Earnings Call Transcript - KB Q2 2022

Peter Kweon, Head of IR

Greetings. I am Peter Kweon, the Head of IR at KBFG. We will now begin the 2022 first half business results presentation. I would like to express my deepest gratitude to everyone for participating today. We have here with us our Group CFO and Senior Managing Director, Scott Seo, as well as other members from our group management. We will first hear the 2022 first half major financial highlights from CFO and Senior Managing Director, Scott Seo, and then have a Q&A session. I would like to invite our Senior Managing Director to deliver 2022 first half earnings results.

Scott Seo, CFO

Good afternoon. I am Scott YH Seo, CFO of KB Financial Group. Thank you for joining the company’s first half 2022 earnings presentation. Before moving on to our earnings results, allow me to briefly run through key business highlights of the group. Q2 ‘22 group net profit was KRW 1.3 trillion, up 11.4% year-over-year as of the first half, reporting KRW 2.8 trillion. Group ROCE was 12.5%, remaining steady as of the first half, while annualized EPS, earnings per share, was around KRW 14,000, up 11% year-over-year on a robust uptrend. Also, today, KBFG’s Board of Directors approved KRW 500 per share as the quarterly dividend. And following last February, we decided to cancel KRW 150 billion of treasury shares and, as such, do KRW 300 billion of total share cancellation this year. In the midst of the spread of macro uncertainties and difficult business backdrop, underpinned by our outstanding capital adequacy and stable earnings capacity, we have been consistent and differentiated in implementing our shareholder return policy. Globally, there is growing concern over saturation while the Korean economy is mired with three highs: high interest rate, high inflation, and high exchange rate, which may undermine profitability of the banking business and widen credit risk. We are therefore focused on the fundamentals and preemptive risk management. For example, this quarter, based on conservative projections for GDP growth, policy rates, and the FX rate as well as other indicators and scenario analysis for crisis, we made around KRW 121 billion of additional provisions. By way of such conservative provisioning stance, we’ve enhanced loss-absorbing capacity, bringing the group’s NPL coverage ratio to 222.4%, which is the industry's top-notch level as well as top-notch in terms of global standards. Also, last May, we ran a group-level stress test based on internal and external economic conditions and probable future risk factors. Even under a severe recession scenario of negative 6.3% GDP growth of the IMF, the group’s capital adequacy will be above the regulatory requirement, yet again attesting to KB’s sound financial prudence. Meanwhile, as a leading financial group fulfilling its social responsibility, KBFG is extending various different financial support for the vulnerable and the less privileged who are suffering from economic slowdown and rate hikes. Also, ahead of the end of the COVID-19 financial forbearance program in May, to alleviate the burden for small businesses and the self-employed, depending on the borrowers’ repayment capacity, we allowed up to a 10-year extension for amortization and introduced a COVID-19 special long-term repayment amortization program offering a grace period for repayment of the loans to allow for a soft lending. And out of all of the commercial banks, KB Bank was chosen as an affiliated bank for Citibank Korea for the rollover of unsecured retail loans. This has proven KB’s distinctive expertise in household loans and customers’ trust, and we expect some growth in household loan activity going forward amidst somewhat of a sluggish first half growth. Next, I will move on to the details of the company’s earnings. KBFG’s Q2 2022 net profit was KRW 1,303.5 billion, up 11.4% year-over-year, landing at KRW 2,756.6 billion on the first half basis. Despite the greater macro uncertainties and financial market volatilities and such difficult operational backdrop, we have shown the group’s solid earnings capacity. However, Q2 net profit was down 10.3% Q-on-Q as conservative forward-looking criteria were used to preemptively book provisioning. And due to the lack of one-off gains such as the bank’s corporate tax reversals in Q1, excluding the impact of such nonrecurring items, net profit is down 2.4% Q-on-Q. In more detail, first half 2022 group net interest income was KRW 5,441.8 billion. Q2 net interest income was KRW 2,793.8 billion, up 18.7% year-over-year and 5.5% Q-on-Q, driven by rising rates leading to the repricing of loans which widened the NIM as well as due to loan growth. Q2 group net fee and commission income was KRW 874.9 billion, down 4.4% Q-on-Q. And on a first half basis, it reported KRW 1,789.9 billion, down slightly year-over-year. This year, against sluggish financial markets both at home and abroad, brokerage fee income was constrained. On slower sales of financial products, the sale of trusts and funds also slowed, dampening the group’s fee and commission income. However, thanks to our business diversification and efforts to strengthen competitiveness, the earnings fundamental behind generating fee and commission income has improved a notch, driving the investment banking business performance by twofold year-over-year, landing the group in a solid market position. The Securities business has gained a leading position on the league table for its DCM as well as ECM, M&A, and acquisition financing business. Next is other operating profit. Other operating profit this year underperformed due to valuation loss from bonds following market rate hikes, while the rise in FX rates and foreign equity index drove losses from ELS and CVA valuation, dampening performance from securities, derivatives, and FX, leading to sluggish performance both year-over-year and Q-on-Q. But for insurance underwriting profit, we saw overall improvement in loss ratio from the non-life business, while life insurance profitability was sustained, continuing on a positive performance trend. In the second half, we expect additional interest rate hikes. Since there is the added possibility that financial market volatility can increase, including for FX, we wish to maintain a defensive management stance for the time being and improve earnings stability through portfolio diversification and a flexible position strategy. 2022 first half group general and administrative expenses posted KRW 3,445.9 billion. Despite the increasing group-level investment in digitalization, as a result of cost-control efforts including labor costs, it only increased 1.6% year-over-year and is being well controlled. Additionally, for Q2, G&A expenses increased 3.7% Q-on-Q due to seasonal factors, including an increase in advertising and promotion costs and taxes and dues. Q2 group provision for credit losses posted KRW 333.1 billion, which increased by KRW 203 billion, a slightly high range Q-on-Q. Reflecting the conservative forward-looking criteria in this quarter, there will be around KRW 121 billion of additional provisioning. The recurring level of provisioning, excluding these nonrecurring items, posted around KRW 210 billion. First half provision for credit losses posted KRW 463.2 billion, an increase slightly year-over-year due to preemptive provisioning and asset growth but is maintaining a stable level on a recurring basis. I will cover the major financial indicators from the next page. First, 2022 first half group ROCE posted 12.49%. As a result of solid core earnings growth and cost control efforts, a level higher than 10% is being well maintained. As of June 2022, bank loans in won posted KRW 323 trillion, which grew 0.4% compared to March and 1.2% YTD. Overall, loan growth remains at a low level. Corporate loans posted KRW 157 trillion as of June, increasing 2.1% compared to March and 5.5% YTD, maintaining a solid growth rate for each quarter. Particularly, general SME loans increased by around KRW 4 trillion YTD, driving SME loans growth. For large corporate loans, with loan demand growth following worsening conditions for corporate bond issuance and as a result of efforts to strengthen the investment banking business, it decreased 7.5% YTD. On the other hand, household loans as of June posted KRW 166 trillion, reflecting 2.5% YTD decline and showing a minus growth rate. This was due to weaker overall loan demand from strengthened household loan regulations and the burden of increased loan interest rates, particularly the increasing pressure to repay unsecured loans. In the second half of the year, partial recovery of household loan growth is forecasted. Still, since this is a period requiring conservative risk management due to internal and external conditions, we wish to focus on asset quality and profitability management, concentrating on qualitative growth centered around high-quality assets. Next is net interest margin, NIM. 2022 Q2 bank NIM posted 1.73% and rose 7 basis points Q-on-Q; on a cumulative basis, it expanded to 12 basis points. This was mainly attributable to the rapid loan asset repricing, reflecting steep key rate hikes from the previous August and improvement in valued asset profitability. On the other hand, Q2 group NIM posted 1.96% and rose 5 basis points Q-on-Q. With the card financial asset yield decline, including card loan and cash advance, and effects from card NIM contraction following funding cost increase, the increase was limited compared to the bank’s NIM. Next, let’s discuss the group’s cost-income ratio, CIR. For the 2022 first half, group CIR posted 46.5%, indicating continuously improving cost efficiency. Additionally, even excluding nonrecurring items, including digitalization costs, CIR shows a market-lower stabilization trend. With the visualization of strengthening efforts for workforce efficiency, we believe that cost efficiency will improve further. Our goal is to maintain a recurring CIR so that it can improve to the mid-40s. Next, I would like to cover credit costs. 2022 first half credit costs posted 0.23%. Even as credit risk increases from rapid interest rate hikes and an economic downturn, it is being maintained at a stable level. Q2 CCR, excluding preemptive additional provisioning, is at a low level of around 0.20%. Next is the group’s capital adequacy. As of end of June 2022, group BIS ratio posted 15.64%, and CET1 ratio posted 12.93%. With the expansion of corporate and overseas assets, an increase in risk-weighted assets has occurred alongside interest rate hikes and some price declines as well as a decrease in accumulated other comprehensive income. However, supported by robust profit generation and strategic capital management, we secure the highest level of solid capital buffer in the financial industry. From the next page are detailed materials related to the performance that I just mentioned, so please refer to it if needed. With this, I will conclude the 2022 first half KB Financial Group business results presentation. Thank you for listening.

Peter Kweon, Head of IR

We will now begin the Q&A session. We will take questions from Samsung Securities, Mr. Kim Jaewoo.

Jaewoo Kim, Analyst

I would like to ask two questions. The first question relates to your shareholder return decision. You’ve decided to maintain the DPS and cancel your treasury shares. I think that helps alleviate concerns in the market. But my question is, would you be able to sustain this stance? There is some positive hope as well as some negative assessment. We see that the U.S. banks have started to end the treasury share-related cancellations, so we’re concerned about whether this stance could actually continue into the future. If you have any guidance, that would be helpful. The second question pertains to your asset quality. As mentioned, the economic situation is quite challenging, and I’m wondering whether the provisions you have in place are sufficient. As you mentioned, your NPL coverage ratio is relatively high. However, NPLs could also potentially rise quite steeply. In the bank’s assessment, with respect to your potential concerns and risks, where do you see the biggest risk? Is it in project financing or other types of products or segments? Are there any countermeasures in place for you to manage your asset quality stringently?

Scott Seo, CFO

Yes, I am Scott Seo, the CFO of KBFG. I will respond to your question about shareholder return and then the appropriateness of the provisions that we have in place. Regarding the provision details, we have our Chief Risk Officer, who is with us, so he will provide you with more details. Let me respond to the shareholder return-related question first. In June and July, we had an NDR, during which we met with our major shareholders and investors. We conducted an overseas NDR, which gave us the ability to listen to the feedback of our investors and shareholders. I delivered that feedback to our Board of Directors and top management. What we believe our foreign investors and major shareholders in the domestic market want is not a steep rise in the dividend amount but a continuous trend, as well as an appropriate mix and balance between cash dividend payout and overall shareholder return. The second confirmation we received regarding Japanese banks is that their dividend payout amount has not been very significant, yet over the past couple of years, Japanese companies have executed cash payouts and treasury share cancellations, making their approach rather shareholder friendly. We are, of course, considering all of these approaches. And after Q2, the U.S. banks have started to stop issuing dividends. While some major U.S. banks exhibit different cases, we cannot directly translate the U.S. situation to Korea. Regarding dividend payout, we’ve emphasized multiple times that we have both cash dividend payouts and treasury stock buybacks. Our objective with these two approaches is to reach a 30% payout ratio as soon as possible. That is the first point I wanted to emphasize. Secondly, if our net profit this year is at least KRW 1 more, we will do our best to ensure our DPS also rises. Third, I would like to highlight that once we reach the 30% payout ratio, rather than increasing cash payout, we will focus more on share buyback and cancellation. That will be our direction moving forward. Our price-to-book ratio is only 3.3 times. Given this condition, a mid-to-long-term perspective indicates that share buybacks and cancellations would be the better course for us. In terms of the appropriateness of the size of the provision, we’ve looked at many aspects. Compared to banks in the U.S., excluding credit cards, our provision level against total loan books is comparable. Even when considering credit card carve-outs, there are some credit card products in the U.S. that have bigger exposure, and vice versa for us. So due to that situation, there’s a difference between the credit card provisions for U.S. and Korean banks. In KB Financial Group, we have global standards and the highest criteria, based on which we’ve provisioned as much as possible for our credit card loans. Now, I would like to turn over to the CRO to provide a little more elaboration.

Pil-Kyu Im, CRO

Yes, I am Im Pil-Kyu. I’m the CRO of KBFG. Regarding asset quality and project financing. You’ve also mentioned project financing, so let me respond to that question. With the interest rate hike in Korea, there is some concern about a potential systemic risk. I do not think that will be the case. If you reflect on the global financial crisis and the subprime crisis, during that time, the LTV regulation was set in place preemptively by the regulators, allowing us to overcome the crisis. We think that the interest rate will stay in an uptrend for some time. However, starting last year, there have been strong DSR regulations in phases, which provide rigorous asset quality-related discipline. We believe this regulation will act as a safety fence for the system. That said, savings banks may be impacted quite severely due to the increasing delinquency rate. The reason for this is that in the past two years and up to the first half of this year, savings banks saw a steep rise in household loans, last year more than 50%. A significant proportion of those new loans were via platform-linked loans like Pinda, Kakao Pay, or Toss. For all these platform-based customers, savings banks accounted for via these platforms more than 40% of total new loan originations. This was a new marketing methodology utilized by these companies. Interestingly, platform-linked loans for credit cards do not exhibit the same connection to fintech platforms. Within the household loan segment, the potential risk factors in the savings bank industry may have a considerable impact. However, it will not spill over to the credit card industry due to differing customer bases and marketing structures. Based on overall market data, for the credit card industry, the platform-linked loans are minimal. While there may be some impact from interest rate hikes based on customer segmentation, for the time being, we believe that the risk will be contained within the savings bank industry. In terms of the banking sector, as you know, we are rigorously managing the situation. Entry management is conducted quite systematically, and we believe that we will continue to do so. Should any risk events arise or if there are borrowers whose creditworthiness may significantly deteriorate, we have a model in place for preemptive assessments and readiness. For those needing to extend their repayment periods, we can enhance their collaterals or explore loan restructuring. We have all the necessary mechanisms well-established to guard against or prevent any asset quality degradation within the company. Hence, I am not overly concerned about that. Regarding project financing, specifically, which has recently been a topic of audit articles, we have exposure of about KRW 14 trillion. For each of the associated work sites, we have conducted thorough reviews and inspections. If there is a specific site prone to issues, we have identified a potential risk of about KRW 40.3 billion. However, our position is that we already have a senior debt position on all projects, meaning we are not highly exposed to bridge loans or project financing loans. For any potential real estate-related issues, we believe the impact is not significant. Furthermore, for all of our project financing sites, we categorize them for proper management, in addition to having a risk management regime in place involving 20 different variables to track which sites need monitoring. Our underwriting process is also in place, helping us assess risks effectively. Therefore, regarding our project financing-related exposures, we have well-defined protections in place. As for our securities on the project financing side, I can assure you that we are not currently encountering any problems.

Peter Kweon, Head of IR

We will take the next question, Yafei Tian from Citi Securities.

Yafei Tian, Analyst

I have a couple of questions. Yes, the first one is there is relatively lower trading-related income for this quarter. Would it be possible to give a breakdown of some of the losses that is weighing that line down? A little more granular detail there would be super helpful. The second is on the net interest margin outlook. Clearly, the BOK has turned more hawkish since the end of the first quarter in terms of raising the rates. So, would that change the net interest margin outlook for the bank? At the same time, we are also seeing the regulator asking banks to provide relief to more vulnerable borrowers to prevent their debt servicing burden. How should we balance the trends of rising rates with potentially needing to pass some of the benefits to customers? Finally, are there any discussions regarding proposing a bank-related tax in this current environment?

Unidentified Company Representative, CFO

I’m Kim Jae-keun, the CFO of the bank. Regarding the bank NIM, I would like to answer your question first. In Q2, it was 1.73%. So compared to the previous quarter, it rose 7 basis points, and it expanded by 12 basis points on a cumulative basis this year. Comparing it to the early NIM, you can see in the first half, an improvement of 11 basis points. Prudenctly, we are expecting additional NIM improvement in the second half as well. We believe that 5 to 6 basis points may improve. However, as you mentioned, policies to help vulnerable borrowers may also need to be implemented. Due to decreased demand for household loans, there will be increased competition between the banks, potentially leading to spread declines. Therefore, the range of NIM improvement might be limited, but we do expect the improvement trend to continue. In addition, through effective portfolio management based on profitability and to enhance profitability on our managed assets, we are making consistent efforts and aiming to persist in this direction. I would like to answer your question related to trading. To answer your question, there were some FX fluctuations and an increase in fixed income yield; thus, trading volatility was very high. However, we believe that for trading, the direction will be as follows. In the second half, we expect improvement in profits. For more details, please contact our IR team, and we will be happy to provide you with more detailed information about the trading forecast.

Peter Kweon, Head of IR

Yes, I don’t think you’re connected, so we’ll go to the next question.

Unidentified Analyst, Analyst

My first question is quite simple. The biggest concern that people have is that BOK by the end of this year will likely hike rates to between 2.7% to 3%. When that time comes for household loans, this will also apply to corporate loans as well, and interest rates on household loans are expected to increase significantly. By the end of the year, what do you think the lending rate for household loans will be? According to our estimates, we believe that the household interest burden is expected to rise by 50% compared to the previous year. If that’s the case, borrowers are going to really feel the pressure. From the bank’s perspective, what are some of the measures to alleviate this interest burden, maintain your customer base, and ensure no excessive stress? I would like to understand what your measures are. The second question is a difficult one. If you look at BOK’s financial stability report on the mutual finance side, there are cases where a household basically took out a loan under a corporate name and made investments into property. It appears that many have utilized short-term floating rate loans, and there seems to be a considerable burden felt by these borrowers. With further interest rate increases, this may exert stress. If you consider that more than 50% of these borrowers are banking customers, it indicates that there is rising risk. You may also have a lot of customers taking out loans under both household and corporate names. What are your plans to manage this potential risk?

Pil-Kyu Im, CRO

Yes, I am Im Pil-Kyu, the CRO of the holding company. On the household side, by the end of this year, the BOK is estimating around 300 basis points. I would like to discuss the potential impacts on our lending rates and how this may drive changes. When we look at our household loan repricing cycle, it’s typically 6 months; therefore, 60% will come every 6 months and 20% every year. Essentially, after 1 year, 80% of our loans will have experienced repricing. We believe that by the end of this year, around 60% will be affected by these changes. As interest rates rise, we conduct retroactive assessment to correlate with delinquency rates. Our past experience with unsecured loans indicates that after 11 months, we begin to see a meaningful uptick in the delinquency rate. Thus, we preemptively booked provisions. For corporate loans, we also maintained adequate provisions. As for this year’s household loans, as our CFO mentioned, we’ve allocated substantial provisions for these household loans. Considering interest rate hikes, there could be some vulnerable or at-risk borrowers. Similar to corporate customers, we have a long-term amortization reprogram. For any customers whom we perceive may be at risk, we can revert them to a long-term repayment program. This not only helps alleviate their repayment burden but also preserves our asset quality. Based on past experience, we are operating these different mechanisms at a granular level. You asked about borrowers’ configurations in the second-tier financial market for unsecured loans and how we manage these burdens. More than 95% of our credit card and savings bank loans are amortization and fixed-rate products. Given interest rate increases, these nonbank affiliates will not be significantly affected. Nevertheless, there could be risks associated with mutual financing; hence, we heavily manage these individuals since they represent multiple risk profiles. To summarize, any potential risk affecting our bank from these multiple loans is significantly contained and mitigated.

Peter Kweon, Head of IR

Thank you very much for the detailed answer. It seems there are no other questions in the queue, so we will wait for a few minutes to see if there are other questions remaining. If you have further questions, please contact us, and we will be more than happy to respond. I believe that due to the absence of significant or important nonrecurring items in this quarter, there may not be additional questions coming in. So, I believe we have covered the major highlights. We will wait a few more seconds, but it seems there are no other questions. With this, we will conclude.