Nomura Holdings Inc Q1 FY2020 Earnings Call

Good day, everyone, and welcome to today’s Nomura Holdings First Quarter Operating Results for the Fiscal Year Ending March 2020 Conference Call. Please note that this telephone conference contains certain forward-looking statements and other projected results, which involve known and unknown risks, delays, uncertainties, and other factors not under the company’s control, which may cause actual results, performance, or achievement of the company to be materially different from the results, performance, or other expectations implied by these projections. Such factors include economic and market conditions, political events and investor statements, liquidity of secondary markets, level and volatility of interest rates, currency exchange rates, security evaluations, competitive conditions, and size, number, and timing of transactions. With that, we’d like to begin the conference. Mr. Takumi Kitamura, Chief Financial Officer. Please go ahead.

Good evening. This is Takumi Kitamura, CFO of Nomura Holdings. I will now give you an overview of our results for the first quarter of the year ending March 2020. The market environment remained challenging as heightened U.S.-China trade friction and concerns over the economy led to monetary easing by central banks, and market activity was generally muted throughout the quarter. Despite strong market activity in April, investors quickly turned cautious in May, and share prices dropped as trade negotiations stalled following comments by the Trump administration on raising tariffs on Chinese products. In the fixed income market, a sharp decline in U.S. rates and credit spread tightening, coupled with higher volatility, prompted many investors to sit on the sidelines ahead of the G20 meeting at the end of June. Amid this challenging environment, we delivered services tailored to the needs of our clients and saw results from reviewing our business portfolio and other efforts to improve profitability, resulting in higher income before income taxes in all business divisions. As you can see on the bottom right, the three segment income before income taxes was JPY46.3 billion. Retail reported a rebound in total sales, especially sales of investment trusts and bonds, as investor sentiment improved, and we overhauled our product strategy. Asset Management saw assets under management climb higher on the back of inflows, and a gain related to American Century Investments contributed to earnings. In Wholesale, the realignment of our business portfolio in April is yielding results and Global Markets reported stronger revenues quarter-on-quarter. Performance aside from the three segments was also up as economic hedging gains/losses improved and legal expenses declined, resulting in a marked increase in income before income taxes to JPY74.8 billion. As shown on the top right, our international businesses expanded revenues by focusing on areas of competitive strength, which, coupled with prudent risk and cost management, meant all three international regions returned to profit for the first time in two years. As a result, our effective tax rate for the quarter was 24% and net income was JPY55.8 billion. ROE was 8.4% and EPS was JPY16.48, representing a good start to the new fiscal year. Next, let’s look at each division in more detail, starting with Retail on Page five. Net revenue increased 9% from last quarter to JPY80.6 billion. Total sales increased 21% quarter-on-quarter, driven by sales of investment trusts and bonds. As we announced last month, we plan to consolidate some of our Retail branch offices in Japan from August as part of realigning our organization to meet the changing needs of our clients. This quarter, we booked expenses for construction works related to the consolidation. Retail costs also increased due to higher bonus provisions in line with pay for performance. Income before income taxes grew 146% to JPY8.1 billion. Please turn to Page six. Annualized recurring revenue was JPY90.4 billion and the cost coverage ratio was 31%. The top right shows discretionary investment net outflows of JPY40.5 billion, mainly in our Fund Wrap product. Wrap trusts aimed at meeting estate planning needs performed well, and assets under management in SMAs have grown steadily to reach JPY740 billion. Please turn to Page seven for Asset Management. Net revenue increased 12% to JPY34.5 billion and income before income taxes grew 26% to JPY18.1 billion. ACI-related revenue of JPY8.7 billion was up 77% quarter-on-quarter. Net revenue excluding ACI was JPY25.8 billion as asset management fees remained solid. We reported our twelfth straight quarter of inflows and assets under management at the end of June stood at JPY51.6 trillion, the second highest level ever. Total inflows in the quarter were JPY508 billion, with JPY672 billion from the investment trust business. The systemic shift away from defined benefit pension plans and the introduction of iDeCo have spurred growth in the DC market. Nomura Asset Management established its product offering and increased the number of corporates using its funds, resulting in assets under management in DC funds increasing to nearly JPY1 trillion. Please turn to Page nine for Wholesale. Net revenue was JPY159.5 billion, an increase of 12% quarter-on-quarter. Although Investment Banking revenues declined, Global Markets revenues increased by 20% with both Fixed Income and Equities reporting stronger revenues. Wholesale expenses declined by 10% as the JPY8.4 billion restructuring charge booked last quarter was no longer present and allocations from Corporate declined. As a result, income before income taxes rebounded to JPY20 billion. The Americas and Japan reported revenue growth, while AEJ remained resilient despite a decline from the strong previous quarter. Please turn to Page 10. Global Markets net revenue increased 20% quarter-on-quarter to JPY135.7 billion. Fixed Income revenues increased 21% to JPY82.5 billion. Rates products, particularly Agency Mortgages, had a strong quarter amid the declining rate environment in the U.S. Credit spread tightening led to improved revenues for Credit and Securitized Products. As shown by the heat map on the right, the Americas reported its highest revenues in 10 quarters, while Japan is also trending up on increased demand for Credit products. Equities booked net revenue of JPY53.3 billion, up 17% from last quarter. Please turn to page 11 for Investment Banking. Net revenue was JPY23.7 billion, down 17% from last quarter when we closed a number of high-profile M&A transactions. Although revenues were also down year-on-year, M&A and ALF reported stronger revenues amid declining global fee pools. Please turn to page 12 for an overview of non-interest expenses. Quarterly expenses totaled JPY257.2 billion, down 7% quarter-on-quarter. The biggest decline came from Other shown at the bottom. Last quarter included JPY12 billion in legal expenses related to legacy transactions. These expenses were mostly gone this quarter. In addition, fees paid to attorneys and other professionals declined. Compensation and benefits, which represents nearly half of all expenses, remained roughly unchanged. Although the restructuring costs booked last quarter were not present this quarter, bonus provisions increased in line with pay for performance. Please turn to page 13 for details on our financial position. Our balance sheet at the end of June was JPY42.5 trillion and shareholders' equity was JPY2.7 trillion. We retain a robust financial position with a Tier 1 capital ratio of 18% and a CET 1 capital ratio of 16.8%. Our capital ratios declined compared to the end of March as risk assets, the denominator in calculating capital ratios, increased by about JPY400 billion mainly due to market risk. Our leverage ratio was 5.06% and our liquidity coverage ratio was 188.4%. That concludes the overview of our first quarter financial results. We faced challenging market conditions this quarter, but we have regained momentum after performance bottomed out in the fourth quarter. Our annualized EPS for the quarter was JPY66 and ROE was 8.4%, representing a good start to the year. We also begin to see the results of our restructuring plan announced in April. Cost reductions are moving ahead as planned. As of the end of July, we have achieved about 50% of the planned JPY140 billion of cost cuts by March 2022. Recent performance in Wholesale has seen Fixed Income remain relatively resilient, but we must remain vigilant given the ongoing U.S.-China trade friction and fluid situation surrounding Brexit. August is generally a quieter month in terms of market activity. In Japan, market volume in the TSE first section has dipped below JPY2 trillion, and in Retail, we are seeing investors continue to sit on the sidelines. We are now in the process of realigning our Retail channels. This may have a slight impact on revenues in the short term, but this is a necessary organizational change in order for us to better meet the individual needs of our clients.

The first question is from Mr. Muraki of Deutsche Securities. Muraki, please go ahead.

Thank you. This is Muraki. Two questions, please. First is regarding the wholesale costs. On page nine, under upper left you showed the expenses and the expense is JPY140 billion, which is about an 87% expense ratio. There was an improvement, and the reduction speed is very fast. But what do you – how do you see the cost levels of Q1? Can this be deemed to be the run rate expenses? That’s my first question. My second question is regarding the fixed income trading on page 10, and there was a big recovery in earnings, but the areas of strength, for example, rate trading, benefited from the rate decline and also credit. How are you doing in terms of these two businesses and also fixed income overall? Why have you been able to outperform your peers? And going forward, is this strong trend sustainable? You say that July has been good, but how do you see the sustainability of this strong trend? There should be some effects or impact from the restructuring. So, can you maintain this higher level of market share?

Thank you. This is Kitamura. Regarding your first question about the wholesale costs and can you deem the first quarter level as the run rate. In April, we had the Investor Day on April 4th and we announced the cost reduction plans. Last fiscal year of March 2019, we assumed the same revenue environment to continue from last year and revenue of $5 billion as our assumption. In Q1, the earnings was $5.8 billion. So it was higher than expected. In some areas where we wanted to strengthen, we made additional investments. So if you exclude these factors, the current run rate expenses is $5 billion or more than $5 billion. However, the course of the expenses fluctuate due to various factors. Regarding your second point, why we were able to outperform our peers in fixed income relates to our business portfolio review. There were some businesses which were at low profitability and also cyclical businesses, which we chose to optimize. As a result, we are focusing on the businesses where we have strengths. For example, mortgages in the U.S. and also the sovereigns in Europe where we have client franchises and competitive strength. These are areas we are focusing on, and these initiatives have worked well. In terms of our peers and their results, we haven’t scrutinized them, but our peers struggled in areas where volatility was low, for instance, FX. In our case, we benefited from the decline in rates. For example, the mortgage bonds where activity picked up and also interest rate derivatives where we benefited from the capturing and monetizing the client flow. The sovereigns in Europe have seen a big decline in interest rates, and we were able to capture those revenue opportunities. In Japan, we have seen a recovery after quite a long while due to the low interest rates and interest rate declines. A lot of clients are starting to take action. We saw a recovery mainly in credit. This was a big difference from our U.S. peers, I believe. Whether this is sustainable or not is something we need to continue to monitor. The market environment remains difficult, and there will be macro events and geopolitical events that could impact us positively or negatively. Overall, there is a fair chance that interest rates could fall even further, and under these circumstances, the rate decline and investors started the full-fledged rebalancing of their portfolios. We cannot be overly optimistic, but we are not that pessimistic either, would be my answer.

Thank you. This is Muraki again. In relation to credit, just a follow-up question, if I may? In Japan, I don’t know who is buying what kind of credit outside of Japan. So that would be my question. Also, on page 13, the low liquidity level three assets had a big increase over the past year, and low liquidity debt and debt-related products are increasing. But which areas? What kind of risk-taking is being conducted at the moment?

This is Kitamura. In terms of domestic investors, these clients are pursuing yield and are adding emerging market currencies to their bond portfolios. The sentiment has been picking up for this type of product. The slight increase in level three assets, as you pointed out in the latter half of your question, has seen resilient trends, with strong demand expected in infrastructure financing. These are relatively low-risk financing areas, and we are expanding there. This is mainly in the U.S., and these are products which are not significantly impacted by market cycles, and we are building our product portfolio in this direction.

The next question is by Mr. Watanabe of Daiwa Securities. Please go ahead, Mr. Watanabe.

Thank you very much. This is Watanabe from Daiwa Securities. I have two questions. First, fixed revenues. The rate between customer flow and profit in Q1: If the rate business visualization is to progress, the commission rate could decline. But if we are seeing the conclusion of the business platform reconstruction, do you think that the same level of profit as you recorded in Q1 can be sustainable? Secondly, on risk assets referring to base 13 risk asset as of June as explained in the presentation, but with restructuring, you mentioned that this risk asset could decline by 10%. Is that possible depending on the risk-taking? Is it possible that the decline of risk assets will not fall as expected?

Thank you very much, Watanabe. To your first question regarding customer flow and trading profit breakdown: The revenue from customers accounted for slightly below 80% and the trading profit was slightly over 20%. Regarding visualization, as I have explained from some time ago, the AI market meeting Phonetic platform is gradually being introduced. There will be more sophistication in terms of the AI level. Your second question regarding RWA reduction by 10% through wholesale overhaul: Already, the review of the business portfolio is underway. Risk-weighted asset allocation to wholesale has declined, and if you look at the details, the RWA of businesses under review has actually dropped. On the other hand, in the reported quarter, risk weighted assets increased slightly, due to the businesses that we are maintaining or seeing expansion in. For example, European bonds, activity was motivated among our customers, and we have seen a slight increase.

Thank you. Your points are well taken.

The next question is from Mr. Otsuka from J.P. Morgan Securities. Otsuka, please go ahead.

Thank you. This is Otsuka from JP Morgan. Two questions. First is regarding wholesale revenues. In this quarter, JPY159.5 billion, and some of the positive reasons we already heard about. But out of this, last year in your announcements, you said some of the unprofitable businesses, some of the negative contributors were included in the past two years, and that was bringing down the overall revenue. So now that they have been removed, is the overall revenue close to JPY160 billion? How have the negative contributors been addressed? My second question is I want to check the figures mentioned earlier on a quarterly basis. The non-interest expenses you talked about the ups and downs, which I understand, but for example, in Q1, total expenses were JPY257.2 billion. If you analyze that Phonetic, then there’s quite a difference compared to March 2018, March 2019; there’s a big decline. So the JPY140 billion mentioned, is not really what you’ve already achieved based on our Q1 figures. You also mentioned 50% progress by the end of July. Am I getting the figures right?

Thank you. This is Kitamura. To your first question regarding revenue improvement and what happened to the negative contributors or detractors that used to exist, I guess is the question. Last year in Q1, there was the trading and client revenue client earnings balance. At that time, I think the answer was 100 to zero. Most of the breakdown was on the client revenue side. There were some detractors last year, but this time in Q1, about 20% is trading revenue, which means the items that were dragging down revenues have been removed. In Q1 of this year, the rates business did well, and we were able to benefit from the decline in interest rates. Regarding expenses, yes, we have already achieved JPY140 billion, which was annualized, but I would like to clarify that we are looking at a more run-rate type of expenses, excluding one-off items. Achieving 140 billion cost reduction on a more run-rate basis would be our goal.

This is Otsuka again. I just want to ensure I’m getting this right. Regarding the improvement in wholesale earnings and removal of unprofitable businesses: Is the $400 million positive impact already included in the figures? Have you already seen the benefits? Regarding the second question, progress was to be worth about 60%. Is that correct?

Yes, as you mentioned. For the current fiscal year, by March next year, we want to achieve 60% progress. We are making good progress in line with our targets on cost reductions. Regarding unprofitable businesses discussed at Investor Day, the $400 million improvement includes those businesses and also the normalization effect from a very bad last year. So not all of the $400 million is from unprofitable businesses.

This is Otsuka again. Understood. Thanks very much.

The next question is by Ms. Tsujino of Mitsubishi UFJ Morgan Stanley Securities. The floor is yours.

Thank you very much. First of all, the progress rate of cost reduction, you mentioned 50%. I have a question on the definition: If you had taken action, but there’s a time lag of three months or six months until an actual realization of cost reduction, does that count as progress? Also, for the first quarter being three months, what percentage was achieved in July? What’s the pace for the rest of the accounting year? Secondly, regarding RWA reduction, you reduced the RWA and cut unprofitable businesses. You mentioned capital adequacy and whether it would be possible to reduce further was unclear, but now profitability improvement seems more important. The stock price is low, so due to price-to-book, could this be a timing for share buybacks?

Thank you. Your first question was regarding the progress rate of 50% in terms of cost reduction. In Q1, certain actions have been taken, and the cost reduction impact will be realized after some time lag for some of the initiatives, but they are included based on the nature and substance of the action. We aim to take additional initiatives in the following months. Regarding RWA reduction, the first priority was to obtain the approval of 300 million shares and JPY150 billion was the ceiling for share buyback. We smoothly began the fiscal year with a good Q1, but we’re not in a position to commit to additional share buyback at this time. However, it is an option we can consider.

The next question is from Mr. Sasaki from Merrill Lynch Japan Securities. Sasaki-san, please go ahead.

Thank you. This is Sasaki. I have two questions. First, on page 30 of the presentation, you talked about rationalization. Has that already been 100% reflected in the headcount figures you showed here? Or is the headcount going to decline further? Is the headcount optimization already completed? That’s my first question. Secondly, regarding the domestic retail business, in August, there will be a big change in the organization. What will be the effect on the retail top line in Q2? Would it be positive or negative?

Thank you. This is Kitamura. Regarding the headcount reduction, some of that is included in the figures, and some is not. Just because we communicate with an employee does not mean that they are immediately deducted from the headcount figures you see in this table. Not all of the headcount optimization has been reflected in these figures. Regarding retail, there will be some negative impact on our top line due to the changes in the salesperson formation, which affects more than one million accounts. August tends to be a relatively slow month due to summer holidays; however, I believe we are going in the right direction. The short-term impact may be negative, but we will be able to meet client needs more effectively in the long term.

Thank you. This is Sasaki again. Just a follow-up on those two points. With the big improvement in wholesale revenues, could there be a chance that Nomura will change its strategy and start adding to the headcount again? Also, regarding the retail matching process, is there a decline in momentum or sentiment?

Thank you. This is Kitamura. Our strategy will not be impacted by the European players cutting down on their headcount. There are areas where we are reducing headcount, but also areas where we add headcount to strengthen our strategy. Regarding retail, we announced the changes in organization on July 12. The succession of operations has already started; thus, the July top line has already been affected by that.

The next question is by Mr. Niwa of Citigroup, Japan. Please go ahead, Mr. Niwa.

Thank you very much. I have two questions, one on retail and the other on wholesale. On page five, you talk about the improvement of customer mindset. Can you elaborate? If we look at the sector as a whole, these are somewhat extraordinary anomalies. Why are you particularly feeling this improvement? Is it because you are offering different products? Or are you targeting different customer segments? What about the sustainability of this good performance? What’s the tone at the moment? Second, regarding wholesale, on page 9, it appears profitability is around 12%. Do you think this margin or profitability can be maintained or could there be a shift in the level of profitability?

Thank you. This is Kitamura. Regarding retail and the customer mindset improvement, the review of product strategy was a major element in recent years. Fund Wrap was heavily biased in our strategy, and we probably had not fulfilled the requirements of our customers. Since April, we’ve been offering a better product lineup that meets customer needs. Sales have increased by over 40% since the previous quarter in investment trusts and bonds. It’s challenging to maintain this high performance; however, we aim to sustain it. Regarding wholesale profitability of 12%, the geopolitical risks were heightened overall. We wish to maintain the top line, and we are committed to efforts in cost reduction, which could further enhance our profitability.

Thank you. Just one question. For retail, international bond sales were 5.7% up Q-on-Q. Meanwhile, commissions were up 42%. Does this include some bonds which are products other than international bonds, or are you selling very high-profitability bonds? What’s the reason for this discrepancy?

Thank you. This is Kitamura. Yes, for foreign bonds there has been a pickup, but the commission fees did not really pick up. The sales increased by around 6%, but the fees generated increased more than 40%. This is for bonds overall, so it includes domestic bonds, which may not yield as much. The sales commission includes foreign equities-related commissions as well, contributing to the mismatch in figures. Thank you very much for participating today. The business environment for financial institutions grows increasingly uncertain, but amid uncertainty comes opportunity. We will seek out revenue opportunities while managing risk prudently in this difficult environment. By implementing the realignment of our business platform, we aim to gain further traction on the signs of change that became evident in Q1. Thank you very much, and we look forward to your continued support.