of view, I am not happy with this level, especially Global Markets. Well, Global Investment Banking was good, but Global Markets. Ordinary loss was posted for Global Markets, which was the second -- from the second quarter of 2012. And the second quarter of 2012 was under Prime Minister Noda's administration. So since then, this was the first ordinary loss. So I regret that we could have done better, if we could do better job market position management and so forth, but obviously market was not easy market for us to operate. So for the FICCs business in Japan and Europe, it was a difficult market to handle in the third quarter, so unfortunately, business was very, very tough. And your second question, ordinary income target of JPY 200 billion, currently JPY 65.4 billion. And your impression was that we are a bit behind after the third quarter. External environment is much worse than then, let's say, Nikkei average, foreign exchange. So the profit level is lower than we expected when we made the midterm plan, but we cannot just pursue [indiscernible] profits, meaning back then when we made the mid-term plan, Nikkei average assumption for 2020 was JPY 27,000. So the current market environment is totally different from the market assumption we had back then. So at the moment, we are not planning to change our target in the midterm plan, but unfortunately environment that we are witnessing now is very different, much worse than the market assumption we had. So

[Audio Gap]

[Unknown Analyst]

And I think you had those targets, but is my understanding correct, that you are continuously working on those as planned business improvement, efficiency improvements?

[Unknown Executive]

We are stringently working on that. Under the cost level, we were behind our systemization, and we are catching up or we have caught up. And depreciation is up because of the new systems, and uncertain costs related to IT systems is increasing. So on the surface, you don't really -- you don't see the improvements. But the headcounts are not increasing really. In this environment we are addressing new businesses, so our businesses are improving in terms of efficiency. And the digitalization is making a good progress, although you don't see those improvements in numbers immediately. But every day, I think, we are making good progress.

[Operator]

Next is from Merrill Lynch Japan, Mr. Sasaki.

[Futoshi Sasaki, analyst]

My name is Sasaki from Merrill Lynch. I have 2 questions. The first one, about the Q3 numbers, the FICCs segment. The others was JPY 2.29 billion. However, it includes others and adjustments, and that was the reason for the increase. And the second one is about balance sheet, financial income and financial cost expenditure. When I look at that, the fixed income position has been changing. According to the balance sheet end of the year, trading-related account is not really increasing, but during the term, you increased the Treasury bond [indiscernible] operation. That's my assumption. Is my understanding correct? Position management is difficult, and because of that, you are increasing the quantities. So how can I interpret these balance sheet figures?

[Unknown Executive]

Thank you very much, Mr. Sasaki, for the questions. First, others and adjustment. For example, in group headquarters we have an ordinary income from headquarters in the holdings and because of the distribution to these companies. It's -- accounts for consolidation, so when you account [ a young ] companies, it's always deficit. And this time, the major one is Daiwa Next Bank, which is generating a lot of profit. Daiwa Next Bank is included in others now. And that's where the position of Daiwa Next Bank, and we will have to review the positioning. And that is reflected on this 1 -- Q3 operating efficiency. Q3, the profit was large for others part in the segment family. And one more question was about the effective tax rate. When we look at the overseas business, Europe have deficits and loss, so effective tax rate is higher

[Audio Gap]

And as for Q2, there is a benefit in terms of the taxation. Daiwa Securities SMBC Principal Investments, this is -- and the company is not subsidiary anymore. So there's a tax benefit. So Q2, 28% was lower. Q3 was higher. That was the gap, and that's if we looked around this number. And the next question was about fixed income positioning -- position management.

[Futoshi Sasaki, analyst]

Well, during the term, you increased [ and you ended the term ], right? This may decrease.

[Unknown Executive]

No, we didn't do it. Well, we maintained the same level. And for this quarter, the interest rate is not really moving, or it's declining. The position management was difficult in this situation; and where, well, we thought the investment -- the interest rate might go up, but actually it didn't move. So FICC [ the traded ] position management was not easy, so the P/L didn't show an increase.

[Futoshi Sasaki, analyst]

So just simply speaking, Q3 financial income can growth -- increase. Is that because of the credit by corporate? Or do -- and did you increase the balance? The Retail position was large. And in Americas we thought the positions are increasing there because they are making profits.

[Unknown Executive]

So in Americas, I think the fixed income is generating benefits. In the Americas, U.S., they are increasing the position [ of people ] the treasury bonds, [ bad news ]. Rather than with -- gains with customers, you have more increasing amount of principals and proprietary [indiscernible], but for repo they have proprietary trading to obtain the position and to generate profits, sometimes [indiscernible]. So we have both. And then we have -- towards the end of the term, it's increasing, but we have only [indiscernible] with what we have described.

[Audio Gap]

towards the end of the term

[Audio Gap]

talk about treasury. Well, [ considering the fold in ] fixed income, so we have more inventory. For credit as well we have this number, higher number.

[Operator]

[Operator Instructions]

[Unknown Executive]

We still have time. Are there any other questions? If not, we would like to end the Q&A session.

[Audio Gap]

In Q3, on October 2, Nikkei average marked JPY 24,270. And one time, it became less than JPY 20,000, down by almost 20%. And fixed income markets suffered both in government and corporate bonds due to lower interest rates. Meanwhile, IPOs of companies such as SoftBank contributed to attract assets from retail customers. M&A recovered as well with many cross-border deals. However, unfortunately, the weaker market demotivated retail customers in particular. And there is no significant signs of improvement, although there is a slight increase. Well, the global uncertainties such as U.S. and Chinese trade friction and Brexit have yet to be solved. And the market in Japan is highly impacted by the situation and responding accordingly. We, however, believe in the strength of the Japanese fundamentals in both absolute and relative terms. Taking this opportunity of retail markets, we'd like to exert the utmost effort to attract our customers. We would highly appreciate your further support.

Thank you very much for your participation. With this, we'd like to complete this conference. Thank you very much.

[Operator]

With this, we would like to finish the telephone conference. Thank you very much for your participation. Please don't forget to turn off your phone. Thank you.