Earnings Call Transcript - NMR Q2 2020

Takumi Kitamura, CFO

Good evening. This is Takumi Kitamura, CFO of Nomura Holdings. I will now give you an overview of our results for the first half and the second quarter of the year ending March 2020. Please turn to Page 2. For the first half of the year, net revenue increased 29% year-on-year to JPY715.4 billion, while income before income taxes jumped 14.4 times to JPY203.3 billion. Market activity remained muted throughout the period as U.S.-China trade friction raised concerns of an economic slowdown, and geopolitical risk grew in the Middle East. Japanese retail investors stayed on the sidelines, leading to more than a 10% decline in equity trading volumes and sales of stock investment trusts, excluding ETFs. The fixed income market proved to be a challenging trading environment. Although central banks continued their easing policies and interest rates trended down, liquidity remained thin due to seasonal factors and interest rates fluctuated from August onwards while volatility spiked. Amid this environment, we focused on realigning our business portfolio, as announced in April, and maintained stringent cost and risk management. As shown on the bottom right, three segment income before income taxes for the first half increased 65% year-on-year to JPY80.5 billion. By reducing low-profitability businesses and focusing on our core strength in Wholesale, we have improved the stability of our revenues. In Fixed Income, revenue growth was driven by Rates products in EMEA and the Americas, and ForEx and Emerging Markets and Credit in Asia excluding Japan. We also made progress in reducing costs. Wholesale revenue for the period increased 11%, while costs declined by 4%. Retail reported a decline in income before income taxes of 58% as retail investor sentiment weakened and stock and investment trust sales declined. Asset Management booked a 47% increase in income before income taxes due to improvements related to American Century Investments. Segment Other results improved markedly for three main reasons. First, in the second quarter, we booked JPY73.3 billion realized gain from the sale of shares in Nomura Research Institute. Second, in the same period last year, we booked approximately JPY27 billion in expenses related to a settlement with the U.S. Department of Justice and ForEx translation losses related to the winding down of a subsidiary in the Middle East. Third, declining interest rates in Japan and for the Brazilian real and Turkish lira led to an improvement in profitability of economic hedging transactions. As a result, we had a very strong start to the year with net income for the first half of JPY194.4 billion. EPS was JPY57.66, and ROE was 14.6%. Today, we also declared a dividend of JPY15 per share for shareholders of record as of the end of September. Please turn to Page 3 for an overview of second quarter results. Firm-wide net revenue for the quarter was JPY383.4 billion, up 15% quarter-on-quarter. Income before income taxes was JPY128.5 billion, an increase of 72% over the last quarter. The biggest driver of this performance was the realized gain of JPY73.3 billion from the sale of Nomura Research Institute shares I just mentioned. The sale of NRI shares resulted in a JPY27 billion decline in tax expense due mainly to the application of deemed dividend rules and reversal of deferred tax liabilities booked in previous years. As a result, net income exceeded pretax income at JPY138.6 billion, climbing 148% compared to the prior quarter. Earnings per share was JPY41.23. Annualized ROE was 20.6%. As shown on the bottom right, three segment pretax income declined 26% from the previous quarter to JPY34.2 billion. Now to take a look at each business, starting from Retail on Page 6. Net revenue in Retail totaled JPY76.9 billion, down 5% quarter-on-quarter. Income before income taxes declined 35% to JPY5.3 billion. Retail investor sentiment was weaker due to factors such as U.S.-China trade friction, resulting in softer sales of stocks and investment trusts. In addition, we also overhauled our sales structure by reallocating our sales staff in line with client needs, which also had somewhat of an impact on the quarterly results. Please turn to Page 7. As you can see on the bottom left, investment trust and discretionary investment AUM stood at JPY12.7 trillion, representing a decline from June due to weaker sales of investment trust and fund wraps. Annualized recurring revenue, shown on the top left, was JPY88.8 billion, down slightly quarter-on-quarter. We maintained our recurring revenue cost coverage ratio at 31%. Although discretionary investments reported net outflows, SMA contracts and AUM continued to grow, driven by wrap trusts that tap into demand for estate planning. Please turn to Page 8 for Asset Management. As you can see on the top left, net revenue was JPY25.7 billion, down 26% from the last quarter. Pretax income was JPY10 billion, down 45% quarter-on-quarter. This is due to a decline in gains related to American Century Investments, which was JPY8.7 billion in the first quarter but JPY700 million in the second quarter. Excluding ACI, net revenue was relatively stable at JPY25 billion. In addition, Asset Management reported its 13th straight quarter of inflows, lifting AUM to the second-highest level ever at JPY52.4 trillion. The top left of Page 9 shows inflows of JPY381 billion. The Investment Trust business reported inflows of JPY259 billion, mainly from ETFs, funds distributed through banks and funds for defined contribution pension plans. The Investment Advisory business reported inflows of JPY121 billion, having won a mandate for Japan stocks from a Japan public pension plan and large new mandates in EMEA. As you can see on the bottom right, we continue to make progress in our collaboration with ACI. We are providing products to each other to meet the increasing diverse needs of our clients. And during the second quarter, we integrated ACI UCITS products into our platform, further strengthening our strategic alliance. As a result, AUM was $6.4 billion as of the end of September. Please turn to Page 10 for an overview of Wholesale. Second quarter net revenue in Wholesale was JPY156.7 billion, down 2% quarter-on-quarter. Income before income taxes declined 5% to JPY18.9 billion. Global Markets net revenue declined 2%. Equities reported higher revenues, but Fixed Income slowed from the strong previous quarter. Investment Banking net revenue was roughly unchanged quarter-on-quarter as DCM delivered a resilient performance. Please turn to Page 11 for an overview of each business line. Global Markets net revenue was JPY132.8 billion, down 2% from the prior quarter. Fixed Income net revenue was JPY77.2 billion, a decline of 6% from the strong previous quarter. Despite a challenging environment with interest rates fluctuating in Europe and the U.S., prudent risk management ensured revenues from Rates products declined only marginally. As you can see on the top right, the arrows are pointing down in the Americas and EMEA. That said, in the Americas, agency mortgages remained robust, supported by flows from new mortgage bond issuances on the back of lower interest rates. In EMEA, revenues were driven by European government bonds. Japan and AEJ saw stronger revenues from FX and Emerging, and Credit had a resilient quarter. As such, the arrow is pointing up for both regions. Net revenue in Equities was JPY55.6 billion, up 4% quarter-on-quarter. Geopolitical risk and concerns of an economic slowdown fueled market uncertainty, but investor activity picked up as volatility rose, and Derivatives reported stronger revenues in both Japan and the Americas. Please turn to Page 12 for Investment Banking. Net revenue was JPY23.9 billion, roughly unchanged from the previous quarter despite a decline in global fee pools. In Japan, DCM had a solid quarter tapping into demand from issuers. Internationally, ALF revenues slowed in EMEA and the Americas, while M&A improved. Please turn to Page 13 for an overview of expenses. Second quarter noninterest expenses totaled JPY254.9 billion, down 1% quarter-on-quarter. Cost-reduction initiatives contributed to a 4% decline in compensation and benefits. Occupancy and related depreciation declined 4% as a result of a decline in one-off expenses related to the consolidation of branch offices in Japan. Please turn to Page 14 for an update of our financial position. Our balance sheet at the end of September was JPY45.7 trillion, representing an increase of JPY3.2 trillion from JPY42.5 trillion at the end of June. This is due mainly to an increase in repo transactions and trading assets. As shown on the bottom left, Tier 1 capital was JPY2.7 trillion, and risk-weighted assets were JPY14.6 trillion. Accordingly, we maintained a robust financial position at the end of September with a Tier 1 capital ratio of 18.4% and CET1 ratio of 17.3%. Our leverage ratio was 4.92%, and our liquidity coverage ratio was 194.4%. That concludes the overview of our second quarter financial results. To conclude, our second quarter results were lifted significantly by changing our capital relationship with Nomura Research Institute. But looking just at our core business, we had a fairly good quarter given the challenging market environment and our structural reforms. The whole firm moved swiftly to implement cost reductions, and we have now completed over 60% of our cost-reduction target of JPY140 billion. Looking ahead, we will shift our focus to the longer-term work that we need to do to overhaul our operating model and drive efficiencies, mainly in our corporate functions to work towards achieving our March 2022 target. To more accurately meet the needs of each client in our Retail business, we reorganized our sales structure. For accounts assigned with sales representatives, we changed the person in charge for 45% of these accounts, which equals 1.25 million accounts. To ensure these changes are effective, we integrated 25 branch offices, centering on smaller branches. Revenues in October have slightly outpaced the second quarter, but we expect it to take a bit longer before we see the real results of this change. Under the new structure, we are aiming for higher productivity across the board and higher quality services for our clients. In Wholesale, the realignment of our business portfolio and cost-reduction initiatives have led to improved profitability to a certain extent. Second quarter momentum has continued into October. With the U.S.-China trade friction, Brexit and the end of the credit cycle, we expect market turbulence to continue, but we remain focused on pursuing revenue opportunities while controlling risk prudently. Thank you very much.

Operator, Operator

The first question is from SMBC Nikko Securities, Muraki-san.

Masao Muraki, Analyst

I have two questions. First of all, on Wholesale, if I look at the cost in the first half, there has been a significant drop. And in the first quarter, there was a big drop, and the second half decline was muted. When will the timeline when the cost reduction will be reflected in the profit and loss? You said you would be focusing on the middle banking sector, but could you update us on the Wholesale cost reduction effort? Another question on Wholesale. Rates products were the driver of revenue, but in the past three months, there was market activity. But in terms of revenue stream, was the revenue stream balanced by different months? Or were there volatility between months? And second big subject is Retail. You said you will be reorganizing the Retail channel. But can you elaborate on what's ongoing at the actual branches? With regards to business owners and high net worth, in addition to traditional products, alternatives and derivatives, nontraditional products are being advertised and sold. I think that was your policy. Are you beginning to see revenue contribution from such sales pitches? Or do you think more time is required before those efforts will be reflected in the revenue numbers?

Takumi Kitamura, CFO

Thank you very much. The first subject is the Wholesale cost reduction and the timing when that would be reflected in the profit and loss statement. In the first half, as I said, certain actions have been taken. But as you know, there's some time lag until those efforts are reflected in the P&L. And in the second half, we believe that the effects will begin to become visible. Most recently, on the occasion of the Investor Day, we announced our cost-reduction plan. And last fiscal year, the environment was extremely challenging and $5 billion of revenue was the assumption. So the second quarter revenue is approximately $5.8 billion, which is higher than what we had assumed, and necessary additional investment has also been done. So excluding those factors, the run rate cost is probably around $4.8 billion. That's the level to which cost has declined. On the Investor Day, as I spoke, the target for March 2020 exit costs is $4.7 billion, and we will continue our efforts to achieve that goal. On your second point, which is the monthly ups and downs of Wholesale, in this quarter, there were ups and downs. There was the holiday season for summer vacation and the market was inactive, and yet there was volatility. So on a monthly basis in Fixed Income, July was 4%, August was 2%, and September was 4%. In other words, there was a significant drop in August. And if we look at the equity business, July was 30%, August was 40%, and September was 40%. A slight decline in July. Your final question was on channel formation. And as I said in my initial remarks, the 45% or 1.25 million accounts, customers with salesperson assigned. Now the transfer of those accounts have already been completed by the end of August. And when I have conversations with those branches, they say that their goal has been clarified in terms of what they need to do, and that has elevated the general motivation of the people at the branches who are in contact with the customers. But is this going to be shown in numbers? Maybe partly in the near future, but these efforts are rather long-tailed. And therefore, their mission is to capture accurately the requirements of the customers and try to respond to their questions and offer a solution that would fulfill their needs, and that will take some time.

Operator, Operator

Next, Ms. Tsujino from Mitsubishi UFJ Morgan Stanley Securities, please.

Natsumo Tsujino, Analyst

I have a question about the impact of cost reduction. It seems that the effects are not yet visible in the P&L. The fourth quarter costs were elevated due to the JPY12 billion settlement with the DOJ and the JPY1.9 billion in compensation. Excluding those factors, personnel expenses aren’t decreasing significantly. In the first quarter, bonuses had an impact, and I believe there was also an effect in the second quarter. Could you clarify the actual cost reduction since it hasn't shown up in the P&L yet? It's hard to gauge. In the third quarter, regardless of the business environment, will there be a time lag in the reduction of personnel costs? What estimated levels do you foresee to help me understand how the cost reductions will affect the P&L? That’s my first question. My second question is regarding the negative item at the head office. I might have overlooked this in your presentation. There were some negative numbers in the corporate items. While the JPY4.6 billion seems somewhat predictable, the JPY1.4 billion positive figure from the first quarter was significant. This time, we see a negative JPY4.6 billion in corporate items. Is this level noise-free?

Takumi Kitamura, CFO

Thank you very much for your question. The first question was that our P&L has not come down. So in that sense, this is related to the first set of questions that I have responded. And at the risk of sounding repetitive, in Wholesale mainly, performance significantly improved. And as a result, on a pay-for-performance basis, a bonus was given and we had to reverse for bonus allowances. As a result, it appears that still personnel expenses have not come down. I hope that this helps your understanding. So it might appear as though compensation and benefits are not coming down as much. And the second question was about corporate items. It so happens that, as Tsujino-san correctly pointed out, corporate items tend to be in the negative oftentimes. So JPY4.6 billion negative figure is not due to anything extraordinary. This is a result of the accumulation of small items. But in the first quarter, there was a positive factor, so the number was in the positive territory. But the level of the second quarter might be considered a usual level.

Natsumo Tsujino, Analyst

In the second half, the cost reduction level that we may see is my question. Run rate cost reduction level was discussed earlier in your response or actual run rate and the cost cuts that have already occurred but are yet to be reflected in the P&L. How is that reflected? When you say run rate, does run rate mean the already reflected cost in the P&L or cost-reduction measures for which the cost has not been booked yet?

Takumi Kitamura, CFO

Run rate is a complex concept. At the end of September, the situation assumes that it will continue for the next year, which is what we mean by run rate. However, describing the cost reduction target in our industry is challenging. If revenue fluctuates, so do cost levels. Therefore, we need to use certain assumptions to measure progress in cost reduction. That's what we are calculating. As I mentioned in response to the first set of questions, the basis point of cost reduction is based on a certain revenue level, which is $5 billion for Wholesale. Based on that, we are discussing how much progress has been made in cost reduction. Various measures have been implemented, some of which are already reflected in the P&L, while others will be reflected in the second half's P&L. On another note, business performance exceeded our initial expectations by JPY800 million, leading to an increase in the bonus allowance due to pay-for-performance principles. It may be difficult to grasp, but when I mention run rate, I refer to the revenue of $5 billion for Wholesale continuing over the next year. The run rate cost has recently decreased to about JPY4.8 billion.

Natsumo Tsujino, Analyst

So at the end of July, the question, at the end of July, you mentioned the progress of cost reduction was about 50%. At the end of April, it was 40%, and it progressed to 50% at the end of July. And what is the progress to date?

Takumi Kitamura, CFO

As of now, I discussed this in my presentation, it is above 60%. The progress rate is now above 60%.

Operator, Operator

The next question is by Mr. Watanabe of Daiwa Securities.

Kazuki Watanabe, Analyst

This is Watanabe of Daiwa Securities. I have two questions. First of all, on Retail, the reformation and onetime-off revenue impact, how much was that? And in the United States, online securities are not charging any fee nor commission. Is that going to have an impact on your strategy? Secondly, on management goal, EPS JPY 100, that's been delayed. But for Retail and Wholesale together, you are introducing a new organization. In the near future, can we expect any new announcements of new targets?

Takumi Kitamura, CFO

Thank you. On your first question, reorganization of Retail, how much impact is this going to have? This is an initiative that's quite difficult to quantify, and we have not actually measured the impact or sales either. But as I said, 1.25 million accounts have had their assigned salesperson changed. So that means that a certain amount of costs as well as human work and labor have been injected into that initiative. I think that's not difficult to imagine. And also, including Charles Schwab, U.S. online brokerages have announced that they're no longer charging any brokerage that they would offer free of charge. But we're doing the channel formation change to target affluent high net worth through matching. We're doing so because we think that there is a certain level of demand. In Japan, the culture of asset buildup has not become truly rooted, and face-to-face service and contacts will continue to be on demand at a certain level for the affluent group. Of course, we cannot offer full coverage just through our human resources on a face-to-face basis. So we will augment our efforts as such through digital and IT initiatives. So we will enrich the service not only through our face-to-face service, but through digital means. On the EPS JPY100 and postponing that target, various initiatives were most recently announced in April, and we're concentrating on executing those measures. And gradually, we're beginning to see the impact from those measures. So first and foremost, I think our priority should concentrate on those measures. As well as new plans are concerned at the appropriate timing in the future, we will be making announcements. But as I said, they're urgent things we need to do which we should prioritize, and we will concentrate on those measures.

Kazuki Watanabe, Analyst

On your second point, we should not be expecting any announcement in the next investment forum?

Takumi Kitamura, CFO

Well, in investment forums or CEO fora, some large-scale initiatives are announced. But I have nothing to comment on specifically as to the timing of such next announcements.

Operator, Operator

Next, we have Mr. Otsuka from JPMorgan Securities.

Wataru Otsuka, Analyst

About cost reduction in Retail and the 10% reduction in three years, what was the progress in the first half of this year? That is my first question. And the second question is about dividend. JPY15 first half dividend, could you tell us the reason why it was decided to be JPY15 as opposed to EPS of about JPY58 because it's about 25% that you've decided on JPY15 interim dividend?

Takumi Kitamura, CFO

Turning to your first question regarding Retail cost reduction, we have achieved about 50% of our target so far this year. This is in relation to the cost reduction goal we set for the end of the year. As for our second quarter progress, we integrated 25 branches, which I believe had an impact on our overall performance. Regarding the dividend of JPY15, we consider a 30% payout ratio to be an important benchmark. However, in the first half of this year, we also factored in significant stock buybacks while calculating the dividend. We carried out a large stock buyback and utilized proceeds from the sale of NRI stocks to help fund the dividend. Consequently, the payout ratio is nearing 30%. The dividend was set at JPY15, which currently reflects a payout ratio of about 25%. Although our benchmark for the payout ratio is 30%, we are also considering the total return ratio, including stock buybacks, which has influenced the current payout ratio of 25%.

Wataru Otsuka, Analyst

In the second half, I'm sure that amount has not been decided yet. But last year, even though you were incurring losses, dividend was paid, and so the level was higher. As Mr. Kitamura mentioned, dividend payout ratio of 30% will also be the guide for dividend for the second half?

Takumi Kitamura, CFO

Regarding the second half, the dividend payout ratio of 30% for semi-annual consolidated performance is the announced indicator. So based on that, we will consider the amount of the dividend.

Operator, Operator

The next question is David Lui from Guoco Management Company.

David Lui, Analyst

Thank you for the JPY15 dividend. This dividend will cost approximately JPY52.5 billion based on your outstanding shares. The sale of the NRI shares generated JPY160 billion, so you've used about one third of those proceeds to fund this dividend. Could you please share your plans for the remaining proceeds from the NRI sale? Will we see more dividends from this remaining amount in the future, or is the dividend from the NRI now complete? That's my first question. The second question, Kitamura-san, is about the Retail division. As shown on Page 6, the pretax margin for the Retail division has dropped significantly this quarter, partly due to a decline in revenue. With the cost reductions you've mentioned since Investor Day, when do you expect to return to a 15% pretax margin? Last fiscal year, the pretax margin for the June and September quarters was around 14% to 16%. When can we expect to reach that level again, especially since this September quarter is below 10%?

Takumi Kitamura, CFO

Thank you very much. To address your first question regarding the proceeds from NRI sales, which amount to JPY160 billion, our buyback program targets up to 300 million shares and a budget of up to JPY150 billion. You've mentioned that one third has been distributed as dividends, and you're inquiring about the use of the remaining funds. Most of the JPY160 billion will be allocated to the buyback program. Regarding the decline in PTI margin, I have been emphasizing that Q2 was a period during which we implemented various strategies, such as optimizing sales and consolidating branches. I previously mentioned that we anticipated a negative impact in the second quarter, and the actual results confirmed this. However, our efforts in cost reduction are ongoing. As for increasing future revenue, we are also pursuing measures aimed at improving the PTI margin for the Retail business, with several initiatives in the pipeline. However, I previously indicated that recovery will take time. Regarding when we can return to a 15% margin, I must clarify that we are not as optimistic about achieving this in Q3 or Q4 of the current fiscal year.

Operator, Operator

Next, we have Mr. Niwa from Citigroup Japan.

Koichi Niwa, Analyst

I have a question on Retail and Global Markets. Regarding Retail, what KPIs you would be emphasizing going forward? In the discussion so far, you've described that efforts currently underway are of a long-term nature. And in long tail in nature, recurrent revenue and recurrent revenue cost coverage ratio and the net inflows of cash and securities, total sales, these are what I am looking at. But efforts that you are implementing may not be reflected quickly in these numbers. So how are you trying to manage your efforts? Which indicators are you looking at? That is my first question. And the second question is about the fixed business and about the lease business in the United States. Revenue level is high, but it seems that there is a slight downward trend. However, market environment is not so weak. In comparison to the peers, what is your share? And how are you competing?

Takumi Kitamura, CFO

Turning to your first question, there are several indicators in our IR package. With the reorganization of our sales structure, our goal is to align our sales force with the attributes and needs of our customers. We aim to match the skills of our sales partners to support these customer attributes and enhance customer satisfaction. We believe this will lead to an increase in assets under management. By improving customer satisfaction, we expect to see growth in net inflows of cash and securities, total sales, and assets under management. To achieve this, we have clearly defined roles and responsibilities for our sales partners based on customer attributes, along with internal quantitative indicators to measure performance. These indicators may be limited in what we can disclose publicly. However, to assist our customers in their core business, investment policies, stock prices, and corporate value, we will provide essential services, including advice on balance sheet management, estate planning, business succession, tax planning, and real estate. Key performance indicators for corporate customers will focus on consulting-related revenues, customer account openings, and the number of active customers to measure progress. Currently, these indicators are not included in the IR package, but we are looking into how we can present them in the future. Regarding your second question about the United States, while rates are declining relative to peers, we had strong first-quarter results. In the second quarter, there may have been a slight slowdown compared to the very strong first quarter. In fact, our first-quarter results showed a 21% increase quarter-on-quarter, whereas our competitors experienced negative growth. Thus, while it seems the second quarter has slowed, it's mainly due to the exceptionally strong first quarter. Year-on-year, our performance and that of our competitors are fairly comparable, particularly in terms of agency mortgage performance, which continues to remain strong.

Koichi Niwa, Analyst

I hope that you will be able to indicate leading indicator of performance for the Retail for our better understanding. Those are all of my questions.

Operator, Operator

The next question is from Sasaki-san at Merrill Lynch Japan.

Futoshi Sasaki, Analyst

My name is Sasaki of Merrill Lynch. I have two questions. First of all, on Page 3, there's a comment at the bottom with regards to tax. One of the reasons for the declined amount of tax with NRI share sales, you mentioned the introduction of the deemed dividend system and the reversal of the deferred tax liability. Are these treatments going to continue? Even after Q3, will there be a reversal of deferred tax liabilities? That's my first question. And in the performance in and after Q3, dollar short-term market and tightness in the market is being talked about. If any confusion is caused because of measures not being taken by the Central Bank, what are you going to do? Do you have any plans in mind? Any readiness in terms of possible volatility in the short-term dollar market?

Takumi Kitamura, CFO

Thank you. Regarding the reversal of the deferred tax liability, this is a one-time occurrence related to the sale of NRI shares. We accounted for the deferred tax liability under the equity method when we included NRI in our financials. After responding to the divestment of NRI, we decided to sell our holdings, which led to the resolution of the deferred tax liability associated with those shares. Therefore, this reversal is a unique adjustment linked to this recent sale of NRI shares. Now, about your next question, in September, the U.S. swap market experienced a spike, and short-term repo rates increased along with speculation about Federal Reserve intervention. As for Nomura, we currently have cash reserves of JPY 4.5 trillion available. We manage our liquidity by currency, so even if there's a temporary disruption in the short-term market, we are uncertain whether a situation like September's will occur again, but we are prepared. In April, we stated our intention to review our business platform, and we are feeling a sense of urgency and need for change. We have successfully recorded profits for two consecutive quarters, which demonstrates our strength. As we progress through this reform, Nomura aims to enhance the value we provide to our customers. Thank you for your ongoing support, and thank you for being with us this evening.