Cathay Financial Holding Co Ltd

TWSE:2882

Earnings Call Transcript 2018-Q3

[Operator]

Welcome everyone to Cathay Financial Holding Company's Third Quarter 2018 Conference Call. [Operator Instructions]

And now I would like to introduce Ms. Sophia Cheng, the CIO of Cathay Financial Holding Company. Ms. Cheng, you may begin.

[Sophia Cheng, executive]

Thank you. Good afternoon and good morning to investors from Europe. Welcome to Cathay Financial Holding's 2018 Third Quarter Analyst Meeting. My name is Sophia Cheng. I'm the Chief Investment Officer of Cathay Financial Holding. Today I will host the conference call. And thank you very much for joining us today.

In the beginning, I'd like to introduce the senior managers who are with us today. Today we have Mr.

Daniel Teng, EVP at -- Senior Executive Vice President of Cathy Financial Holdings; Ms. Grace Chen, Chief Financial Officer of Cathay Financial Holdings; Mr. Abel Lin, Managing Senior EVP of Cathay Life; Mr. Joseph Wang, EVP of Cathay Life, Mr. Edward Yung, Senior EVP of Cathay United Bank.

For our today's conference call, Wendy from our IR team will present the third quarter results. And then after the presentation, we are open for Q&A section in which senior management will be more than happy to answer your questions.

And before the presentation, I'd like to highlight one of the company's change that Cathay United Bank has converted its branch of sub-branches in China into a subsidiary. So today, when you look at the bank numbers at current which we already renewed, the China operation in the regional book and therefore when we look at total loans, net interest margin and foreign currency notes, they improved by China operation. And so finally you may see third quarter -- quarter-on-quarter, slight decline in foreign currency loans, it's actually increase. It's purely because it's not apple-to-apple, and we can explain later more.

And so, without further ado, let me pass the call over to Wendy for the briefing of our third quarter results. Wendy?

[Wendy Juan, executive]

Thank you, Sophia. Let's start with Page 4, which provides you with a quick overview of the financial performances of our subsidiaries in the third quarter of 2018.

First of all, Cathay United Bank reported mild growth in loan and deposit, both delivered growth rate of 5%. Credit quality remained benign. Our subsidiary in China opened in September of this year. Foreign currency loan grew 15%. Fees income continued to increase. Credit card related fees were up 13%. Active card number ranked top 1 in the industry.

And we move on to Cathay Life. Cathay Life carried on with its value-driven strategy and continued to generate the highest amount of FYP and annualized FYP among industry peers. Protection-type policy grew 61%. After-hedging investment yield was 4.2%, and overall investment performance remained benign.

Next to our general insurance subsidiary, Cathay Century. Premium income grew 6% year-over-year. It remained in second place with 12.7% market share. Overseas written policy premium increased continuously. As for our asset management subsidiary, Cathay Securities Investment Trust has firmly established itself as the market leader with assets under management amounted to TWD 657 billion.

Lastly, with Cathay Securities, its brokerage business continues to grow and its sub-brokerage business outperformed peers in terms of market share.

Now please look at Page 5 for our net income and earnings per share. Cathay Financial Holding reported after-tax net income of TWD 54. 6 billion for the first 9 months, representing a 13% rise from the same period last year. Earnings per share came in at TWD 4.18. Our subsidiaries net income and return on equity are shown on Page 6. Cathay United Bank's earnings grew 8% with growth of both interest income and fees income. Cathay Life delivered solid growth of 17% due to investment income increase. The holding company's return on equity was 11.6% on a consolidated basis.

On the next page, Page 7. You'll find our book value and book value per share. The holding company's book value was around TWD 612 billion, and book value per share was TWD 40.6 at the end of the third quarter. Now let's look at Page 9 and 10 for our Cathay's overseas footprint in Southeast Asia and China. The holding company continues to expand operations into overseas markets. So far, Cathay United Bank has left footprints in 9 urban countries. Since 2015, it has been gradually buying up a 23% of stake in Philippines RCBC bank, and 40% of shares in Indonesia's Bank Mayapada. Cathay Life Vietnam total premium sourced 49% higher. We not only will continue to deepen our overseas presence, but also reinforce existing strategic partnerships.

As for our footprints in China, Cathay United Bank opened its subsidiary in China in September. Cathay Lujiazui Life fast-growing business was marked by its premium growth of 45%. Cathay Century China's premium income seemed to grow, new businesses are running smoothly in partnership with Ant Financial an affiliate of Alibaba Group. In the future, we will continue to strengthen our operational capability and seize opportunities for growth.

Now please let me walk you through Cathay United Bank's financial performances from Page 12 to 18.

With proper risk management, we continue adjusting our loan portfolio by increasing a proportion of mortgage and foreign currency loans. Loan balance climbed at 5% to TWD 1.6 trillion at the end of September. Deposit growth remained steady. The total amount grew at TWD 2.2 trillion for the same period, representing a 5% increase. The loan-to-deposit ratio was over 70%.

On Page 13, you can see the bank's interest yield. Cathay United Bank's net interest margin and spread continued to improve. The interest spread increased to 1.85% and NIM was up 1 basis point quarter-over-quarter to 1.26%. The improvement was credited to U.S. Fed rate rises, the increase on mortgage and SME loan. The bank's credit policy is on the next page, Page 14. In compliance with our prudent lending policy, Cathay United Bank maintained low NPL ratio at 16 basis points, coverage ratio was 936%, gross provision was TWD 2.6 billion for the first 9 months, mostly from a regulation requirement on loan growth. Recovery was TWD 900 million.

Now please turn to Page 15 for SME and foreign currency loans. In compliance, SME and foreign currency loans played an important role in our corporate banking. We made an effort to maintain good credit quality, while pursuing loan growth. SME loan balance reached TWD 173 billion at the end of the third quarter, which accounted for 11% of total loans. Foreign currency loan balance was TWD 244 billion as of the end of the third quarter, which accounted for 16% of total loans.

Our offshore earnings are shown on Page 16. Overseas profit of TWD 6.2 billion accounted for 30% of pretax earnings. The year-on-year drop was due to a decline in overseas investment caused by global market volatility. Let's look at our fees income on Page 17 and 18. With our efforts in improving noninterest income, fees income continues to increase. Fee income for the first 9 months grew by 11% from the same period last year to TWD 15.2 billion. Credit card's fee growth momentum continued with 13% growth year-over-year. Wealth management fees were up 7% to TWD 7.4 billion.

Now we're about to move on to Cathay Life. Please turn your Page to 20 and 21. Total premium was TWD 492.6 billion for the first 9 months, down by 12% as the renewal premium dropped when some wholesale regular pay policy's premium payment term ended. First year premium was TWD 164.7 billion, fell by 5%, high year-on-year base explained for the decline. And with this a certain sales of investment-linked product in the previous year. This year our focus will be on a more profitable traditional and protection type products, both have increased for the first 9 months. FYP for protection type products has jumped 61% from the year earlier period. The annualized FYP was TWD 53.4 billion, down by 9% due to an increase of shorter premium paying term tradition policy. Nevertheless, our total NOIs premium amount was still the highest in the industry.

On the next page, Page 22 shows our emphasis on regular paid traditional policies. Cathay Life is dedicated to its value-driven strategy by focusing on regular paid products. As we increase the proportion of protection type in traditional products, value of new business increased 3% to TWD 38 billion during the first 9 months.

Please turn the page to Page 23, as we talk about cost of liability. Cathay Life's cost of liability continues to show improvement over the years. Year-to-date, the reserve base liability cost dropped 6 basis points to 4.05% by the end of September. For the whole year, we expect our cost of liability to improve by 6 to 10 basis points. As for life investment portfolio, please refer to the table below. Cathay Life's total investments reached TWD 5.7 trillion as of the end of the September, overseas investment accounted for 66% of total invested assets. The investment returns of each asset class are as follows: for cash and cash equivalents was 0.6%; for domestic equity was 12.1%; for international equity was 10.8% pre-hedged; for domestic bond was 3.3%; for international bond was 4.7% pre-hedged; and for mortgage and secured loans was 2.0%; for policy loans was 5.7%; and for real estate was 2.3%.

Our overall investment yields are shown on Page 25 and 26. After-hedging investment yield was 4.19% for the first 9 months as global capital market becomes more volatile this year, we will actively address our investment portfolio to improve our capital efficiency. Pre-hedge recurring yield was 3.54% for the first 9 months, higher than that of the same period last year. The annualized hedging cost was 1.22%, while the traditional hedging cost continued to rise given higher interest rate differentials between the U.S. and Taiwan. We will continue to adopt flexible hedging strategies along with stabilizing effects of foreign exchange volatility reserve to come to our hedging cost. The FX volatility reserve was TWD 15.4 billion as of the end of September.

Please turn page to Page 27 for dividends and the regional breakdown of overseas fixed income. Cash dividend of TWD 23 billion was recognized for the first 9 months, slightly higher than that of the same period last year. As for overseas fixed income investments, Cathay Life allocated 44% in North America, 19% in Europe, 23% in Asia-Pacific and 14% for the rest. Page 28 shows the book value and unrealized gain of our financial assets. The consolidated book value of Cathay Life reached TWD 449.4 billion, and the unrealized gain of financial assets was TWD 5.3 billion as of the end of September.

On Page 29, you can see Cathay Life distribution channel which bear witness to our strong agent force and effective cross-selling strategy for over 65% of FYP was sold through Cathay Life agents, and another 26% through Cathay United Bank. Persistency and expense ratio are on Page 30. The 13 and 25 months persistency ratio was 99% and 94% respectively. Expense ratio increased to 10% due to increase of sales of regular pay, traditional life and protection type products.

Lastly, please turn the page to Page 32 to 34 for the performance of Cathay Century. Cathay Century's premium income for the first 9 months grew by 6% for the same period a year earlier to TWD 16.8 billion. Market share was 13%. Effective cross-selling strategy helped to bring about a 63% of premium through our group channel. Gross combined ratio and retained ratio in combined ratio remained steady.

This concludes our operating highlights. We look forward to discussing more in detail with you in the following Q&A session. Thank you.

[Sophia Cheng, executive]

Thank you Wendy. We are ready for Q&A.

[Operator]

[Operator Instructions] The first question is coming from Anthony Lam, HSBC.

[Anthony Lam, analyst]

I've got just a few quick questions. First 2 on the Life side than I think one on the bank side. I think in the Chinese section discussed the hedging strategy. I'm not sure whether I got it correctly. You mentioned that the currency swap which probably accounted for about 55% to 60% of the hedging. But if we look at the non-hedging -- currency hedging structure in third quarter, I think that's related to sum of currency swap and NDF close to 69%, and that's up quite a bit from the 64% in the same quarter. And I think I'm not sure whether that's the main driver behind the pickup in hedging cost in third quarter? I mean what sort of in hedging cost level do you think about in your previous guidance from 1% to 1.5%. I mean prior to this quarter, you've been achieving somewhere below 1% or 1.1%. So just trying to understand, in a sense of this sort of hedging cost level whether we should expect going forward, I think within that 1% to 1.5% range? That's the first question. The next question is on the product and may be slightly related to distribution. I think the FYP growth this year has been a little bit weak and I think, obviously, how do you -- or in strategy on the focus of margin over volume. But even then if I compare your FYP with some other peers, I think not sure whether you offset any further competitive pressure from some of your peer group, which have been more aggressive in pushing products this year? And could you give in a sense, why the dollar amount of distribution through -- by Asian channels actually quite weak in the third quarter. Just trying to get a sense, that what initiative you will pass in the fourth quarter in the kind of revitalize the product distribution -- in product -- protection product distribution in the fourth quarter and beyond? And on the bank side, could you give a sense of, why should we look at, for cast income ratio and efficiencies in the fourth quarter and then for full-year and beyond? Those are my two questions.

[Chang-Ken Lee, executive]

So I think the first one about the hedging cost, I just mentioned in Chinese version, yes, this is in the third quarter, overall, our CS dropped indirectly around 69%. Looking forward, especially, next year, I think that because right now the currency swap or [ NDF ] because it's at highest, almost 3%. And we look forward, next year, will be better than 3%. So our strategy will reduce at least the traditional, including [ NDF ] first. So that is hedged. So I think probably we will, next year, we will go back our traditional list percentage will decrease and increase the basket hedge because unfortunately that can make us reduce the higher -- highest of hedging costs 3% CS swap to maintain our more stable hedging cost. And I think because if you look at this third quarter, our overall hedging cost was almost 2%. But of course, this year, the currency swap is almost 1% higher than that same period. So it means that if we exclude this hedging cost, if you compare from that third quarter, I think I remember, last third quarter, the same period, our hedging cost was 1.1 around percent. So only a little bit higher. In fact, the hedging cost for this year is much higher than that. So it means that our basket hedge is quite effective and also we gained from that. So we expect in the future we will adjust this dynamic from the fixed to reduce the [ NDF ] portion, our CS portion to increase in basket hedge. So this is just talking about our hedging strategy. And second one is that, I think overall, our -- because of this year, we are focused on higher margin products means that protection-type products. If you look at -- this is our first priority. We want to increase this protection-type product. It's very -- I think, we want to do our best to increase this type. So this year, we increased by -- Y-o-Y increased by 61% of this protection types. And also, you will see that our VNB margins also increased, but this is -- so this year, we didn't -- overall, our FYP still number 1, but we think that you will see we didn't push too much in like most savings types. Although in our -- our company's still regular paid, but we didn't push too much on this kind of product because we think that margins relative grow, and we want to focus on high margin product. This is our strategy.

[Sophia Cheng, executive]

And Anthony, if you just -- to add a point on it, if you look at Slide 21, and if we look at the detailed analysis of the FYP breakdown. Because in 2016, it was a very hard sell traditional life policy before insurance, saw an increase in the following year, and they pushed [ varied skews ] to last year, very high concentration into investments-linked. We have spent 5 years to reverse the trend. And if you look at the traditional life combined single pay, regular pay, it actually grew by about 10% year-on-year in the first 9 months already. And on top of that, if you look at health, accident and others, this traditional protection, health accident life insurance, the margin is very strong. It actually grew by 30%. So superficially, when we look at the revenue numbers, it can be distorted by the amount of investment-linked. That is really not our focus. And we look at the progress, how do I grow accident and health insurance, how do I grow the traditional life. If you look on Page 20, we can see the offering in past years compared with 2010, on Page 20, to the right-hand side. In year 2010, the health, accident, these relate to insurance protection type was TWD 74 billion and last year already TWD 102 billion. So there was very strong constant growth into these higher-margin product area, and that's what we want to do. Until the -- what I tried to explain, looking into the revenue, it could be quite volatile. We focused more on [ 31 ]%, whether we can sustain a muted, but stable growth.

[Chung-Yi Teng, executive]

Anthony, this is Daniel from Cathay United Bank. Were you asking about the capital ratio for the third quarter?

[Anthony Lam, analyst]

For cost-income ratio, it's around 49%. Could you remind us -- I think the target for cost income ratio of Cathay United Bank for 2018 and just trying to get a sense whether this can be maintained going forward.

[Chung-Yi Teng, executive]

Cost income ratio, it's around 50%.

[Grace Chen, executive]

Yes, okay, 50%.

[Chung-Yi Teng, executive]

I believe 50 something. 51% or 49%. It is around 50%.

[Operator]

[Operator Instructions] And the next one is coming from Anthony Lam, HSBC.

[Anthony Lam, analyst]

It's me again. Nobody else is asking besides me. I think in a prior session, there was a question around Internet bank application, but I couldn't really catch the response from the management. Could you repeat that response again here and then try to give a sense of what you think about Internet bank application? There was a comparison with some of the peers which have been more aggressive in doing -- preparing for such an application? And maybe could you give us some colors around what you think when this license is given out to those 2 players and how it would change the competitive dynamics in the Internet banking industry? So yes, that's the question.

[Chang-Ken Lee, executive]

Okay. For me, no. We call it Internet banking or e-banking, right? It's not a banking business. It's like a Internet business. So from our point of view, it's not necessary to join Internet banking if you want to do some Internet business. Because if you know, in banking -- Internet banking, you have to put more and more resources to the new company and the new capital, right? So we can take another known point of view, maybe we can cooperate with some of the Internet or -- I would say Internet is like a platform business. Then we can know if we get the same impact or the same effect from the pure Internet banking. So I'm not saying, no, we are not going into that kind of business. But from our point of view, we do view -- it's a [ very top ] issue to stay outside the Internet bank or get into that.

[Sophia Cheng, executive]

Anthony, let me add a few points there. When people talk about online banking license, we are talking about pure online banking. So the question is whether this online banking license has some exclusive business that the regular bank cannot do? And this all goes together we think that, which goes together means, we are applying good technology to enable better banking service for today and for future. So that, to me, means we can expand more service. That's financial inclusion. We need to enhance the user interface, so you can entice your resource customers who no longer visit your branch as often, but they like you in all the integrated platform you provide. This shows also together with a consolidated service our financial group can provide. Unless you are making a very strong marketing trend, I would think just having an online banking license is a very important [ standpoint ]. Now whether this license or this group can really service and penetrate into the general public is very critical. So -- and then last one is you need to service future tech-savvy users that we have to think about challenging how we penetrate and grow into young population for future. So these have been things that Cathay has been doing, and we do have internal plans. And so far, in Taiwan, you have Cathay which has KOKO Bank. The KOKO stands for local dialogue of coins. And also [ Tianjin Bank ] has a [ reach out ] with this online payment when people can share their bills. We have been -- having some various projects ongoing together to make sure people that use the Internet, computer, they use mobile, they use various channels, they can get good access to Cathay banking service. They can also get combined service by Cathay Financial Group. So in our view, this type of application must be used to enhance your banking and your financial service capability and further enhance your customer loyalty and broaden your customer base. So I would think it's more than just whether to get a license. And follow that, is there only a banking license for you to penetrate, approach, to reach the general public in Taiwan, and you can see our some initiatives announced in the past year also provides some points to consider. Third, combined together, I think what we try to answer you is, we do think various channels are all very important for banking service, and we are working on those. That whether I need that to do -- to a pure online banking license, do I have control on the license, can I truly make a big, big difference, can I eventually really benefit from a shareholder point of view? This only to put together consideration and since we do consider that and we have some projects ongoing.

[Anthony Lam, analyst]

Okay. So, in short, If I just understand it, that you don't see Internet-only bank, even when they are established, pose any sort of immediate threat to your banking business given that you only run omni-channel strategy and you think you have good penetration strategy to work in the new markets. Is that these Internet banking maybe after anyways and you're not really that concerned about the new investors coming into those 2 consortium outside the banking or financials industry, that will mean -- I mean, affect your [ profitability only ] growth? Is that the correct interpretation of what you just mentioned?

[Sophia Cheng, executive]

We think penetration to customer, depend on one this year, you have to think more than just 1 platform. You have to think multiplatform. And as a country, [indiscernible] we have creation into wealth preservation. The whole country require, one, service to their cash and as a division corporate; two, how can they make their daily life more convenient. If you look at the past year, we have aligned -- we have -- you can use your -- our credit card in 7-Eleven store, in FamilyMart. These are our interesting ideas, and we are also the settlement bank for some of the large e-commerce platform. When you do shopping, regardless of what credit card you use, they use MyBank in settlement. So there are many areas that we can grow and making sure people know we are in their daily life. I think you have quite many angles to make sure they know you are there and you need to do a good job. And so they want you to service cash and wealth management, you need to have good global view, strong investment team and good products. So it's a mix of many things. It's very hard to decide whether a company has future [ fix channel ], whether they have one specific license. And we're more than happy to discuss more when we have a chance.

[Operator]

And the next question is coming from Jemmy Huang, JPMorgan.

[Jemmy Huang, analyst]

I just have two questions here. The first one is for Cathay Life. I think you are still continuing to gradually increase your overseas investment proportion. I just wonder whether you will still allow the asset liability currency mismatch to further increase or will you try to sell more foreign currency-denominated policy at the same time to try to keep the currency mismatch on the balance sheet to be largely the same as what it is now. That's the first question. Second one is for Cathay United Bank. If we look at operating expense, double-digit growth this year, just curious is any portion of the operating expenses are related to the credit card marketing or promoting expenses. That also resulted in quite good credit card fee income. If we -- if any -- if we carve out the expenses related to your credit card businesses, what's the underlying operating expense going forward look like?

[Chang-Ken Lee, executive]

Jemmy, I think the first one about the -- because we will increase the oversea investment, especially in fixed income. And first one, our productivity, from our company point of view, actually the first priority is U.S. dollar policy. So this is the first one we want to more and more. So we want to increase a lot at this portion. And also, as you maybe know, that next year, because right now, we have 25% limit on foreign policy to our total result, can be exclude from the oversea limit. But next year we will increase to 35% of the total result. It means that we still have a lot of room to increase the U.S. dollar policy. So I think that this is, first of all, increase too much of the currency mismatch. But on the other hand, is the Taiwan dollar policy still has some demand no matter if our protection type product need, this is major, is the Taiwan dollar policy. So still, I think that the currency mismatch still will increase this a bit because the Taiwan dollar policy still has some demand. And also, some savings-type like type for our customers still has some need. So we can see the lag both, so we have some priorities. Though at first we will increase it as much as large, we can increase in foreign currency policy. And secondly, we will make our [ effort ] not that much in U.S. dollar policy. No matter -- if you can see that in the hedging cost at this moment, and also, you're like the investment vehicle, you can have right now. We don't think Taiwan dollar policy is the right time to increase too much, but still had some demand, and this -- we cannot avoid that. So I think that in the future round, the mismatch amount, I think still will increase, but will go down compared to before. This is my answer.

[Chung-Yi Teng, executive]

Okay, for the operating expense for the Cathay United Bank, from the quarter-to-quarter basis, the main increase for our operating expenses from the products point on cost per cost, for every year, during mainly June and July. And the membership case, the membership fee can now exchange funnel from the products point. And for the year-on-year basis, no, from the beginning of this year, we change our accounting -- I mean, the accounting rule for the year-end bonus for the employee. For the past years, we recognize that kind of expense only in December. But from the beginning of the year, we now amortize the year-end bonus through the 12 months.

[Jemmy Huang, analyst]

So does that mean, on a full-year basis, your operating expense will -- may slow down on a full-year basis compared to the first nine months?

[Chung-Yi Teng, executive]

Yes. So I just mentioned maybe -- currently, our CI ratio is around maybe 50.

[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]

Yes. Thank you all for participation in today's Cathay Financial Holding's conference call today. And the IR team will stand by here. If you have further questions, you can contact Yajou and his team. Thank you very much, and see you next time. Thank you, and goodbye.

[Operator]

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.