Cathay Financial Holding Co Ltd

TWSE:2882

Earnings Call Transcript 2020-Q1

[Operator]

Welcome, everyone, to Cathay Financial Holding Co. First Quarter 2020 Conference Call. [Operator Instructions]

And now I would like to introduce Ms. Sophia Cheng, the CIO of Cathay Financial Holding Co. And Ms. Cheng, please begin.

[Sophia Cheng, executive]

Thank you. Good afternoon, and good morning for those in Europe. Welcome to Cathay Financial Holdings' 2020 First Quarter Analyst Meeting. I am Sophia Cheng, the Chief Investment Officer of Cathay Financial Holdings. Today, I will host the conference call and thank you so much for joining us today.

In the beginning, I would like to introduce the senior managers who are with us today. Today, we have Mr. Daniel Teng, Senior EVP of Cathay Financial Holdings; Ms. Grace Chen, Chief Financial Officer of Cathay Financial Holdings; Mr. Abel Lin, Managing Senior EVP of Cathay Life; and [ Ms. Joyce Tang ], Senior EVP of Cathay United Bank.

For today's conference call, Shane Sun, our IR team, will present the first quarter results, and we also will update the 2019 embedded value details. After the presentation, we are open for a Q&A section in which senior management will be more than happy to answer your questions.

Without further ado, let me pass the call over to Sun for the briefing of the first quarter results.

[Shane Sun, executive]

Thank you, Sophia. Let's start with the business overview of first quarter 2020 on Page 4, which provides a quick highlight on each subsidiary. Cathay United Bank continue to adjust the loan mix with benign credit quality. Net interest income grew steadily. Overseas expansion continued. Cathay United Bank obtained Myanmar regulatory approval to upgrade the rep office to branch. Foreign currency loan grew steadily. Offshore earnings accounted for 51% of pretax earnings.

Cathay Life continued its focus on value-driven strategy. First year premium ranked #1 in the industry. After-hedging investment yield reached 4.16%. Overall investment performance maintained stable.

Cathay Century, the general insurance subsidiary, premium income grew 2% year-on-year. Market share was 11%, maintained #2 in the industry. Overseas premium increased steadily. Asset management subsidiary, Cathay SITE, has AUM of TWD 781 billion, ranked #1 in the industry. Lastly, Cathay Securities' brokerage business continued to grow, and its sub-brokerage market share remained #1 in the industry.

Please look at Page 5, Cathay Financial Holdings net income and EPS. Cathay Financial Holdings reported after-tax net income of TWD 23.5 billion for the first quarter of 2020, increased 74% year-on-year. All the subsidiaries had over double-digit growth. Our earnings per share was TWD 1.77.

Page 6 shows the subsidiaries' net income and ROE. Cathay United Bank's earnings grew 19%, with higher interest income and investment income. Cathay Life earnings grew 136% because of better investment performance. Cathay Life adjust its investment portfolio to reduce the impact of market volatility, which result in higher capital gains. On a consolidated basis, the holding company's ROE was 13% in first quarter of 2020.

Please turn to Page 7 to see the book value of Cathay Financial Holdings. The holding company's book value as of the end of first quarter was TWD 670 billion, and book value per share was TWD 43.1.

Page 9 and 10 show our overseas expansion, which is on the right track. Cathay Financial Holdings continues to expand its overseas business by deepening its overseas presence and reinforcing the relationship with local partners. In April, Cathay United Bank obtained Myanmar regulatory approval to upgrade the rep office to branch. Cathay Life Vietnam's total premium increased by 58% year-on-year and Cathay Century performed steadily in Vietnam.

For the operation in China, Cathay United Bank's China subsidiaries business is on the right track. For Cathay Life joint venture in China, the total premium grew by 9% year-on-year. For general insurance, the strategic alliance with Ant Financial was going very well in China.

Please turn to Page 12 for more details about our banking subsidiary. With proper risk management, Cathay United Bank continued to adjust its loan mix by increasing foreign currency and consumer loans while reducing loans to government. The banking increased their capital efficiency and focused on asset quality.

Cathay United Bank loan balance was TWD 1.5 trillion as first quarter of 2020. Deposit grew by 7% year-on-year to TWD 2.4 trillion. The bank continued to maintain high demand deposit ratio.

Interest yield is shown on Page 13. The net interest margin was 1.25% for the first quarter of 2020. Interest rate was 1.91%, up by 5 basis points compared with last quarter, benefiting from rate [ cuts ] with low-funding cost.

Page 14 shows the asset quality of Cathay United Bank. Due to our prudent lending policy, Cathay United Bank maintained low NPL ratio at 15 basis points and coverage ratio at 1,190%. Gross provision was TWD 0.8 billion, in which most was the general provision for the regulation requirement. Recovery was TWD 0.3 billion.

Please turn to Page 15 for SME and foreign currency loans. Cathay United Bank's strategy is to grow loan with quality. SME loan balance reached TWD 206 billion in the first quarter of 2020. Foreign currency loan balance also reached TWD 247 billion, accounting for 16% of total loans.

Our offshore earnings is shown on Page 16. Offshore earnings was TWD 4.4 billion, and offshore earnings accounted for 51% of bank pretax earnings for the first quarter of 2020.

Please turn to Page 17 for fee income. Fee income was TWD 5.5 billion in the first quarter of 2020, declined 5% year-on-year. Credit card fee declined due to impact from COVID-19 pandemic with lower consumption. Wealth management fee declined due to low bancassurance fee.

Page 18 shows the breakdown of wealth management fee. Wealth management fee income declined 2% year-on-year, amounted to TWD 3.2 billion. Starting from April 2019, continuing with falling credit fee rates has decreased the demand of saving type insurance policies.

With the strategic shift into focus on protection-type policies and the impact from COVID-19, the bancassurance fee declined year-on-year. However, the bank continued to promote asset allocation with diversified products. Fee income from mutual fund and security product increased significantly year-on-year, largely offsetting the decline of bancassurance fee.

Please turn to Page 20 and 21 for Cathay Life premium performance. Total premium was TWD 163 billion in the first quarter of 2020, down 3% year-on-year. The decline was due to lower first year premium. However, the renewal premium increased year-on-year, driven by growth of protection-type policy and traditional regular pay policy.

On Page 21, first year premium was TWD 42 billion and the annualized premium, APE, was TWD 18 billion, down by 30% and 37%, respectively. The decline was mainly due to the impact from COVID-19 pandemic and the lower policy reserve rate.

Page 22 shows the value for new business. The sales volume and product mix were impacted by COVID-19 pandemic and a lower policy reserve rate. Based on the 2019 embedded value assumptions, value of new business in first quarter of 2020 was TWD 8.5 billion, decreased by 47% comparing to TWD 16 billion in first quarter of 2019. In later part of the presentation, we have provided updated embedded value, including assumptions.

Page 23 shows our cost of liability, which continued to improve. The reserve base liability cost was 3.92% at the end of first quarter of 2020, improved 3 basis points year-to-date.

Please look at Page 24 for our investment portfolio. Cathay Life's total investment reached TWD 6.4 trillion at the first quarter of 2020. Overseas investment accounted for 66%. The investment return of each asset class are as follows: cash and cash equivalents, 0.5%; domestic equity, 5.8%; international equity, 8% pre-hedged; domestic bond, 6.9%; international bond, 5.9% pre-hedged; mortgage and secured loans, 2.2%; policy loans, 5.4%; real estate, 2.6%.

Overall investment yield are shown on Page 25 and 26. After-hedging investment yield was 4.16%. On Page 26, pre-hedging recurring yield was 3.11%, declined by 23 basis points year-on-year.

To reduce the impact of market volatility, starting from the second half of last year, Cathay Life adopted the risk strategy to adjust its investment portfolio, reduce its equity position and enhance the fixed income credit mix. Therefore, the relatively higher cash position in January and February this year affected the recurring yield of first quarter.

However, since March, Cathay Life has taken the [ market ] opportunity to increase its investment position. The cash position has reduced, most cash dividend comes in the second and third quarter, which will help improve the recurring yield.

The annualized hedging cost was 1.69% for the first quarter. New Taiwan dollar depreciated 0.5%. However, other foreign currencies were still relatively weak comparing to the new Taiwan dollars, which reducing the effectiveness of basket hedging. Cathay Life will continue its flexible and dynamic hedging strategy to ensure the effective control of the hedging cost.

Please look at Page 27 for the regional breakdown of overseas fixed income. Overseas fee income investment, Cathay Life allocated 44% in North America, 20% in Europe and the rest are in Asia Pacific and other countries.

Page 28 shows the book value and unrealized gain of financial assets. Both the consolidated book value and unrealized scheduled financial assets was down in first quarter of 2020. COVID-19 triggered risk aversion and caused global capital market volatility in the first quarter. However, in April, the capital market rebound. The unrealized gain and loss balance increased significantly by the end of April.

Next, please turn to Page 32 for the performance of Cathay Century. Cathay Century's premium income was TWD 5.8 billion, up by 2% year-on-year. Market share was 11% in the first quarter of 2020. Cross-selling synergy continued to perform well. Over 60% of total premium income was generated by the group channel.

So far, I have updated the first quarter 2020 operation results. Today, we have one additional topic we would like to update, which is the 2019 embedded value and appraisal value estimates.

Please turn to Page 36 for Cathay Life's 2019 EV and AV estimates. On Page 36, we have summarized EV and AV major components. In this table, we have provided the asset yield assumptions for various insurance policies. You can see that we have reduced the equivalent asset yield by 58 basis points to 3.86% and discount rate by 0.5% to 9.5%.

Based on the new assumption, Cathay Life 2019 embedded value increased by 4% year-on-year to TWD 74.1 EV per holding company share. As for appraisal value, Cathay Life AV as of 2019 was TWD 1.24 trillion or TWD 98.4 AV per holding company share. We have also estimate 2020 value for 1 year new business of TWD 35 billion and apply multiples of 8.8, which deriving value -- when deriving value for new business. In the following pages, you can see more detailed analysis on 2019 movement of EV components.

On Page 43 and Page 44, we have provided the scenario of impact from various investment yields and discount rate. Where, on Page 45, you can also see a summary table for year-on-year comparison. We hope the information is useful to you.

This is the end of presentation. Now let's open to Q&A.

[Operator]

[Operator Instructions] The first question is coming from Jemmy Huang of JPMorgan.

[Jemmy Huang, analyst]

A couple of questions on -- mainly on the banks. I think the first one is you mentioned you are focusing on consumer loans as part of your loan growth strategy. Could you let us know what kind of mortgage consumer loans you are doing? If you are cautious on the economic outlook, should we perceive that consumer loans compared to mortgages are actually carrying higher asset quality uncertainty?

The second question is, I think according to FSC, the payout cases or loans at Cathay United Bank is actually one of the highest among the private banks. Just trying to understand, for all the payout cases you have done so far, are this for your -- all for your existing customers? Or you're actually doing for the new customers as well?

The third question is on bank's operating expenses. It was down year-on-year in the first quarter. I looked at the financial statement, it's mainly due to the other [ marketing ] and administrative expenses. Are those -- the year-on-year decline, are these related to credit card promotion over anything else? Should we expect the operating expenses to decline for the whole year? Or first quarter is just on some seasonal effect?

And the final question is for the FYP. I think you have your own definition for protection-type policies, and the sales was growing over 20% year-on-year in 2019. Just trying to understand how the momentum looked like in the first quarter this year.

[Chung-Yi Teng, executive]

First one about our consumer loan. We're talking about -- we are focusing on the consumer loans. So most of that is from the mortgage. And a very small part, maybe 10 -- or TWD 10 billion or TWD 20 billion is from the high credit score consumer loan. It's for our credit cards, our clients for a short-term loan, short-term lending with very high margin. It's only for the like May or June, this tax season. So we're offering some kind of our credit card clients' very short-term loan and consumer loan with a high -- increased margin. But most of that is from the -- our mortgage loan. For the first part, right?

[Sophia Cheng, executive]

And the second is for [ the payout loan ].

[Chung-Yi Teng, executive]

Yes. For the payout loan, it's most from our existing clients, okay?

And then for the third part about the expenses. The expense reduction is because, for the first quarter, our business activities is reducing because of COVID-19, so the travel, commission, everything. Even though as we [ continue ] without clients, it reduced a lot compared to last -- I mean, quarter-on-quarter or year-on-year. So our expenses compared to last year has slowed down a lot. I forget how many percentage. So it's a seasonal -- I won't say it seasonal because there's a very special situation currently.

[Sophia Cheng, executive]

Yes. This is more temporary.

[Chung-Yi Teng, executive]

Yes. I guess it's temporary. But if -- I mean, the COVID-19, it relaxed and our business activity is getting more and more, I expect the expenses about -- especially related to our business activity will be getting more and more.

[Sophia Cheng, executive]

So for cost income ratio, the level at low 50% should be a reasonable range as before. It's quite similar...

[Chung-Yi Teng, executive]

I would say currently lower than 50%. Right now it's very reasonable. But for the next season, our next quarter or for the next half year, it really depends on how strong we will push our business to where.

[Sophia Cheng, executive]

So it's really mainly related to business activities and the [ things ] you asked.

[Grace Chen, executive]

Yes, mainly -- I might reiterate. For example, you can see the first quarter, our insurance premium was lower down, around 30%. So the related incentive personnel, especially paid to those wealth management consultants, is much lower. So you can see the expense -- operating expense is much lower. CE ratio is lower.

[Chung-Yi Teng, executive]

Yes.

[Sophia Cheng, executive]

On [indiscernible] traditional...

[Chao-Ting Lin, executive]

Jemmy, the first quarter, FY 20, we expected that -- I think that because there's 2 reasons. The first one is the reserve rate is down. So we expect the momentum should be lower. Second one is COVID-19 also will impact our sales to approach our customer. So I think this number refers to our value of new business. Right now, it's at TWD 0.5 billion. And this is also as expected. So I think that -- but if we look at from the April, I think the momentum is a little bit stronger than the first quarter.

[Sophia Cheng, executive]

Last year, the pure protection and protection rate have...

[Chao-Ting Lin, executive]

Yes. I think no matter the protection rate or protection type or the like savings type, I think that because mainly the reserve rate is down, so the premium increased, they still need time to catch up. So I think the -- we expected the first quarter is the lowest quarter. And we expect that the second quarter, as we see is -- or the volume, I think, especially traditional, we think that should be gradually stable and picked up. And because at the third quarter, we also lower down the reserve rate more. So we expect the second quarter, the volume should be increased.

[Operator]

[Operator Instructions] And the next question is coming from Edwin Liu of HSBC.

[Edwin Liu, analyst]

So I have 2 questions. First one is on the banks. I saw that in the first quarter, the interest spread and the NIM actually increased despite the Feds has been cutting rates since the last few months of last year. Can I get more color in terms of why the interest spread and NIM actually increased in the first quarter this year? I know you mentioned that deposit rate came down first. But in first quarter this year, I think the Fed has further cut rates, and I just want more color from some -- to understand the mechanism in terms of the minimum interest rate -- interest spread movement.

And my second question is in terms of Life's expense ratio. If I understanding correctly, through some more sort of protection-type business, your expense ratio should increase. But in first quarter, the expense ratio actually decreased. If you can just give more color in terms of why the expense ratio actually decreased. And if I may add, a final question is on your investment portfolio of your Life. You -- for the fixed income portfolio, I understand in March you might have had some bonds probably in the U.S. due to the [ water ] market. May I know, as of now, do you see any deterioration in terms of your credit rating of your bond portfolio? So that's the question from me.

[Chung-Yi Teng, executive]

So for the first one, the only reason is our deposit rate [ reflect ] -- in fact, rate-cutting is faster than the lending rate. So our funding -- I mean, the deposit rate reflects the rate-cutting.

[Sophia Cheng, executive]

So on Page 13, if you look at the slide, certainly, you can see the funding costs actually reduced by about 15 basis points, if you look at first quarter versus whole year last year. So that is the main reason. And the second one is, of course, we have continued to maintain stable in SME, and there is a small growth in foreign currency loan. These all balances. So therefore, contribution from the better loan mix is not as significant as a sizable improvement in funding cost.

And Daniel explained earlier today in the other analyst meeting call that the pricing on lending rates over time will also be adjusted. So if you look at from here toward the end of this year, we might be seeing a couple few basis points of deterioration as you also start to reprice your loan book. But we will try to hold the net interest margin for the whole year toward year-end. If we can manage that at around 1.2 percentage, we'll be quite happy.

The second question is the Life insurance operating ratio. In first quarter last year, it was 11.0%. In first quarter this year, it was 8.5%. If you could look at page -- Slide 21, where you see FYP premium. And you'll notice that the product mix. In first quarter last year, the traditional life, especially regular paid, the contribution was a lot higher than this year. But this year, in first quarter, if you look at the contribution -- investment-linked contribution, it's also higher than last year for the same period. And they explain -- it's actually in line with what you said. The more traditional, the high expense ratio.

And the third question you're asking about the fixed income bonds, corporate credit rating. We have not seen a noticeable credit rating downgrade in our portfolio. If you could look on slide -- on Page 48, this is Cathay Life overseas bond, our direct housing. The credit rating and also by the breakout of currency, you can see that 94% of our bonds is in -- denominated in U.S. dollars, regardless of what country that is. Where to the right-hand side, you can see noninvestment-grade was 3%. If you compare with 3, 4 years, this noninvestment grade was 5% to 6%.

So we have prepared early. In 2019, we used the time to derisk. So if you look at 2-year spend, we believe this noninvestment-grade has already reduced from about 5 percentage level to 3%. So we have taken last year the opportunity to derisk. Whatever corporate bond we own, more sensitive to potential market correction, we have already trained to prepare for possible market volatility. In fact, we'll not just offer the -- after if there is a credit rating. In the meantime, it will not affect our capability to buy on when I see the valuation is better. So the overall, if you look at our bond portfolio, we have not seen not much of credit rating in the portfolio. Overall risk is contained quite well.

[Edwin Liu, analyst]

Okay. May I just follow-up quickly on one general question. You mentioned in terms of insurance sales, starting in the second half of this year, because of the regulatory change, the insurance product will be more expensive. But there's new -- much liquidity in the system, in the society, so your customer would want to invest somewhere. But if you look at deposit rates, it's been quite low. Insurance return also quite low. Investment market right now is quite volatile, but uncertainty in your second half.

If you look at your potential demand from more customer, where would they likely invest their money in the second half? And what kind of position or strategy would you use to capture that opportunity?

[Chung-Yi Teng, executive]

For that, okay, I say more than 50% of our highest deal came to invest in like the fixed income market. Now whether it's like insurance or fixed income fund or just fixed time bond. So they need a very stable interest earnings. So that said, I'll say it's a matter of [ customer needs ].

[Sophia Cheng, executive]

And the insurance guarantee rate is always on relative basis if the bank deposit rate has also fallen. So it usually takes some time for the market to accept a new rate, and that's why it will take 1 quarter to 2 for the FYP to push up again.

And besides the rate cuts in first quarter -- in first quarter, there was also the coronavirus. Even there, typically, if [ Taiwan's ] sector, if there are agents selling force. And this year, this special situation has slowed down the process of the completion of insurance policies. So the profit is lower. But over time, the past 2 months, we have adjust now the procedure flow. So it will start to be more smooth. We are into second, third quarter of all the economy activity is set to resume. They will also help the premium to regrow a little bit.

[Operator]

And next we have Chien Po of Crédit Suisse for questions.

[Chien Huang, analyst]

I just wanted to follow-up on questions for net interest income earlier. So based on management guidance, NIM is targeted to be maintained at above 1.2% this year. So if we take into account of your loan mix adjustments, can we expect to see positive net interest income growth this year?

[Chung-Yi Teng, executive]

So I always explain our net interest will stay -- will remain the same. Because currently, if we don't now make any change on our loan mix, I would expect the net income will be reduced by, I think, more than TWD 1 billion.

[Sophia Cheng, executive]

You mean net interest income?

[Chung-Yi Teng, executive]

Net interest income, yes. But we do have a plan to make some loan mix change to mitigate the effect of our -- I mean, the net interest margin lowered -- coming down.

[Sophia Cheng, executive]

Chien Po If you look at Page 15 -- sorry, 53 of the presentation material, that is the financial summary for Cathay United Bank. And if you see the [ asset ] of this bank over the years, it grew loan book [indiscernible] supported net interest margin direct is better loan mix.

If you see 2017, net interest income was TWD 29.7 billion. A year later, it was TWD 33.4 billion. Last year, it grew further 9%, 36% -- TWD 36 billion in the net interest income. To the bank, the basic requirement is nothing competes with asset quality. So we remain quite cautious on the overall macro. When we see opportunity, we will then. But we will not try to lend to grow the loan book to just jeopardize the asset quality. So if you look at the net interest margin, it remained flat. With loan cost, it's a flat at best, I think. So on a compound basis, probably net interest income will be flat to tiny declines.

[Operator]

[Operator Instructions]

[Sophia Cheng, executive]

Jason, if there's no further question, maybe we can close this conference call?

[Operator]

Thank you, Ms. Cheng. And ladies and gentlemen...

[Sophia Cheng, executive]

Thank you very much. Thank you very much for your participation in Cathay Financial Holdings conference call. And the IR team will stand by here for you if you have further questions. Thank you and goodbye.

[Operator]

Thank you, Ms. Cheng. And ladies and gentlemen, we thank you for your participation.