Shinhan Financial Group Co Ltd (NYSE:SHG) Q3 2020 Earnings Conference Call October 27, 2020 3:00 AM ET

Company Participants

Park Cheol Woo – Deputy Head of IR

Roh Yong-hoon – Deputy President & CFO

Park Sung-hyun – MD and Chief Strategy & Sustainability Officer

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Kim Tae Youn – General Manager, Finance Management Team

Bang Dong-kwon – MD & Chief Risk Officer

Conference Call Participants

Kim Jin-Sang – Hyundai Motor Securities

Seo Young-Soo – Kiwoom Securities

Kim Han Lee – KTB Investment & Securities

Park Cheol Woo

Greetings. I am Park Cheol Woo, in charge of IR. I would like to thank all participants in our business results presentation and begin the 2020 Q3 earnings release. From Q1 of this year, we have been having this earnings call with only voice in order to have the minimum number of staff due to COVID-19. We ask for your understanding.

We have here with us our CFO, Roh Yong-hoon; CSO, Park Sung-hyun; CRO, Bang Dong-kwon; Head of Strategy Planning, Kim [indiscernible]; and Head of Finance Management, Kim Tae Youn. We will first hear the 2020 Q3 earnings presentation from CFO, Roh Yong-hoon, and then have a Q&A session. I would like to invite our CFO, Roh Yong-hoon, to walk us through the 2020 Q3 earnings.

Roh Yong-hoon

Greetings. I’m Shinhan Financial Group’s CFO, Roh Yong-hoon. Thank you all for taking part in the 2020 Q3 earnings release. With the weather turning cold, a second wave of COVID-19 pandemic is spreading around the world, and the speed of economic recovery is becoming delayed. With still a great amount of uncertainty regarding the economic recovery, while maintaining solid basic fundamental, it is an important juncture for us to prepare for the future. In particular, utilization of capital, the basis of activities of financial companies, will become an important yardstick that will decide the future competitiveness in an environment like in the current situation.

Based on this diagnosis, Shinhan Financial Group in Q3 worked hard to continuously create conditions to generate capital and asset profitability even after the post-COVID era. I will briefly cover this from Pages 5 to 6 and then explain about the group’s Q3 earnings.

Let’s go to Page 5. A characteristic of Q3 activities of Shinhan Financial Group is that we continued efforts to improve capital profitability. In particular, in the investment banking area with high capital and asset profitability, based on operating income, GIB rose 24% Y-o-Y and GMS rose as much as 128% Y-o-Y, a high-growth rate, respectively.

Shinhan, in order to increase the profitability of investment banking and property asset management, has adopted the matrix operational system, the basis for cooperation between many subsidiaries. The experience of the matrix operational system accumulated for many years is showing its effect in a difficult situation like in the current situation.

On the other hand, with the continuation of SME funding support in order to overcome the COVID-19 situation, the growth rate of corporate loans has grown 11.2% compared to late last year and is maintaining a high-growth rate from Q4 of this year. We will utilize raised capital so that the growth momentum of the business areas with high profitability can be maintained.

As aforementioned, we believe that in a situation like in the current, the utilization of capital is an important yardstick to determine the future competitiveness of a financial company. And when we announced the paid-in capital increase in September, we also forecast our midterm capital policy target. It’s not at the level of the detailed guideline, but we expect the CET1 ratio target of 12% going forward. And based on this target, we mentioned that we will implement diverse shareholder return measures, including quarterly dividends. As of September, we have reached CET1 ratio of 12% and, based on this, more aggressive profit growth, and ultimately, shareholder return will be possible.

As you can see on the next page, we will communicate with the market regarding the details about our capital utilization. The material that you can see on Page 5 shows the CET1 ratio as of September 2020.

The current CET ratio as of end September is posting 12%, and this is an 89 bp improvement YTD. And you can see that we had an improvement. The capital ratio accumulated through income generated until end September is 108 bp, and the capital allocated for profit generation was 76 bp. With the expansion of other comprehensive income, including GMS, the CET1 ratio improved 18 bp. With the expansion of assets in the new growth areas, including IB, the size of allocated capital can get bigger than the current situation.

On the other hand, as a part of M&A activities, the change of capital ratio caused by the integration of Orange as a complete subsidiary early this year was neutral. Apart from this, there was a 44 bp improvement with paid-in capital increase, which was resolved in September.

As you are well aware, as a part of the government’s deregulation measures regarding the COVID-19 situation, there was early adoption of Basel III credit risk, which led to a 110 bp nominal improvement in capital ratio. However, taking into consideration the Basel III adoption schedule, capital management will be continued, centering on the CET ratio of the past standard.

Assuming that the CET1 ratio as of September end is maintained and if the ordinary income at the end of the year is realized at a similar level to the previous year, we expect to pay out at least the previous year’s levels dividend per share. From the next quarter’s earnings call, we will show you the capital ratio allocated for shareholder return.

Now let’s go to Page 8, group’s management of performance highlights. The financial performance as of Q3 2020 posted KRW2.9502 trillion of net income, a level up in recurring fundamentals. On a quarterly basis, it posted KRW1.1447 trillion, the largest quarterly income since we were founded despite the COVID-19 situation. And the provisioning against investment product issues, you can see that the situation has improved.

And as aforementioned, despite the COVID-19 situation and the provisioning against investment product issues, the size of income grew 1.9% Y-o-Y, not only on the back of 2% interest income growth following the high loan asset growth rate following COVID-19 support measures and margin guarding, but also because there was a 4.8% Y-o-Y increase in highly profitable base noninterest income.

On the other hand, in terms of cost, SG&A and provisioning is being managed stably. SG&A increased 2.6% Y-o-Y, and the group CIR ratio posted 42.5%, the lowest level in the industry. With acceleration of digital transformation going forward, through efficiency improvement of front, middle and back, we believe that a low level of CIR can be maintained.

Despite concerns regarding the COVID situation, the CCR is being maintained stably at 42 bp. Excluding the provisioning related to COVID-19 and investment products which took place in Q2, the recurring credit cost ratio is maintaining a 30 bp range, showing the effects of preemptive risk management considering COVID-19.

From Page 9, I will cover the details of Q3 financials. 2020 Q3 group interest income posted KRW6 trillion, a 2% increase Y-o-Y. With the continuation and maintenance of external growth, it seems to have offset the margin decline effect caused by the policy rate cut in May. On the other hand, despite the group quarterly margin drop of 3 bp in Q3, we expect more stability from Q4, taking into account the recent market interest rate trend.

The bank’s loans, in won, growth rate on a cumulative basis until Q3 posted 7.7%. Looking at the breakdown per annum, household loans grew 4.4%, and corporate loans grew 11.2%, respectively. In particular, with the maturity extension of the COVID-19 financial programs, SME and SOHO loan assets grew greatly, driving the overall asset growth trend. With high concerns over the situation about the financial support program, when it is over, through a loan early warning system utilizing big data and other measures, we will continue preemptive risk management.

I will now cover the group’s noninterest income from Page 10. The group’s noninterest income in Q3 rose 4.8% Y-o-Y to KRW2.7119 trillion. This is attributable to valuation gain on securities due to capital market stabilization in Q2. But what is noteworthy is the increase in fee income. The fee income as of Q3 YTD increased 8.4% Y-o-Y to KRW1.755 trillion. The breakdown of fee income shows growth in many areas, with the exception of retail investment products due to the PE-related incident.

Despite concerns of shrinking consumption due to COVID-19, the credit card fee maintained a growth rate of 2.8% on a cumulative basis. With a brokerage fee increase of 121.5% driven by the retail investors stock trading, the profit base related to retail investors was well defended. In addition, lease financing fees and IB-related fees, except for one-offs, led the fee income increase in Q3.

Let me now discuss costs on Page 11. The group’s SG&A in Q3 YTD grew 2.6% Y-o-Y, and the group’s CI ratio is maintained stably at 42.5%. We will continue to keep the CI ratio at a low level through efficient management system enabled by digital innovation.

The group’s loan loss provision increased 40.6% Y-o-Y. But if we take out the provisioning related to COVID-19 and DLS in Q2, it is actually a decrease of 0.8% Y-o-Y. Considering the recurring credit cost ratio said to be in the latter 30 bp, according to the 2020 business plan, credit cost is still in the stable range.

The delinquency ratio, which is considered the leading indicator for future credit cost, has fallen both Y-o-Y and Q-o-Q, not showing signs of deterioration in asset quality due to COVID-19. However, taking into account the uncertainties, including the extension of the COVID-19 relief program up until Q1 next year and economic recovery not taking off, preemptive risk management is vital. We’ll be prepared for the uncertainties through many different means, including the early warning system utilizing big data that I mentioned earlier.

Page 12. Please refer to the slide for capital adequacy indicators. As of Q3, ROE stood at 10%, recording a 2-digit ROE every third quarter for 4 consecutive years. We will continue to work to enhance ROA and ROE in a sustainable manner.

The subsidiaries business performance on the next page. Thanks to the outstanding performance of the nonbank subsidiaries in Q3, nonbank’s contribution to net income increased 23 — 8% Y-o-Y, and it increased to 41%. With the securities capital and IB arms going strong this quarter, we were reassured of Shinhan’s diversified portfolio able to maintain its fundamentals despite the challenging environment.

Across the matrix, due to COVID-19 and DLS, the operating income in wealth management and global business fell. However, wealth management maintains its growth momentum in size and the number of customers, so it is expected to recover when the external conditions improve. Income from global business decreased 16.2% Y-o-Y, but this is because they had provisioned in Q2 compliant with Korea’s domestic standard. Without that factor, the recurring income is at a similar level or even a 7% increase Y-o-Y. We will continue to manage profitability, liquidity and soundness in each country.

Please refer to the next page for more detail on the status of the global business. I will now continue with the explanation about the contribution made by the digital initiatives. Please look to Page 15. Recently Shinhan Financial Group has stated that it will accelerate its digital transformation by, for example, setting aside a separate budget for digital. Right now, we’re in the middle of measuring the financial return on digital activities. And we would like to share some of that with you on this page.

Digital transformation is not limited to a strategy based simply on channel expansion. It is a group-wide innovation affecting all front, middle and back office activities. In that regard, we’re measuring the impact by developing both profit and cost indicators. Let us first look at how much digital contributed to operating income. In Q3, its contribution to the group’s income was 11.6% growing year-on-year. And by subsidiaries, we can see that the digital contribution is high in Shinhan Card through digital pay.

And let’s look at the cost side. Digital’s contribution to cost saving is most pronounced in the front office with the expansion of new digital products. And we also see some cost-cutting effect in mid to back office through paperless branches and robotic process automation. We will continue to develop a number of indicators so that we can communicate the various financial impacts digital activities have.

Lastly, ESG on Page 16. We believe ESG is not limited to a simple set of strategic initiatives in enabling long-term sustainable growth and creating results. Since they have impact on the long-term financial status, we will keep communicating with the market the ESG activities that we are engaged in. This page shows that up to Q3 2020, the total amount of green finance executed was KRW1.990 trillion; and inclusive financing, KRW22.722 trillion. Shinhan does not stop at calculating the financial support extended to each ESG scheme. We are getting ready to properly measure the impact of our ESG activities, for example, by introducing the carbon neutral concept based on carbon emission and developing the social value measurement system based on social values. We will share more concrete results with you once we are ready. Detailed information about the group’s ESG activities, thus far, can be found in the annual CSR report.

The remaining slides are for your reference, guiding you through major subsidiaries’ performance and business indicators. The year 2020 will be remembered as a year facing unprecedented challenges of COVID-19. It is essential to be prepared for the future, which we don’t know how it will unfold. To make the best possible preparation, we will strengthen our fundamentals as well as keep working hard to create sustainable corporate value. Please show us your kind attention and support so that we may continue on our differentiated Shinhan way.

This concludes the earnings presentation. And now we will have a Q&A. Thank you.

Question-and-Answer Session

Operator

[Operator Instructions]. We will get the first question from Hyundai Motor Securities, Mr. Kim Jin-Sang.

Kim Jin-Sang

Congratulations on your great earnings. I have 2 questions. First question is a simple question. Regarding your CIR, you mentioned it’s 40.5% — 42.5%, so it’s quite good. And looking into the next 3 years, I’m sure that you have integrated-related costs as well and digitalization-related costs actually. So you think the numbers of CIR will be affected? And do you think the cost will be big in the beginning, and then your CIR is going to go down in the mid to long term? So the current level of CIR, do you believe it can be maintained? That is my first question.

The second question is related to, excluding one-offs, on a recurring level, you had about KRW1 trillion, and in Q2 — in Q3 actually, what were the special factors, outstanding factors? And regarding your recurring fundamentals, do you believe that it’s sustainable?

Last question, actually, regarding the government program, the deferral of interest payments. Or interest holiday seems to be most worrisome, so can you tell us about the situation? And what is the amount of principal, the interest based on the principal? So can you tell us about what impact this may have on your group?

Roh Yong-hoon

I am the CFO, Roh Yong-hoon. I think you gave us three questions. And based on that, first, related to digital innovation, we mentioned that for the next three years, about 10% of our group’s net income. In the past, we didn’t have a separate digital budget, and it was included in our ICT budget, but we mentioned that this will be separate so that we will accelerate digitalization. So we announced that after setting it as our plan going forward. And the 10% that we mentioned, well, it can include the recurring costs, but capital-related costs are included as well.

With the digital innovation, regarding one-off expenses and costs, we are still getting material for next year’s financial plan, so we cannot give you concrete details, but a sizable amount will be related to capital. So regarding the CIR ratio, even though we do have digitalization efforts, we don’t believe that it will deteriorate in the next 2 to 3 years. And because of our increase of income regarding our raising of capital, we believe that the CIR-related factors that could push up the CIR a bit will not be that sizable.

And in Q3, you mentioned one-offs. In Q3, what they are, the breakdown, and whether we can maintain the recurring level of fundamentals. Regarding the one-offs, there could be many factors. And looking at it conservatively, the biggest one-off is Shinhan Life Insurance’s building that we have as a type of profitable security, but we sold this off. So we had a profit of KRW49 billion. So that is the biggest one-off factor.

And then, we accumulated additional provisioning, but if that is not seen as one-offs, then the KRW49 billion will be seen as a one-off factor. Then in a quarterly recurring level, the fundamentals, well, it goes beyond KRW1 trillion. And for our recurring income, and in Q4 and in next year, we have a goal to push this up. And of course, we do believe that we have possibility of sustainability.

Bang Dong-kwon

And regarding the interest holiday, I am the CRO, and I will answer your question about the interest holiday. And the amount of interest is about KRW6 billion, and principal is about KRW300 billion. And it is not a sizable amount, so we believe that it will not affect our robustness.

And we believe that, as you know, for this year, well, if this becomes reflected into the financials next year, then there could be some marginal companies, marginalized companies that will be affected. But we are actively preemptively preparing for these possibilities.

Kim Tae Youn

I am Kim Tae Youn, Head of Finance Management. And just to elaborate on the first and second questions relate the digital expenses, we mentioned that we will invest more than 10% of our net income into digital innovation, but it is on a cash basis.

So capital expenditure or capital type of expenses, well, that could be another type. And you can see that the expenses will just be for the — of depreciated for the, 5 years going forward.

And you also mentioned fintech companies. And in our collaborative efforts with fintech companies, there could be some capital going in, but this could be seen separately, so we believe that it will not have a great impact on CIR. So the depreciation because of capital-related expenses and others will be limited. So we will not have a big impact on CIR.

And regarding the quarterly recurring income, whether it can be maintained at this KRW1 trillion quarterly level. Looking at last year’s earnings, it was about KRW900 billion per quarter, and we believe that was realized.

And regarding what has changed between last year and this year, you can see that Orange Life, 60% to 100% of the shares was acquired. So if they have more than KRW250 billion of income this year, then we could have about KRW100 billion of plus because of that.

And we had capital increase of KRW660 billion for Shinhan Investment Corp. And related to those funds for Shinhan Investment Corp., they had — Shinhan Investment Corp. accumulated KRW300 billion of provisioning, but they were able to realize sizable profit and income.

So looking at those two factors, we believe that, financially, we already have reached the KRW1 trillion line, and we believe that it is indeed sustainable. Thank you very much.

Operator

[Operator Instructions]. The next question is from Kiwoom Securities, Mr. Seo Young-Soo.

Seo Young-Soo

I am Seo Young-Soo from Kiwoom Securities. Can you hear me well?

Unidentified Company Representative

Yes. Please go ahead.

Seo Young-Soo

In Q2, because of the DLS incident, you had some difficulties. And as we had expected in Q3, there were no mishaps related to such misselling of PE products. But nonetheless, we are still concerned regarding other types of PE funds, including real estate funds going bad. Internally, what are your plans? Do you think this incident is over?

And second question is about provisioning. Will there be additional provisioning? I think you mentioned that if there is a need, so maybe in Q4, applying the IFRS 9, will you be provisioning additionally? And will that be affecting the financial results? And going forward, applying the DSR is becoming a topic these days. And how are you getting prepared for DSR?

Roh Yong-hoon

Yes. I am CFO, Roh Yong-hoon. I would like to take the question about the DLS and our outlook for the coming quarters. As for the PE-related products, the distributors, the bank and financial — the investment corp., how we have been affected is what we are keenly looking out for. We need to do in-depth reviews, and we are still waiting for the decision coming from the FSS and the dispute settlement body.

We have a contract with a foreign accounting firm, and they are doing a due diligence. So we have requested a due diligence to that accounting firm about the loss amount. And the result of the due diligence will be coming out in Q4. So depending on the result, we will decide accordingly how we are going to reflect it on our book by consulting with that foreign accounting firm. And we will recognize losses accordingly.

What our expectation is, as for the Lime CI fund, we do have insurance against the losses, and so there is the possibility of the insurance payment. And we also have to watch out for the decision coming from the dispute settlement body, and so we will be reflecting that accordingly.

Bang Dong-kwon

And the next questions were DSR. Yes, this is the CRO, Bang Dong-kwon. As for the DSR, we have adjusted the RC for the sector, and we have provisioned additionally. In Q3, in stage 2, there was additional positioning. In Q4, there could be some more. And there will be RC forecast in Q4 for the next year. In Q4, probably we won’t be provisioning as much. The amount will be less. And as for the marginal companies, looking at the growth trend, we will be working on a selective basis, and we will move conservatively.

And the next question about DSR, there is the overall bank average. Maybe it could be done on a region basis or on individual basis, individual company basis, and we plan to apply differentiated DSR on a conservative level.

Kim Tae Youn

I am Kim Tae Youn, Head of Financial — Finance Management, and I would like to add some comments. And as was mentioned by the CRO, in Q3, for selective companies, KRW22 billion of additional provisioning was set aside. And as for the PE-related funds, KRW40 billion of provision was set aside for Lime fund.

In Q2, we had a sizable provision. But starting from the end of last year, if you watch closely, the provision was around KRW50 billion every quarter. And so it was quite a sizable amount.

In Q4, what will be the size of provision in Q1 and 2 and 3, we had continued to provision. Of course, there won’t be as large provision as in Q2, and things could change. But we don’t believe any future big shock will be there.

Park Sung-hyun

I am Park Sung-hyun, the CSO. As to the private equity fund, in Heritage, we had the provision for, and we had made the payment to — for the Lime fund. And in August, we had provisioned by agreeing to the terms that 100% payment will be made out. Of course, depending on the macroeconomic situation next year, we cannot say for sure that the PE issue can all be taken care of, but we do believe that the major issues have been taken care of. And if there are some minor issues that remain, they can be handled at the bank level and at the investment corp. level, and it will not make a huge difference. Thank you.

Operator

Next question from KTB Securities, Kim Han Lee.

Kim Han Lee

I’m Kim Han Lee from KTB Securities. I’m curious about dividends. And you mentioned about growth regarding raising of capital. And I think this was something that many people were wondering.

And I have a question regarding your top line because it’s very good for the group and for Shinhan Investment Corp. as well. And can you tell us about whether this is sustainable for next year? And you mentioned the matrix organization and the review, but when you are drawing a business plan for next year, are you going to be conservative in certain areas? Can you tell us about what they are? And how conservative are you going to be? I think that will help us try to understand next year’s financial forecast.

Roh Yong-hoon

I am Roh Yong-hoon, the CFO. Thank you for your question. For next year, we are actually setting forth our business plans, our management plans. And GIB and GMS are very important. And while having sales increase, RWA will increase. But we already have a capital increase so that is not going to be a big issue. But regarding GIB and GMS, through this noninterest income expansion, we believe will follow next year, and it needs to follow. And we’re going to drive that.

However, for PE fund or trust, when we sell it in our channels, we can be impacted in the sales commissions and fees. So we believe that those targets will not be very high. So income and — we will increase fee and commissions through GIB and GMS and interest income expansion. Thank you. Noninterest income expansion, actually. Thank you.

Park Sung-hyun

Regarding the matrix, we did have some good results this year. And for GIB and GMS, we have some realizations that did not occur because of foreign circumstances abroad. But through this system, we have a very good inner system as well, internal system as well. So we believe that on a recurring level, growth and sustainability will be possible. And for GIB and GMS, actually, even when interest rate falls, we believe that it can be complemented, so we can maintain the recurring income.

For WM for this year, we had some difficulties because of the PE fund issues, but we believe that the direction is very positive. And we believe that for the other accounting factors, it is very positive on a recurring level. So the level of income, we believe that we will have growth going forward, and it will be maintained.

Park Cheol Woo

So that was our CSO, Park Sung-hyun. We have no other questions in the queue as of now, so we will hold. This concludes Shinhan Financial Group’s 2020 Q3 earnings release. We will continue to work hard for better results to make a difference in the valuation. Thank you for your participation in today’s quarterly earnings call, and we wish you the very best. Thank you.