Earnings Call Transcript - KB Q2 2020

Peter Kwon, Head of IR

Greetings. I am Peter Kwon, the Head of IR at KBFG. We will now begin the 2020 first half business results presentation. I would like to express my deepest gratitude to everyone for participating in our call. We have here with us our group CFO and Deputy President, Kim Ki-Hwan, as well as other members from our group management. We will first hear the 2020 first half major financial highlights from CFO and Deputy President, Kim Ki-Hwan, and then engage in a Q&A session. I would like to invite our Deputy President to walk us through the 2021 first half major financial highlights.

Kim Ki-Hwan, CFO

Good afternoon. I am Ki-Hwan Kim, CFO of KB Financial Group. Thank you for joining KBFG's presentation on first half 2020 business results. Before moving on to earnings results, allow me to first present on the operational backdrop. Despite prolonged uncertainties surrounding COVID-19, helped by strong monetary and fiscal policies worldwide in an effort to overcome the economic recession, financial markets regained some level of stability. Nevertheless, concerns over the global crisis of the real economy continue. If and when COVID-19's second wave hits us, despite massive quantitative easing, the economic recovery may well be delayed significantly. Thus, we are in no position to loosen our vigilance; and in the face of ultra-low rates, the banking industry is tasked with countering structural pressures as well. In such an unprecedented crisis brought on by the pandemic, KBFG will fully live up to its role and responsibility, befitting a top-tier company, and will proactively respond to changes in the financial paradigm, so as to solidify our position as a leading financial group. First of all, in order to support companies hit by the pandemic and the vulnerable classes, we have provided financial support, and KB independently is running various programs including a good consumption movement to help small local business operators. Also, we are fully committed to asset quality and risk management. We operate a continuous monitoring system on potentially problematic loans and conduct fine-tuned ex-post management of marginal borrowers and have uplifted the group's risk management system to be prepared for possible extended economic recession. Additionally, to be preemptively ready for possible quality deterioration, we made an additional provision of KRW 206 billion this quarter. In addition, KBFG is steadfast in its strategic tasks that seek to enhance earnings stability and gain a growth engine for the future. To that end, last April, we acquired PRASAC, Cambodia's biggest microfinance company, as a subsidiary. In Q3, we'll complete the acquisition process for Prudential Life Korea, a best-in-class company in terms of capital adequacy and channel competitiveness. Last month, we also entered into a strategic alliance with global investor Carlyle Group, issuing KRW 240 billion of exchangeable bonds. The bonds were issued at zero coupon as the company's high exchange premium and treasury shares highlighted KB's undervalued corporate value and growth potential. It is also considered a best case in the strategic use of treasury shares and diversification of funding sources. Lastly, but not least, KB Financial Group is focused on ESG-based responsible management and growth in innovation. Including renewable energies and green industry for environmentally friendly investment, we plan to expand ESG-related product investment loans to KRW 5 trillion by 2030. As seen from recent launches of KB Clean Ocean Deposit and KB Clean Ocean Public Trust, we incorporated ESG elements into new product and service development. As such, we will endeavor to lead ESG innovation growth at the very forefront as a leading financial group. With that, I will now move on to business results for the first half of 2020. KBFG's Q2 2020 net profit was KRW 981.8 billion. On recovery of other operating income from a more stable capital market in the second quarter and improvement from net fee and commission income and underwriting profit, net profit was up 34.6% Q-on-Q. First half net profit was KRW 1,711.3 billion, down 6.8% year-on-year. But setting aside additional provisioning aligned with our future economic forecast and Q1's ERP expenses and other one-off items on a recurring basis, our earnings capabilities continue to be solid despite a difficult operational environment triggered by the COVID pandemic, which led to economic recessions and interest rate declines. Now moving on to more details. The group's first half 2020 net interest income was KRW 4,683.2 billion. Despite lowering the policy rate and loan conversion program which squeezed the NIM, supported by solid loan growth for the bank and the card, NII was up 2.9% year-on-year. The group's first half net fee and commission income was KRW 1,381.3 billion, up 21.6% or KRW 245.6 billion year-on-year, continuing a solid growth trend. This is because although the bank's trust income fell due to restrictions and limits on ETF sales and increases in trading volume, brokerage-related fee income saw KRW 126 billion of sizable increases. Additionally, active card marketing and cost savings efforts led to a sustained rise in the credit card fee income. Next, in Q2, other operating income recorded KRW 227.7 billion, improving significantly over the previous quarter. We saw recovery from the first quarter's securities derivatives, FX-related losses, including foreign currency bonds, CVA, and ELS valuation losses incurred from steep volatilities in the financial markets. Insurance underwriting performance also improved on overall decline of the loss ratio. Since there still exist further volatilities in the financial market from resurgence of COVID-19 and the deteriorating real economy, we will continue with a defensive posture for the time being and manage our earnings in a stable manner. Next is on the group's G&A expenses. Q2 group G&A was KRW 1,586.4 billion on seasonal factors, i.e. setting aside for banks and cards welfare fund and payment of taxes and dues, and inclusion of PRASAC, the subsidiary, in the financials, G&A was up 8.7% Q-on-Q. But excluding these factors, there was only a minor Q-on-Q rise. For the first half, G&A reported KRW 3,045.6 billion, flat year-on-year and well under control thanks to our group-wide cost savings efforts. Next is the provision for credit losses. Q2 provision for credit losses posted KRW 296 billion, a 21.5% increase Q-o-Q. This was a result of additional provisioning based on FOC, or future economic outlook scenario, despite some large-scale reversals. Excluding these one-offs, it decreased by around 26% Q-o-Q. In this quarter, KB applied forward-looking criteria from a conservative perspective and reclassified some high-risk loans from stage one to stage two. KBFG provisioned an additional approximately KRW 206 billion in order to improve capability to respond to future uncertainties. For your reference, as of the end of June, the group's NPL coverage ratio, including the current reserve for credit losses, posted 296.5%, a 3.0% improvement Q-o-Q and is maintaining a high level. I will explain the major financials from the next page. 2020 first half cumulative group ROE posted 8.88%, and the recurring ROE excluding additional provisioning is being maintained quite stably. These results are the fruit of our continued efforts to strengthen our non-banking site. And going forward, KBFG will respond to the low growth, low interest rate regime and continuously diversify our revenue basis. Next, I will cover the bank's loans in won growth. As of the end of June 2020, the bank's loans in won posted KRW 287 trillion, a 6.8% increase YTD and a 2.4% increase Q-o-Q. In the case of household loans, driven by our focus on expanding Jeonse loans and quality unsecured loans, it grew 4.2% YTD. And compared to the end of the previous quarter, most of the safe conversion loans were securitized, and there was a slight downturn in growth. In corporate loans, SOHO, SME, and large corporate loans showed balanced growth, recording a 10% growth YTD and 4.2% growth Q-o-Q. In particular, SME loans including SOHO loans grew KRW 8 trillion YTD on the back of the expansion of COVID-19 related financial support programs. KBFG in the second half of this year will continue to have qualitative growth, centering on safe, quality assets and also strengthen loan review standards as a measure to preemptively manage risk and reduce potential NPLs. KBFG plans to focus more on profitability and asset quality management going forward. Next is NIM. Q2 bank NIM posted 1.50%, a 6 bp drop Q-o-Q. This was mainly a result of a slight contraction in asset yield, with key rate cuts taking effect in earnest and with a partial increase of FX liquidity management burden, although funding burden was relieved through growth of low-cost deposits and decrease of time deposits. On the other hand, the Q2 group NIM posted 1.74%, with decreasing mid-interest rate products, including car loans and cash advances. The card NIM also dropped, leading to a 10 bp drop Q-o-Q. Taking into consideration the recent key rate reduction and expansion of policy loans, it will be quite challenging to safeguard our NIM this year. But based on the best channel competitiveness in Korea, we will focus more on expanding low-cost core deposits and apply a selective and sophisticated loan pricing program to guard the NIM as much as possible. Let's go to the next page. First, I'll elaborate on the group's cost income ratio. 2020 first half cumulative group CIR posted 50.6%. Excluding one-offs including digitalization expenses including next-generation IT investment costs, CIR on a recurring level posted a 48.5% level and showed a significant improvement compared to the recurring CIR level of the previous year. With non-interest income source expansion and group-wide cost-cutting efforts, cost efficiency is gradually tangibly improving, and we plan to improve it to a mid-40% level in the mid to long term. Next, I would like to cover credit cost ratio. 2020 Q2 group credit cost posted 0.29% and it rose slightly Q-o-Q on the back of additional provisioning that I aforementioned. However, excluding one-offs at 0.14%, it is still being well managed at a low level. Next, I will cover the group's BIS capital adequacy ratio. 2020 June-end group BIS ratio posted 14.13%. CET1 ratio recorded 12.80%, similar to the previous quarter. Despite the risk-weighted asset growth following corporate loan and unsecured loan-centered loan growth, along with sound net profit growth, strategic capital adequacy management, including issuance of hybrid bonds and disposition of securities, FVOCI, we are maintaining the industry's highest level of capital buffer. Please refer to the following pages since they cover the details related to the earnings that I just mentioned. With this, we will conclude KBFG 2020 first half management results presentation. Thank you for listening.

Operator, Operator

From Hyundai Motor Securities, Mr. Kim Jin-Sang, please proceed with your question.

Kim Jin-Sang, Analyst

Yes. First of all, thank you very much for the good business results. Starting with your net profit, as well as other financials, all show quite positive results. But it seems that the bank's NIM has declined quite significantly, which is a bit unfortunate. I believe that the banking industry as a whole, on the backdrop of policy rate cut, was relatively speaking not as negatively impacted because there was demand for loans and more growth. So, I know that you provided some background information, but could you elaborate a little more as to why your NIM fell and what your plans are to recover? And you've mentioned KRW 206 billion of additional provisioning. Can you provide us some more color and breakdown of more details? My last question has to do with COVID-19. It seems that this situation continues to fluctuate in the capital markets and if this whole situation prolongs, there would be more pressure felt by the company. So, in terms of asset quality prospects forecast, what's your feel as we experience the prolonged COVID-19 pandemic?

Kim Ki-Hwan, CFO

Well, thank you very much, Mr. Kim Jin-Sang for your question. The bank's NIM basically fell by 6 basis points on a Q-o-Q basis. Let me provide you with some more background information. As we entered into Q2, we've seen a surge in market liquidity, and basically, the low-cost deposit on a Q-o-Q basis rose by about 8%, which is about KRW 9 trillion, while time deposits fell by about KRW 3 trillion. So, on the funding cost side, basically, the pressures were relieved. But if we were to look at the drivers behind the decline in the NIM, they are as follows: First, the biggest impact was felt from the policy rate cut. This year, there was a 75 basis point cut, and market rates therefore declined, negatively impacting NIM. So, due to the market rate decline, NIM was impacted by negative 3.2 basis points. However, in terms of interest rate sensitivity, we believe this extent of interest or movement – or NIM movement is within the normal range. Second, the impact of spread. Based on COVID, we provided policy loans and also there were market stabilization funds, so various different types of financial support programs. Also, loans to large corporate and Jeonse loans, where it's less profitable for us, grew more on high-quality loan assets. So, the return and spread basically declined, and that had an impact of about minus 1 basis point on NIM. Additionally, in Q2, with respect to COVID, we expanded foreign currency short-term assets to secure ample amounts of FC liquidity; therefore, that had a downward impact on NIM by negative 1.2 basis points. However, we believe that after June, things normalized. So, starting Q3, we believe that pressures on NIM will get resolved. Lastly, in April, we acquired PRASAC from Cambodia, and we financed for that investment, which had about a 0.5 basis point impact on NIM. So, all in all, there was a 6-basis point impact on NIM. In terms of investment, we want to expand our quality assets to manage our NIM, which is our growth strategy based on a risk-adjusted return basis. However, by different business segments, we will look at profitability and capital efficiency and adjust our loan portfolio accordingly. Additionally, we will make our loan pricing more sophisticated by different segments to best guard our profitability as much as possible. On the funding side, LDR and LCR, which are liquidity regulations, have been temporarily softened. So, in terms of lower funding costs, we want to be very flexible and utilize market funding as well. KB has its channel competitiveness, and we want to fully utilize that to strengthen our marketing and expand low-cost deposits. Our annual NIM projection for this year, in light of the policy rate cut, market situation, and the impact of loan conversion, considering all of these factors, we believe that we will record 1.5% for this year. We anticipate that in Q3 and Q4, we will probably hit bottom, after which we will stabilize. Responding to your second question about the additional provisioning for the second quarter, due to the COVID pandemic, in order to preemptively respond to potential asset quality deterioration, we've implemented a very conservative future projection criteria, reclassified assets, and set aside an additional KRW 206 billion in provision. Based on different scenarios, we are assuming that COVID-19 will come again, and next year there could be another massive pandemic, applying a forward-looking model. Based on that model, we've set aside a provision of KRW 143 billion as additional provisioning. Additionally, from the stage one loans, we looked at some high-risk loans, reclassified them, and accordingly, we have provided an additional KRW 63 billion from this adjustment. So, regarding the level of provisions of the banks, we've applied forward-looking criteria and by the end of last year, we provisioned KRW 529 billion, and this time around, we've provisioned KRW 206 billion. So, basically, on a forward-looking basis, we've set aside KRW 735 billion. If you look at the group's NPL coverage ratio, it is 144.4%, and if you were to add the reserve, it's roughly 295%, indicating our NPL coverage ratio, while our loan-to-value collateral coverage is around 80%. This indicates that the loss absorption capacity of the company is relatively high. Responding to your third question regarding COVID-19, we have concerns about asset quality outlook going forward. Because of COVID-19 and the economic downturn, there are concerns about quality deterioration. However, in the case of the bank, we have the liquidity ratio, and our NPL ratio is the industry's best. We believe that we can rigidly manage this through upgrades in our credit risk management process. We are quite focused on quality management, being aware of factors like qualitative easing, financial support, and the low-interest-rate environment. We think that the credit cost within this year can be controlled within 30 basis points. Even under more conservative scenario assumptions, we believe our group's credit cost will still be within 40 basis points. Therefore, even considering the worst-case scenario, we believe our asset quality will not significantly degrade. However, on the back of COVID-19, we do recognize there are some marginal borrowers and we could see NPO forming from such segments. We have a scenario analysis and contingency plans based on different industry sectors and the types of borrowers to enable more refined strategies. We will continuously monitor vulnerable classes, ensuring our risk management regime and tech schemes are in place. For households, we will consider credit ratings of the borrower and whether that borrower has multiple loans; we will have a monitoring system that allows soft lending where necessary. For corporates, especially those sensitive to COVID-19, we plan to tighten lending origination criteria and reduce potential NPLs. Our loan portfolio is continuously being improved; as of the end of June, above BBB-, the ratio is about 80%. So, we think there is limited possibility for deterioration below fundamentals, particularly for SOHO loans as they are sensitive to economic cycles. The delinquency at this point is 0.16%, and collateral ratio is around 90%. Additionally, the high credit rating portion is about 90%. All asset quality indicators are positive, and regarding debt servicing capabilities, our reviews are focused on preserving the actual loans. So, we have a robust basis for managing these aspects. In the case of credit cards, the delinquency ratio on a Q-o-Q basis has fallen by 0.2%. However, if COVID spreads again, individual small operators and small businesses may be exposed to further deterioration in their credit quality. For that reason, we are applying more fine-tuned review strategies based on exposure to economic cycles, ensuring we are prepared for crises. I provided some more detail on the asset quality management.

Operator, Operator

Thank you very much for the detailed answer. We'll take the next question from Samsung Securities, Mr. Kim Jaewoo. Go ahead with your question.

Kim Jaewoo, Analyst

I have two questions. The first question is regarding our loan growth; you mentioned that it grew this year. Can you tell us more because it seems that you have reached your goal? So, can you tell us about the changes that you may have and your future loan-related policy guidance going forward? And related to the recovery of your other operating losses, in Q1, you mentioned some details about why you saw some operating losses, and since they improved, we find it fortunate. Can you tell us in more detail about what actually improved leading to the recovery? It would be very helpful if you could explain to us. Thank you.

Kim Ki-Hwan, CFO

Thank you very much for your question, Mr. Kim Jaewoo. Regarding our second half loan growth goal, on a Korean won basis, we have seen a 6.8% growth. Our goal was between 5% to 6% loan growth for this year, so it has actually exceeded that. Regarding this, in the second half of this year, we are going to focus on profitability and asset quality, and we are going to implement a very conservative loan policy. We will aim for qualitative improvement, centering on portfolio improvement, so that we can monitor the speed of our growth. We also anticipate some regulatory effects from the strengthening of real estate regulations, which we believe may lead to a decline in loan demand. Therefore, we believe that, overall, there will be limited growth factors for loan growth in the second half of this year. Our second half loan growth goals will be more limited than in the first half. For household loans, we will focus on unsecured loans and Jeonse loans; for corporate loans, we will implement a more conservative loan policy and flexibly respond to market conditions to control our growth speed, centering on high-quality growth industries. Now, regarding other operating gains and losses, you can see that it was KRW 227.7 billion and it was actually a minus figure, so minus KRW 207 billion. In Q1 of last year, we saw surmountable losses because of the FX market, but in Q2, we experienced a stable stance in the financial market and saw KRW 545 billion of gains. For profits, we had seen a growth of KRW 495 billion, similar to the previous quarter level. In Q1, the losses from securities ETF ELS portfolio investment and CBA as well as PE fund-related losses amounted to about KRW 330 billion, while in Q2, we had about KRW 170 billion of profits. Consequently, we had seen a KRW 500 billion of improvement for our FX bonds. Most of it was recovered and our securities ETF almost all recovered, with our portfolio ETF also recovering. However, our losses related to ELS and PE funds are recovering at a slower pace. If the market continues to stabilize going forward, we can expect profits from prepayment. With the anticipated expansion of COVID-19 and the potential for market shocks, we will maintain a defensive stance to focus on stable profits.

Operator, Operator

Thank you for the answer. We will take the next question from Hana Financial Investment, Mr. Choi Jung-wook. Go ahead.

Choi Jung-wook, Analyst

Hello.

Operator, Operator

Apologies. I think we got disconnected. Bear with us one moment. Yes, we will move on to the next question. Mr. Baek Doo-san from Korea Investment Securities. Yes, please go ahead.

Baek Doo-san, Analyst

I have a question on asset quality and loan classification. My first question is, this quarter, Q-on-Q, I see that your recovered loans volume has declined. Does that have to do with the reversal of the provision? Second question, regarding substandard loans, we've seen some increases, but this didn't come from the bank or card. Is it from KB Securities? What's the type of this loan? And also, as you reclassified to stage two, you've also added to the provision. So, below substandard, what is the size of the substandard loans for this quarter in relation to the reclassification into stage two?

Kim Ki-Hwan, CFO

Thank you for your question. Because your question was very specific, I had to look for some numbers. I will be able to respond to certain questions, and there are some numbers that I do not have, and I will make sure that our IR department responds to that later. In terms of doubtful loans, there were some reversals of the provision, as the classification shifted from doubtful to normal. For substandard loans, I would have to double-check our numbers later.

Operator, Operator

We will hold on until the next question comes in. From Hana Financial Securities, Mr. Choi Jung-wook, you're on the line, sir.

Choi Jung-wook, Analyst

Yes. I'm Choi Jung-wook from Hana Financial Securities. Recently, we see fintech or big tech, which are buzzwords in the market, and KakaoBank's asset is fast-growing, while Naver Financial is trying to expand its influence. So, regarding these big tech companies, what are your thoughts? And from the group, do you have a specific strategy to respond? What are the different approaches for your subsidiaries to cope with big tech?

Kim Ki-Hwan, CFO

Thank you very much, Mr. Choi Jung-wook, for your question. There is a lot of talk about big tech and fintech, and you asked about our strategy to respond to these trends. With COVID, the on-tech trend has been expanding, transitioning from offline to non-face-to-face channels, with major channel shifts in sight. We are seeing the competitiveness of fintech expanding according to government policies, as well as the emergence of various financial models in the market, leading to increased competition from big tech companies, with regulatory policies regarding fintech differing from those of the past. This change could threaten the banking business overall, but alternatively, it could lead us to new markets that were blocked before and allow us to evolve into new platform companies. Overall, we believe we can leverage these changes effectively. In the digital, big tech, and fintech market, we aspire to lead the way due to our 35 million customers, diverse subsidiaries, and extensive range of financial products and services. We aim to utilize these strengths as we have robust offline channels and can provide seamless services between online and offline platforms, enhancing customer experiences through digital innovation. Our strategy includes the following: First, we will identify the pain points of customers and reestablish our platforms. Our main apps, Star Banking, Liiv, and Liiv ON will be revamped to be customer-focused, providing polished experiences that are faster, simpler, and more customized with improved communication. Secondly, we aim to cooperate with other companies to lead innovative service development and create innovative APIs, forming an open API platform that fosters a unique financial ecosystem. Within our group, our cloud-based KB Drive has already been implemented, and we will introduce a cloud-based collaborative platform, Play On, to discover startups. We have also implemented a KB Innovation Hub and launched a CVC Fund within our group since 2018 to make strategic investments. Thirdly, we will address customer needs by offering differentiated products and services tailored to various age segments. For seniors, we can provide asset management services, while for millennials, we will cater to their specific needs in a digital environment. We plan to act aggressively in this regard. Fourthly, regarding data, we will optimize internal data integration and link it to external data sources. We will employ public and non-financial data to perform big data analyses, allowing us to provide more services and generate profitable offerings. Starting in August, we will implement MyData with a specialized task force within our group and have already submitted preliminary demands for MyData to financial authorities for our eight subsidiaries, including the bank, securities, insurance, card, and capital divisions. Our card business has independently implemented MyData since February last year, and we will enhance our KB MyMoney service to offer simultaneous online and offline asset management services while establishing leadership in the MyData domain.

Operator, Operator

Thank you for your answer. It's now been 50 minutes since we began our presentation. I think we are entertaining a sufficient number of questions. So, due to time constraints, we will take the last question. If you have any additional questions, please contact the IR team, and we will respond.

Kim Do-ha, Analyst

I just have one question I would like to ask. If you look at credit cost and your delinquency figures, I think the figures are quite positive despite the COVID situation. However, when it comes to the other support programs, the moratoriums that you have applied on the repayment of principal and interest, we believe that the moratorium program had an impact. So, extending the repayment period or interest payment, do you have any specific figure that could actually tell us what the impact of the moratorium program on the principal repayment and interest payment is?

Kim Ki-Hwan, CFO

Ms. Kim Do-ha, thank you very much for your question. In relation to the COVID pandemic, the government has announced various forbearance programs. At our group, through these government support programs, we have been providing preemptive liquidity into the market and have been fulfilling our role and responsibility. In terms of preemptive liquidity provision, we view it as pivotal in alleviating sharp asset quality deterioration and sudden increases in provisioning needs. The government programs mainly compensate for interest rates or utilize credit guarantee funds and various government guarantees. Therefore, the actual burden borne by the bank is not that significant. For specific loan data generated under such programs, we will collect that information and provide it later, as I presently do not have the data at hand. Additionally, in our forward-looking provisioning, we reflect some impact from these financial support programs and government forbearance initiatives. While there is government support, we also made efforts to control rising credit costs and delinquency rates to mitigate asset quality deterioration risks. We implemented strategies to continuously and proactively manage asset quality.

Unidentified Company Representative, Representative

Thank you very much. As I mentioned, we will conclude our earnings release. Thank you very much.