Shin Kong Financial Holding Co Ltd

TWSE:2888

Earnings Call Transcript 2018-Q3

[Operator]

Welcome, everyone, to Shin Kong Financial Holding Company's 2018 Third Quarter Earnings Conference Call. [Operator Instructions] And for your information, this conference call is now being broadcasted live over the Internet. Webcast replay will be available within an hour after the conference is finished. Please visit www.skfh.com.tw, under the Investor Relations section.

And now, I would like to introduce Mr. Stan Lee, Senior Vice President of Shin Kong Financial Holding Company. Mr. Lee, please begin.

[Sin Young Lee, executive]

Thank you, moderator. Good afternoon, ladies and gentlemen. Welcome again for joining the Shin Kong Financial Holding 2018 Third Quarter Analyst Call.

Before we start, I would like to introduce my colleagues who are with me today. We are happy to have Min-Yi Huang, President of the Financial Holding Company, to review the third quarter results with us. Also in the room are Sunny Hsu, Executive Senior Vice President of the Financial Holding Company; James Yuan, Chief Investment Officer of Shin Kong Life; Han Wei Lin, Chief Actuary of Shin Kong Life; Isabella and Christine, members of the IR team.

The presentation we are about to go through was sent out 2 hours ago. You may also download it from our website or participate through its webcast. If you do not have the presentation, please let us know now.

Your lines will be muted when we are presenting. If you are cut off, please dial back in or call Christine at (886) 968-929-230 for assistance.

Now, please turn to Page 4. SKFH continued its growth momentum in the first 9 months 2018 with consolidated after-tax profit reaching TWD 19.46 billion. Earnings per share was TWD 1.76 and book value per share as of the end of September was TWD 14.56. On October 1, SKFH formally completed the acquisition of MasterLink Securities. Following the deal, SKFH will keep leveraging our platforms across insurance, bank and securities business to bolster synergy. Core business of each subsidiary remained stable in the third quarter, which will be covered in the presentation.

Page 10. FYP for the first 9 months 2018 reached TWD 83.87 billion, securing a market share of 1 -- 8.1%. Not simply aiming for sales volume, Shin Kong Life actively promoted foreign currency policies and protection products to compare the hedging cost, facilitate ALM matching and grow value of new business. FYP of foreign currency policies for the first 9 months increased 20.9% year-on-year to TWD 46.14 billion, accounting for 55% of total FYP. With sufficient inflows of savings policies, cost of liabilities decreased another 3 basis point in the third quarter to 4.13%, in line with our guidance.

Page 14 shows the overall view of Shin Kong Life's investment portfolio. Annualized investment return for the first 9 months 2018 reached 4.4%, which [ capital trends ] in recurring income, both higher than the same period last year. Breakdown of investment returns for each classes were: real estate, 3.2%; mortgage and corporate loans, 1.8%; policy loans, 5.8%; overseas investment, 3.8%; domestic securities, 8.4%; and cash, 0.6%.

Page 15 presents the portfolio of overseas fixed incomes. At the end of the third quarter, overseas fixed incomes reached TWD 1.68 trillion. Corporate bonds accounted for the largest share, representing 45% of the total, followed by international bonds at 32% and government bonds at 21.6%, although our distribution was similar to the first half and the average yield before hedging of overseas fixed incomes was around 4.7%.

The chart on the upper right displays overseas fixed income's portfolio by region. Shin Kong Life focuses on North America and Europe as its key investment areas. The share of Asia and others edged up to 39.6% deployed in higher-yielding government and corporate bonds denominated in U.S. dollars with superior credit quality.

Page 17. Annualized hedging cost for the first 9 months was 1.76% and foreign currency volatility reserve was TWD 3.14 billion at quarter-end. Hedging ratio was 79.3%, including CS, NDF and the naturally hedged foreign policies. In order to contain hedging cost, Shin Kong Life will ramp up sales of foreign currency policies and the share is expected to exceed 50% of total FYP.

I will now hand over to Isabella, who will take you through the results of Shin Kong Bank and MasterLink Securities.

[Isabella Wang, executive]

Thank you, Stan.

Please turn to Page 21. Shin Kong Bank sustained its growth momentum in the first 9 months with interest income increasing 6.5% year-on-year to TWD 8.85 billion. After PIF losses were fully provisioned in 2017, the provision expense for the first 9 months decreased 36.5% year-on-year. Consolidated after-tax profit amounted to TWD 3.9 billion, up 25.9% from a year earlier.

Page 22. Total loan balance grew 4.4% year-to-date to TWD 558.49 billion. Consumer lending maintained an upward trend with mortgage and unsecured loans increasing 5.4% and 5% year-to-date, respectively. As for corporate lending, Shin Kong Bank has centered its efforts on overseas syndicated loans with an existing loan balance totaling TWD 23.17 billion, which was up 33.4% year-to-date. Loan growth targets for 2018 remains unchanged at 6%.

Page 23. Due to higher U.S. dollar funding costs, both net interest margin and net interest rate came down 4 basis points quarter-on-quarter to 1.53% and 1.94%, respectively. Given the increase in funding costs, the full year figures are expected to be lower than the levels delivered in 2017.

Page 25. Wealth management income for the first 9 months 2018 grew 6.5% year-on-year to TWD 1.58 billion. As market volatility has increased in the recent months, the bank looks to grow the contribution from bancassurance by promoting foreign currency policies and regular premium products. The growth target for wealth management income in 2018 is 5% to 10%.

Page 26. Asset quality was stable with NPL ratio at 0.24% and coverage ratio at 555.75%. New NPL generated in the third quarter was TWD 297 million and this only accounted for 0.05% of total loans.

Page 28. MasterLink Securities recorded an after-tax profit of TWD 0.99 billion for the first 9 months 2018, up 39.5% year-on-year. The revenue from brokerage business grew 24% year-on-year to TWD 2.64 billion, accounting for 60.3% of the total revenue. Brokerage market share was 3.85% and ranked the sixth place in the industry.

So this is the end of our results presentation. Moderator, please start the Q&A session.

[Operator]

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

[Anthony Lam, analyst]

A couple of follow up questions from the Chinese session, the life side question on the bank side. On the right side, I'm just trying to check whether you actually observed some year-on-year pickup in [indiscernible] new businesses were given that we observed, I think, 45% yearly decline in first half. You mentioned that for 9 months basis, it's only a slight decline along with a slight FYP decline in 9 months. So that's the first one.

And the second one is on the recent monthly process of the life side in September and October. Was it mainly driven by hedging costs and much lower income and interest income in these 2 months or was there any other driver that's really driving the monthly [indiscernible] in September and October? So that's the fourth -- second question with the life side.

And then on the bank side, just trying to see what measures have you been taking to contain the cost growth rate on a year-on-year basis comparison. The cost income ratio compared quite favorably with the 9 months [indiscernible] income. [indiscernible] so just trying to see whether that's sustainable going forward.

[Min-Yi Huang, executive]

We talked about the VNB margin, the balance in year-on-year. So [indiscernible] at the end of quarter 3, FYP down less than 1%. So the VNB for Q -- for quarter 3, it may be down about less than 1% also. I also mentioned for October, our FYP has already grown than last year, so VNB might also grow.

[Sin Young Lee, executive]

Anthony, well, I'll actually talk about the third question first and maybe the second, I would let the CIO to talk about it, all right?

And third question is about the cost income ratio for the bank. We have shown the number that you can see the year-on-year growth for the bank cost was contained at around 3% while you can see the net interest income grow at over 5%, but the areas that we can put some more efforts and enhance, I would say, will be the fee income. The fee income, as a matter of fact, didn't grow for the last 3 quarters.

In the future, I will say, we don't plan to further, say, control the cost growth. This will only grow at 3%. We cannot grow the bank's overall business, including the fee-based business and also the interest-based business, without any cost growth, but it has to grow at a very benign pace. If we want to control the cost income ratios, the focus will be on how we grow income, particularly the fee-based income.

[Honglong Yuan, executive]

Well, regarding the hedging cost, it hasn't changed much. It's running pretty much at the same rate. We are paying the cost of hedging not much different.

[Anthony Lam, analyst]

I think I need to follow-up the third question. Just trying to see whether the monthly loss on the life business and think on a control level in September, October was mainly driven by a hedging issue or was there some other reason behind loss -- monthly loss reported in September and October?

[Sin Young Lee, executive]

As the CIO mentioned, it didn't serve as different pickups in the hedging. Hedging has been a lingering issue for the past quarters. When we are -- we're definitely seeing a spread between NT and dollar being widened. And from time to time, we'll have to pay over 300 basis point for currency swaps, right? That makes our earnings per month relatively vulnerable.

If we do have sufficient capital gains such as what we recorded in the first couple of quarters, you don't see that shown in the net incomes, not because there wasn't hedging costs, but because we have more abundant capital gains. What happened in the global market is that we don't have enough room to further harvest from the equity market for those capital gains, particularly in September and October. However, I have to reemphasize that this year, we will be able to meet the pre-hedging breakevens. We will be able to meet that target. And -- however, even with that target met, we still have to offset the hedging cost every month. Every month for the year, traditional hedges we pay over 300 basis point.

So what we are doing now? How are we going to mitigate that? It's to change the product mix. We presented that, this year, there will be at least 50% of new business sold in U.S. dollar-denominated policies. Next year, that will be further leveraged to over 60%. And the other way we can do is, such as the CIO mentioned in the Chinese session, is the hedging cost is really unreasonably high in a relatively short term. We don't change the hedging ratios for the long term, but in a relatively short term, we had a wide some NDF and somehow mitigate what is the overly priced hedging charges. I don't know whether there's anything to add on.

[Honglong Yuan, executive]

Yes. Regarding the hedging cost, my personal view is, right now, the pricing is too expensive simply because the demand and supply issue of the CS and the NDF. But if you look at the interest rate differential between the U.S. and the Taiwanese treasury, it shouldn't be that high. For instance, 10 years U.S. treasuries are around 3, Taiwanese is around 90 basis points, so the spread is about 2.1%. If you look at 30 years, it's even lower than that, about 130 basis points. So we are paying now around 300 basis points annualized hedge cost. So we do expect that the hedging cost should alleviate, which means a review in the future to kind of alleviate the pressure on the hedging cost that we need to pay per annum.

[Operator]

[Operator Instructions] And next, we'll have Thomas Wang from Goldman Sachs for questions.

[Thomas Wang, analyst]

Just quickly clarify, given how your investment yield, I'm using overseas assets was 3.8%, that's after hedging cost?

[Sin Young Lee, executive]

That's correct. That's after hedging cost.

[Thomas Wang, analyst]

Yes. So if you get to 3.8% on your overseas assets, I mean you're getting 8.4% now for your domestic assets, so can you tell if that was, I don't know, something counterintuitive if you're going to expand in the floor -- overseas assets? If you're getting 5, 6 or 7, then you are on domestic equity, so just help me sort of a -- just your rationale on that or are you just -- are you assuming your expectation that, that hedging cost will come down quite a bit that before the overseas asset yield will go up quite a bit?

[Sin Young Lee, executive]

Yes. The reason why we invest overseas is for fixed income, right? Domestically, we do enjoy the higher dividend yield. As you mentioned, it's 4.5% or sometimes over 5% or similar names. However, those are equities. Those have volatilities. And even though those are lower beta equities, it still has beta. And as an insurance company, we have to strive matching the assets to liabilities duration. And without investing overseas, domestic market just doesn't have such opportunities for us. So even though at the hedge, you see that we have 3.8%. It seems that it's not as high as what we wanted, but again, 3.8% is still safe, too high to be achieved if we invest only in local fixed income. And James, do you have anything to add?

[Honglong Yuan, executive]

The local is just impossible, 90 basis points for the 10 years, 1.5% over the 30. And the perpetual for the banks -- issued by other banks is around a little bit north of 2%. Versus the fixed income yield, it's still -- the overseas is still much more attractive. And again, we do expect that the hedging cost should go a little bit lower. Given the interest rate differential, I don't think -- personally, I don't think that supports the current cost of hedging at a level higher than 3% in the long term.

[Thomas Wang, analyst]

Kind of just following on that, what's the sort of mix between new equity and bond? Is it the part that plays the CE and then the part that goes through your P&L?

[Sin Young Lee, executive]

Well, in terms of yield, local stocks give us a yield higher than 4%, for sure, particularly when we have over half of our local equities invested in the, what we call, low pay to high-dividend stocks, that will be utilities and also telecoms. And we are now the single largest investors for Chunghwa Telecom. So for those names, we enjoy higher yield. Local investments for bonds raise another story. Across the board, I would say other than those perpetuals offered by other insurance companies, those insurance companies with preferred shares, you don't have any chance to have -- to enjoy any yield higher than 2%. And for the foreign ones, we don't count on the equities too much. As for the foreign equities, you see that it accounted for 3.8% of our overall assets, we mainly classify those as PL overlays and we trade those stocks for capital gains for major reasons. And if there is any, say, dividend yield, that's only a benefit -- there's a slight benefit.

And for fixed income, so I would like to let James to add on some conditions, some targets of the yields and to analyze that, please.

[Honglong Yuan, executive]

Well, reinvestment yield is north of 5%, so that's without any question. And again, on the equity side, the dividend, because we mainly invest in the U.S. market and we need to pay 30% on the dividend paid by the U.S. companies -- so if you look at the S&P 500, average yield is around -- so it is straight up 2%, so after that 30% withholding tax, you've got 1.4%, so there is not much that you can gain from the dividend perspective. So again, the overseas equity investment is mainly there for the capital gain generation to supplement our hedging cost as we are recurring income now is pretty much able to meet the current liability. So that's our main strategy for the past few years.

[Thomas Wang, analyst]

Got it. And can I ask a question on the bank? You mean -- you mentioned that they are quite high. I mean, that's down a bit for the quarter, but on absolute level, it's still quite healthy. How do you see that going forward?

[Sin Young Lee, executive]

As we stated in our presentation, we think -- I cannot give you too long a view, but for 2018, I will say the yearly NIM will be lower than what we had last year. Last year, if I remember correctly, the level was at 1.54%, right, 1.54% or 1.53%. And again, you're seeing the number at the third quarter already has a level similarly to what we had last year. Fourth quarter will be further lower. Main reason for that downward trend will be the increasing funding cost for U.S. dollar deposits.

[Operator]

[Operator Instructions]

[Sin Young Lee, executive]

All right. It seems there is no further questions. I believe we have both very comprehensive discussions both in Chinese and English session. If there's any further question, please do not hesitate to contact me or my team. We will be there for you. Moderator, please close the meeting now.

[Operator]

Yes. And ladies and gentlemen, we thank you for your participation in Shin Kong Financial Holding Company's conference call. There will be a webcast replay within an hour. Please visit www.skfh.com.tw, under the Investor Relations section. Should you have further questions, please don't hesitate to contact the IR team of SKFH by phone or by e-mail. You may now disconnect. Goodbye.