Cathay Financial Holding Co Ltd

TWSE:2882

Earnings Call Transcript 2020-Q2

[Operator]

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

And now I would like to introduce Ms. Sophia Cheng, the CIO of Cathay Financial Holding Company. 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 Half Analyst Meeting. I am Sophia Cheng, the Chief Investment Officer of Cathay Financial Holdings. Today, I will host the conference call. Thank you very much for joining us today.

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

For today's conference call, Charlie, from our IR team will present the first half results. And after the presentation, we'll 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 Charlie for the briefing of first half results.

[Charlie Hu, executive]

Thank you, Sophia. Let's start with business overview on Page 4, which provides a quick highlight on each subsidiary. Cathay United Bank loan and deposit both grew steadily. Asset quality remained benign. Overseas business continue to expand. Plan to open Myanmar branch by the end of 2020. Offshore earnings was up by 8% year-on-year, accounted for 48% of total pretax earnings.

Cathay Life continued its value-driven strategy and focus on selling investment linked and traditional regular pay policies. Total premium grew steadily, driven by the growth of renewal premium. FYP and APE, both ranked #1 in the industry. RBC ratio was 347%. Capital adequacy remained solid.

Cathay Century, the general insurance subsidiary, premium income grew by 2% year-on-year. Market share was 12%, maintain #2 in the industry. Overseas premium income continued to rise. Asset management subsidiary, Cathay SITE, has AUM of TWD 873 billion, ranked #1 in the industry. Lastly, Cathay Securities brokerage business continued to grow and its sub-brokerage ranked #1 in terms of market share. Net income almost doubled year-on-year.

Please look at Page 5. Cathay Financial Holdings net income and EPS. Cathay Financial Holdings reported TWD 32.7 billion of earnings for the first half of 2020, declined by 4% from the last year due to the recognition of the tax expense on undistributed earnings. EPS was TWD 2.18.

Page 6 shows the subsidiaries' net income and ROE. Cathay United Bank's earnings grew 9% year-on-year, driven by better investment income and lower expense. Cathay Life's net income was flat compared to the same period last year. The net income of other subsidiaries all grew by double digits. On a consolidated basis, the holding company ROE was 8.3% in the first half of 2020.

Please turn to Page 7 to see the book value of Cathay Financial Holdings. The consolidated book value of holding company was TWD 787 billion, reaching a historical high. Book value per share was TWD 51.9 as of the first half of 2020.

Page 9 and 10 shows our overseas expansion. Cathay Financial Holdings continue to expand its overseas business by deepening its overseas presence. In Southeast Asia, Cathay United Bank has footprints in 9 out of 10 ASEAN countries. We plan to open Myanmar branch by the end of the year. Cathay Life Vietnam's total premium increased by 57% year-on-year and Cathay Century performed steadily in Vietnam.

As for the business operation in China, Cathay United Bank's China subsidiaries' business is on the right track. For Cathay Life's joint venture in China, the total premium grew 8% year-on-year. For the general insurance, premium income continued to grow. The strategic alliance with Ant Financial was going very well in China.

Please turn to Page 12 for more details about our banking performance. Along with proper risk management, Cathay United Bank continues to optimize the loan mix. Total loan was up by 3% year-on-year, driven by the growth of personal loans, SME loans and foreign currency loans. Cathay United Bank loan balance was TWD 1.6 trillion as of first half of 2020. Deposit grew by 7% year-on-year to TWD 2.4 trillion. The demand-deposit ratio reached 67%.

Please look at Page 13 for interest yields. The net interest margin and interest spread was 1.21% and 1.82%, respectively. The decline in spread was mainly due to the rate cut impact and loan yield repricing.

Page 14 shows the asset quality of Cathay United Bank. Due to our prudent lending policy, Cathay United Bank maintained benign asset quality with low NPL ratio at 13 basis points and coverage ratio at 1,330%. In the first half of 2020, gross provision was TWD 1.4 billion. Most were the general provision for the regular requirement on the loan growth. Recovery was TWD 500 million.

Next, please turn to Page 15 for SME and foreign currency loans. Cathay United Bank focuses on developing SMEs and foreign currency loans steadily with benign asset quality. SME loan balance reached TWD 205 billion. Foreign currency loan balance was TWD 246 billion, accounting for 16% of total loans.

Our offshore earnings is shown on Page 16. Offshore earnings was TWD 7.5 billion, up by 8% year-on-year, which accounted for 48% of the bank's pretax earnings in the first half of 2020.

Please turn to Page 17 for fee income. Fee income was TWD 9.9 billion in the first half of 2020. Credit card fee declined year-on-year because of decreased consumption momentum under the pandemic.

Page 18 shows the breakdown of wealth management fee. Wealth management fee income grew 1% year-on-year, amounting to TWD 5.5 billion in the first half of 2020. However, Cathay United Bank continued to promote asset allocation with diversified products. Fee income of mutual funds and securities product increased significantly year-on-year, largely offsetting the decline of bancassurance fee.

Please move to Page 20 and 21 for Cathay Life's premium performance. Total premium was TWD 334 billion in the first half of 2020, grew by 3% year-on-year. On Page 21, first year premium was TWD 84 billion, dropped by 21%. The decline was reported from the impact of the pandemic and the lower policy reserve rate. The annualized premium, APE, was TWD 36 billion, down by 25% due to product mix change.

Page 22 shows the value for new business. Based on the 2019 embedded value assumptions, value for new business in the first half of 2020 was TWD 17.4 billion, decreased by 32% year-on-year because of the impact of the pandemic and lower policy reserve rate to the sales volume and product mix.

Page 23 shows our cost of liability, which continued to improve. The reserve-based liability cost was 3.89% as of the first half of 2020, improved by 12 basis points year-on-year and 6 basis points year-to-date.

Please look at Page 24 for the investment portfolio. Cathay Life's total investments reached TWD 6.6 trillion as of the first half of 2020. Cash position was 3.9% of invested assets. Overseas investment accounted for 66%.

The investment returns of each asset class are as follows: cash and cash equivalents, 0.5%; domestic equity, 8.8%; international equity, 1.4% pre-hedge; domestic bond, 6.8%; international bond, 5.8% pre-hedge; mortgage and secured loans, 1.9%; policy loans, 5.5%; real estate, 3.2%. The overall investment return was 3.78% after hedge.

Overall, investment yield are shown on Page 25 and 26. After-hedging investment yield was 3.78%. The decline was due to the one-off recognition of equity method investment loss and higher hedging costs. Cathay Life has maintained proper risk management and dynamic portfolio management in face of market volatility.

On Page 26, pre-hedging recurring yield was 3.12%. Since most central banks embrace easing monetary policies to sustain economic stability and corporates adopt more conservative dividend policy, Cathay Life reacted dynamically to the volatile capital market and realized capital gains, which resulted in the lower recurring yield.

The annualized hedging cost was 1.8% for the first half of 2020. New Taiwan dollars appreciated 1.5% and 2% in the first half and the second quarter, respectively. However, other foreign currencies were still relatively weak comparing to the new Taiwan dollars, which reducing the effectiveness of basket hedging. On top of that, Cathay Life recognized TWD 2 billion extra foreign currencies moving reserves. 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 dividend income and regional breakdown of overseas fixed income. Cathay Life has recognized dividend income of TWD 4.9 billion and TWD 12.3 billion in the first half and the first 7 months of 2020, respectively. For overseas fixed income investment, Cathay Life allocated 45% 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. The consolidated book value was TWD 618 billion, and unrealized gain of financial assets was TWD 121 billion as of the end of the first half, both at record high.

Lastly, please look at Page 32 to 34 for the performance of Cathay Century. Cathay Century's premium income was TWD 12 billion, up by 2% year-on-year. Market share was 12%. Cross-selling synergy continued to perform well. Over 60% of the premium income was generated by the group's channel.

It is the end of 2020 first half results briefing. Thank you.

[Sophia Cheng, executive]

Thank you, Charlie. And now we're ready for Q&A.

[Operator]

[Operator Instructions] The first to ask question is Yafei Tian of Citigroup.

[Yafei Tian, analyst]

I mainly wanted to focus on the Mayapada loss. If you were to exclude this loss from the life business, it's actually a very decent quarter. I just wanted to understand a little bit more details about the strategic plan for this business going forward, understanding you have just under 40% of the stake, and in our view, it perhaps makes sense to increase the stake to a controlling state. Given that you are, at the moment, fully made provisions for all the investments you have made, in a hypothetical scenario, right, if you were to increase the stake to 51%, what would be the acquired cost in aggregate that you're going to transfer it from the life business to the holding company or even to the bank?

And then based on that assumption, what would be the additional required capital if you were to increase the stake to 51%? And what will be the implication from a capital perspective for the financial holding company?

[Sophia Cheng, executive]

Yafei, thank you for your question. You are asking a question like that this is definitely going to happen. Let me allow us to clarify, this can be breakdown in a couple of things.

First one, on the recognition of equity method loss, Cathay Life has done this TWD 14 billion equity loss -- equity method loss on Bank Mayapada. This is more on our due diligence work and several scenarios on their NPL -- potential NPLs and loan book. So by taking a more conservative calculation, Cathay Life feel that it's more comfortable if they can recognize it right now, whatever rates are there.

However, the company, you can see their share price still there. But if you really think about the market liquidity. So currently, there is a gap between the loss we realize in equity method, but where the operation-wise and the share price on the financial market in Indonesia, not much has changed, okay. But by doing that, Cathay Life can have a clean pace to start going forward.

Your second question is whether Cathay Group, Cathay Financial Holdings or any of its subsidiaries will be taking a controlling stake. This is really at very early stage. We had the relationship with the bank, and therefore, naturally, being one of the important shareholder, we should care about how to help them to stabilize their liquidity, current situation and of course, there will be various scenarios that different shareholders and the regulator can brainstorm. At current stage, there is really nothing we can share to investor.

The only thing we can share with the investor is when we think about any possibility, Cathay shareholders' common interest is the most important and therefore, we strongly recommend that monitor our company's formal announcement, although the question you just asked is more like a brainstorming and it's next to impossible for us to comment because some of them may be just at ideal level, some of them are totally not a number, okay?

And you also talk about the impact to capital, whether the company has the ways to source the fund. If there is, there is any goal? This definitely is important consideration when any company make any potential M&A acquisition scenario. If we were to do anything, that will be part of our discussion, okay? So -- but as of today, everything is still at very brainstorming discussion stage. So there are so many uncertainty.

And because the outcome of operational status quo or there were more drastic stress to liquidity, all kinds of scenario will lead to very, very different outcome and that's why it's so hard for us to give you a guidance, whether we will take a stake or even a controlling stake, it's go or no-go deal. At current stage, it's very, very unclear, okay. So what we want to highlight is that nothing compete with Cathay shareholders' interest.

[Yafei Tian, analyst]

That's super clear. Is there a time line where this decision would have to be made, given that I presume that Mayapada would need to perhaps raise capital to support the current business as it is? So I wonder if there's anything that investors can look forward to from a time line perspective.

[Sophia Cheng, executive]

First of all, what we can look at is, it's already 100% clear that Cathay Life's balance sheet through this equity method. So you can expect no downside in accounting numbers. Second, there's no time line at all. And we think before we have more clarity on what we want to do, giving any guideline is not right. So there's no time line at all. But as you say, the possible outcome, the potential whether there would be a deal, whether they will need money, these are all very, very early stage.

And bear in mind that Cathay United Bank does have CET1 of over 11%. But we need the strong CET1 to support our loan growth. And we also need to follow the DSIP with extra 2 percentage CET1 requirement as a domestic systemically important bank. So when we think about capital planning, there are many, many angles. And it's unfair to make it such a big calculation because of uncertain deal. We do put all -- everything into consideration. And we do take whether we need money from a right issue extra curious because we do care about every dollar we take from shareholder, what does that mean to our return on equity.

And lastly, I want to highlight, as our CEO mentioned in today's -- the earlier analyst meeting conducted in Mandarin, when we do investment, there's always positive and negative. And of course, when you go to new markets, sometimes there will be some lessons learned. And we feel that we could have done a much better job. If we don't -- if we can do anything to minimize the loss, we will help -- we really want to do. So there was an analyst asking whether this will affect our regional expansion. Our CEO has clearly highlighted that, we want to learn and try to strengthen as much as we can through investment or equity investment management. So this will not affect Cathay's M&A into the region.

When we think about M&A, it will depend on availability of M&A target. You will base on the size of the deal. For example, so far from 2013 up to now, all the M&A deal we have done were less than USD 400 million. So some market, it could be for the purpose of assessing through a license. Some are because of the local market, it may -- some types of operation, it would be already sufficient.

For example, the deal we have in Cambodia, we own 100%. Initially, it was far less than USD 100 million. So availability of target, size of deal, and then operation capability, do we have the competence we can do more there, and then I think, going forward, on overall corporate governance area, we would promote, make a little more detail into those areas.

So this will not affect our plan. And that we'll put extra attention through more detail to do better job than before.

[Operator]

Next, we'll have Chung Hsu from Credit Suisse for questions.

[Chung Hsu, analyst]

Sophia and Grace, I want to ask a more broad question about Cathay's overseas investments. Specifically, I was wondering if you can give us or your shareholders a sense of if there is any consistent approach that you'll use to evaluate whether and what to invest?

For instance, if there is an investment threshold, investment return threshold, excuse me, over a certain period so that we can understand that your overseas investments is not entirely dilutive because if I look at your Cathay United Bank, for the past 10 years, making 10% to 11% return on equities, put aside this Mayapada Bank investments, I don't think any of your overseas operations are making anything close to that.

So just trying to understand if, going forward, when Cathay look at overseas investments projects, is there anything -- any criteria that you look at? And how do you prioritize your investments? I understand this is a bank specific investments, but if you look at the nonbank, the Cathay Life overseas investment as well, if you can give us some more color on that, that will probably help us to get a sense of how you'll, in the future, allocate your capital and how we think that as you grow bigger overseas, how is your return on equity of your group could turn out to be?

And my second question is on a more specific detailed question on the Cathay United Bank. The OpEx is down 6% in the first half. Just trying to understand how much of that is tied to a credit card decline in the first half this year? And if we strip out the credit card related expense, what's the OpEx year-over-year change look like? And also, if you could give us some guidance for a full year OpEx of Cathay United Bank?

[Sophia Cheng, executive]

Thank you, Chung, for your question. Let me work on the -- your question regarding our overseas expansion. And then Grace can comment on the OpEx ratio for Cathay Bank later.

First of all, if you can kindly look on Page 6, this show you the profit and the return on equity of Cathay Holdings and the subsidiaries. And if you can see that Cathay United Bank has ROE over 10% in the past years, and this year, in first half, it was 11.9%. Cathay Life, because of the nature of the equity spread, it has made some one-off gains. So you can see the ROE is more volatile. Where if you look at Cathay Century and Cathay SITE, the ROE has been very, very strong. Cathay Century has high teens whereas Cathay asset management in first half even reached 30%. So besides Life, Bank, we do put asset management as our important third pillar.

And the second point is, if you look out on Page 9 and Page 10, this is our regional expansion. Naturally, following your customer to a new country is easy and after that, if you have a minimum size of business, you can use that as a foundation to localize. So on Page 9, when you see the asset table on Page 9, you can see where our footprint is. China and Vietnam, we were there since the year 2000. So through the past 2 decades, we were able to expand business line by business line, where when you go to newer countries like the others, you can see, banking has broader footprint.

So to answer your question, when we go to a new market, I think there were 2 things that are very important. One is whether the market you can follow your customer. Corporate movement, you can see a lot of Taiwan corporate in the region. They have to move to the new production base. Some corporate also go there to capture local consumption opportunities. And if we have relationship with them in Taiwan already, naturally, we can follow them. And then after that, we will learn to more localize. That is why in China, in Vietnam, in Cambodia, we do have retail banking license.

The second important would be, when you talk about localize, that means you were seeing future growth in economics, in product consumption, in their future corporate success, say, getting more market share in the market or in global market. So you do need to take a look at every single country and their economic characteristics. And then when you -- after that, you will look into every country that are there, if you talk about consumer, you think about their lifestyle. Do the people save? Do they borrow? Do they pay back after they borrow? How do they view foreign financial institution in their country? And is it easier to go through insurance, through banking or through asset management?

So there are many angles. And that's why when you think about Cathay United Bank, we had a restructuring after the year 2012, I think, we were taking banking as a easier first step to go there, where insurance, you need the household to accumulate some wealth for that to take off. That's why so far, on insurance, we have more focus on China and Vietnam.

And I'd like to share with you in Vietnam and in China, in the FYP, if you take 2019 versus 2016, both market total premium has tripled. So we are growing into this country. Just on equities, if you put Page 9 and Page 10 together, simply on insurance or simply on banking, fewer loan processed, it means very tiny versus my consolidated financial holdings' profit, okay.

So these 2 pages you see here, this is the 10-year, 20-year plan. Even if you look at China and Vietnam, it took us 2 decades to get today, we might be sizable amount of finance, but we are still small in those countries.

And lastly, when we think about each investment, we do care about return on capital. So I'll come back to Page 6, ROE is definitely our target. And for our banking operation when I think about our KPI -- our group has a KPI, it's overseas earnings contribution to the pretax profit. They will include loan and business with other financial institutions, our own treasury, that's all combined. So I hope this has explained the logic when we do regional expansion.

And lastly, I want to share a few numbers with you. Because when we expand this regional footprint, it does help my regional loan book. So in the old days, we have the OBU, which is the main booking center. And for the past years, when we enhanced our operation in Hong Kong and Singapore branches, they are also contributing a lot. So today, we have OBU, we have Hong Kong, we have Singapore as our important regional loan booking center.

So if I take today the total loan book in Hong Kong and Singapore combined, that's already over TWD 100 billion versus in 2015, 2016, was only at about TWD 30 billion, TWD 40 billion level. So we do have good growth in regional corporate banking and through the 2 important booking center, Hong Kong and Singapore. None of this can grow overnight. And we were helped through good opportunity, through syndication, project finance, we can also cooperate and learn from our regional and global peers. Over time, we hope we can continue to strengthen our banking core competence.

And with this, I'll ask Grace to update on the first half at the operating ratio -- the expense ratio.

[Grace Chen, executive]

Yes. Chung, our CI ratio for the first half of this year is 47.4%. Compared with the same period last year, 51.1%, there was a 3.7% drop. And absolute operating expense is -- the saving is TWD 1 billion. And you are right, 50% of that is due to credit card related promotion expense. As you know, we have some alliance card like EVA Air or Infinity MileageLands. Now those are severely influenced by the COVID-19 pandemic.

So our first half year, the credit card spending contraction is 15%. So that's part of the reason our CI ratio compared with last year is lower. However, the spending momentum recover, looking forward for the second half this year. So the full year's cost income ratio might expected to be at a range of 52% to 53%.

[Chung Hsu, analyst]

Okay. Grace and Sophia, I have 2 follow-up questions, if I may. It's very interesting, Grace, you mentioned about TWD 1 billion cost savings from credit card, if I looked at -- if I hear that number correct. But if I look at your fee income on Slide 17, your fee income has declined by less than TWD 1 billion. So is it correct for me to say that certain credit card or brand product is actually not profitable? Because if I've seen a consumption value decline on those credit card products, you're actually seeing a bigger decline in OpEx than the loss in your fee income?

[Grace Chen, executive]

Chung, if we look at the first half, the credit card related fee income, TWD 3.4 billion, last year, and this year, TWD 2.7 billion. So the reduction, the shrinkage is TWD 0.7 billion. However, our expense saving is around TWD 0.5 billion.

[Chung Hsu, analyst]

Correct. I -- my mistake. I thought it was TWD 1 billion, sorry. Okay. Okay.

[Grace Chen, executive]

50% of the TWD 1 billion is due to credit card-related promotion expense. Not all.

[Chung Hsu, analyst]

Not all. Okay. Got it. My mistake. My second question is for Sophia. If I may ask, if I look at Slide 15, if you look -- think about Cathay's goal and longer-term plan for overseas, the overseas contributions. In terms -- if I look at look foreign currency loan as a percentage of your total loan, it's still quite small compared to some of the bigger banks, your direct competitors in Taiwan. What is this ideal target would be? I'm not sure if this is the right way of looking at it because you do have an overseas profit contributions in Slide 16, 40%, but that probably includes some treasury or trading gains from overseas.

So what is the broad mix that Cathay United Bank is targeting? Will all these help us to go overseas in Southeast Asia?

[Sophia Cheng, executive]

Sure. Good question. The only thing we know is there is a lot of room. But if you can see, year-to-date, if you take 2019 versus 2018, there was an increase, but the magnitude -- percentage of increase obviously will differ a little bit. Because starting from about mid- of last year, we get more cautious on global macro uncertainty. And this year, specifically the COVID-19 is affecting rather quickly how they respond to this. So we have been extra cautious on asset quality because the currency margin, nothing competes with asset quality.

So on Page 15, to the left-hand side, you can see SME loan year-to-date is quite flat, where to the right-hand side, year-to-date foreign currency loan increase is also quite muted. Now if you look at the percentage, yes, you are right, SME is only 13% of our loan book, whereas foreign currency loan is less than 16% of our total loan book. If I can -- if I look at our main -- some main peers we benchmark, they do have a range all higher than us. For some company, there are foreign currency loan either in 30%, 40% of their book whereas some sizable peers, they're probably at around 20-ish percent, okay.

So it's a question hard to answer because I think, naturally, if I don't have asset quality concern, this can grow a lot faster. But whenever there is a macro downturn, I can review whether we respond earlier. For example, in China, it has been so many years that we don't lend to pure real estate collateral loan, [ Shenyang ], Beijing, Shanghai, Shenzhen and Guangzhou.

So every country have different kind of criteria wherein regional syndication, project finance, we remain active, but except that I think this year, we need longer time to monitor every country, how they respond to the whole virus thing and how their country import-export significant Y-o-Y decline can improve. So we would not expect the rest of the year to see a very big growth. But longer time, I do think such a growth in both SME and foreign currency loan, the growth could be expected.

And then if you move to Page 16 on the contribution, the reason we have more treasury income today is because when you look at my -- for U.S. dollar, loan deposit ratio is still at below 50% because you can always compare lending and investment, as you kind of added opportunity cost. We think at current stage, lending before you were very comfortable, sometimes you were investing in bonds versus loan or lending to many Asian -- Southeast Asia countries, their bank may not have sufficient U.S. dollar. So you can be a net interbank lender. So you need to combine all the potential business opportunity and the relative opportunity cost.

Okay. So in terms of loan, I would -- I do think that structurally, there should be growth in both SME and foreign currency loans. In terms of overseas earnings as a percentage of pretax prices, our -- originally, our target is around 40%. We are there. So it can be up and down, but if we can maintain it above 40%, we'll be very happy.

So long term, it might be shifting from treasury into local loan if we can now each -- localize to each market better than before. Yes. I hope I have answered your questions.

[Operator]

[Operator Instructions] There appears to be no further questions at this point. And Ms. Cheng, can we close the conference call now?

[Sophia Cheng, executive]

Thank you. Thank you all for participating in Cathay Financial Holdings conference call. And Yajou and IR team will stand by here. If you have further questions, please do feel free to contact us. Thank you, and goodbye.

[Operator]

Yes. Thank you. And ladies and gentlemen, we thank you for your participation in Cathay Financial Holding Company's conference call. You may now disconnect. Goodbye.