Earnings Call Transcript - SHG Q4 2021

Operator, Operator

Recording in progress. Group CSSO; Corso Kun; Group CMO, Heo Young-Taeg; Group CRO, Bang Dong-Kwon; Shinhan Bank CFO, Chong Chang Hak; Shinhan Card CFO, Moon Tung Gwan; and Shinhan Investments CFO, Kim Song Hwan are here with us. We will first hear about the 2021 early business results presentation highlights from Group CFO, Etaeg Young, and then Group CDO, Kim Myoung-hee, will also deliver results, and we will have a Q&A session. I will invite Group CFO, Etaeg Young, who will deliver the 2021 full year business results presentation.

Etaeg Young, CFO

Greetings. I am CFO, Etaeg Young, in charge of Group finance from this year. First of all, I would like to express my gratitude to everyone participating in our 2021 business results presentation despite your busy schedules. Along with the global spread of Omicron and pressures for a global interest hike, there’s still very high uncertainty, including concerns over inflation and global supply chain vulnerabilities. In this situation, we have been strengthening our basic fundamentals and securing our future growth engines while striving to continually increase our shareholder profitability rate. Now let’s go to page four of our business results presentation, Group business results highlights, and I will cover the 2021 business highlights. In 2021, Shinhan posted KRW4,019.3 billion of net income, a record high level since we were first established, and the earning level has been on the rise for eight consecutive years. Excluding non-recurring items which occurred in 2021, including KRW173.4 billion of increasing ERP costs and KRW467.6 billion of investment product-related losses, recurrent level net income posted a KRW4.5 trillion level. Interest income, along with SME-centered loan asset growth and the bank’s quarterly margin improving by four bps, grew KRW898.4 billion. Non-interest income, as well as non-banking securities and fee income improved and drove our earnings growth. CIR posted 45.3%, which may seem to have slightly risen Y-o-Y, but excluding ERP effects, CIR posted 43.1%, a 1.3-percentage-point improvement Y-o-Y. Lastly, despite the additional provisioning preparing for the uncertain economic outlook and the termination of COVID-19 forbearance programs, our credit cost ratio (CCR) posted 27 bps, a 14 bp improvement Y-o-Y and is in a downward stabilization trend. From the next page, I would like to elaborate on the current status of investment product losses, which was pointed out to be a factor of uncertainty for our Group. Until 2020, according to our Conflict Settlement process, we recognized expenses that were limited to the investment products which could be recognized as expenses. However, from the second half of 2021, to recover customer confidence and remove uncertainties regarding losses, we actively implemented private reconciliation. Accordingly, a constructive obligation occurred, and it became possible to reasonably recognize costs. Under the accounting standard, in 2021, KRW467.6 billion of investment product losses was recognized as non-operating expenses, minimizing uncertainty going forward. However, there are parts where losses could not be recognized according to accounting standards as of late last year, and we expect that there could be after-tax KRW90 billion to a maximum of KRW200 billion of losses that can occur during the next two to three years. However, we have improved all processes from product sourcing to sales to ensure such incidents do not occur again. Next, I would like to explain about net interest income in more detail. Group interest income posted KRW9.053.065 trillion, a KRW898.4 billion increase, marking an 11.0% growth. This growth was driven by the bank’s margin quarterly profit improvement and growth in bank loans, with a 9% increase, focusing on SME loans. I would like to explain the Group non-interest income on page seven. Group non-interest income posted KRW9.638.1 billion, a 7.7% increase Y-o-Y. However, excluding insurance-related non-interest income centering on non-banking, it increased 19.7% Y-o-Y. Fee income increased KRW292.1 billion, a 12.3% increase. The detail in the table below shows an increase in trust fee income on the back of Asia Trust Income and bank ERP pension trust balance growth, as well as a sizable increase in FX fee income, investment banking, and lease financing fees. Securities and FX derivative income posted KRW289.5 billion, a 25% growth, and this was due to good performance in securities transaction gains and financial investments self-trading. I would like to explain in more detail regarding expenses from page eight. 2021 G&A posted KRW5.754.3 trillion, a 10.2% increase Y-o-Y. Excluding the sizable ERP expense of KRW268.1 billion in the previous year, the G&A growth rate posted 7%. The high growth rate compared to average years was due to Group digital platform and new business-related advertisement and promotion expense increases. The strategic expenses that were saved through digital transformation are being utilized in new businesses, including the activation of digital platforms. As aforementioned, the CIR excluding ERP expenses posted 43.1%, a 1.3-percentage-point improvement Y-o-Y. On the other hand, group provisioning, on the back of the feeding of the 2020 COVID-related additional provisioning due to the underlying effect decreased KRW394.2 billion, a 28.3% drop Y-o-Y. Despite the KRW187.9 billion of additional provisioning preparing for the uncertain economic situation, including the spread of Omicron and the termination of the COVID-19 financial forbearance program, the credit cost ratio posted 27 bps, showing stabilization. The delinquency rate, which can be seen as a leading indicator of credit costs, is showing downward stabilization for both Shinhan Card and Shinhan Bank. Next is page nine, capital and major income indicators. CET1 ratio is 13.0%, a 13 bp improvement YTD. CET1 ratio based on the standard before the adoption of revised Basel III credit risk is forecasted to be 11.8%. On the other hand, with the profit expansion, businesses with high ROE, including capital and asset management, Group ROE improved by 0.8 percentage points Y-o-Y. Please refer to the graph in the lower-right side of the slide for our CET movement in 2021. We plan to continuously improve capital adequacy and profitability, including establishing a solid foundation for core earnings and net income growth.

Kim Myoung-hee, CDO

Hello. I am Kim Myoung-hee, as was introduced. I will talk about the Group’s digital strategy. In 2021, the Group continued its efforts to improve customer experience and provide services close to life on the digital platform, which is our customer contact channel. As a result, MAU of Bank SOL and Card pLay grew 25% and 28%, respectively, Y-o-Y, recording the highest growth rate in the industry. In particular, the Bank conducted various gamification-based marketing with the KBO, Metaverse, baseball field, and Nexen cart writer for the MZ generation, and is currently promoting the establishment of a young smart campus through an agreement with the University. In October last year, Shinhan Card newly launched pLay, which converges various live services with existing pay-oriented services and recently introduced services that apply new technologies such as MyNFT. In addition, Shinhan Bank and Card are promoting their business this year as they acquired the MyData business license last year, and Shinhan Investment and Life are preparing to acquire the license. Each subsidiary plans to provide differentiated services by integrating data into their main businesses, such as banking, payment, investment, and healthcare. Furthermore, we plan to enhance customer value through bold attempts in non-financial, as well as financial areas, such as health fit and AI motion recognition-based home trading platform, Engdangayo, the first delivery app launched by a financial company. For detailed digital coverage and cost savings from digital channels, please refer to the document. On the next page, the Group is also actively pursuing investment and alliances with digital new technology companies. Last year, we created a KRW300 billion Digital Strategic Investment Fund, the first among domestic financial companies, and invested KRW173 billion in 11 companies, expanding our efforts to improve customer contact points, capture future markets early, and secure new technologies. In addition, we are expanding the ecosystem of win-win growth with startups through Shinhan Future’s Lab, the first accelerator launched in the financial sector. In the Baby Unicorn 200 Fostering Project hosted by the Ministry of SMEs and Startups, 10 companies, the largest number in the financial sector were selected, and their expertise was recognized, playing a pivotal role in accelerating the Group's CET. Moreover, we are strengthening cooperation for future businesses through strategic partnerships with other industries, such as fintech and ICT. Recently, we signed a digital alliance with KT in the form of a share swap of KRW440 billion. The two companies plan to jointly advance to a digital company that transcends finance and telecommunication in fields like AI, Metaverse, and NFT. The Group declared a new vision of how finance should be friendlier, more secure, and more creative, aligning with the Group's strategic objectives. Interest income shifts with economic fluctuations. As confirmed in the Q4 results, margin improvement due to interest rate rise and loan asset growth has expanded. With the base effect of margin improvement and asset growth made during 2021, there will be a significant increase in interest rates and net interest income in 2022 as well. Additionally, interest income is expected to increase further this year, as margins continue to improve due to an upward rate revision, factoring in projected asset growth. According to our internal estimates, a 25 bps rise in the base rate will affect the bank margin by about 3 bps to 4 bps annually. Considering the number of rate hikes expected by the market, margin improvement appears to be larger than last year. Asset growth expectations are currently in the mid-5% range by bank standards. In page 17, I will explain the loss-absorbing capacity according to economic uncertainty. Due to economic uncertainty and the scheduled end of the COVID-19 forbearance program, concerns about further asset deterioration in 2022 are growing. In this regard, first, we maintain the PD for collective assessment at the same conservative level as in 2021. The increase in PD this year due to a sluggish economy is likely to be limited. Considering the end of COVID-19 support programs, additional provisioning of KRW187.9 billion for vulnerable borrowers, according to individual assessment, maintains sufficient buffer. The following pages include detailed performance descriptions of the Group and subsidiaries along with key business indicators. This concludes my presentation, and now we will proceed with Q&A. Thank you very much.

Operator, Operator

Thank you very much. The first question is from Hyundai Automobile Securities, Mr. Kim Jin-Sang is on the line. Please ask your question, sir. Mr. Kim, you are on the line.

Kim Jin-Sang, Analyst

Can you hear me?

Operator, Operator

Yes. We can hear you well.

Kim Jin-Sang, Analyst

I have two questions. First of all, thank you very much for your good earnings. I would like to ask your question about your capital policy, and for Shinhan you initiated a quarterly dividend and you are leading very active shareholder return in the banking sector and I know that…

Operator, Operator

Sir, we are hearing some howling on the line.

Kim Jin-Sang, Analyst

Is it okay now?

Operator, Operator

Yes. It’s much better. Thank you.

Kim Jin-Sang, Analyst

And for your treasury shares, I know you have some funds to use them going forward. So, is there any plan for cancellation of those treasury shares? So, do you have any plans to have any changes in the ownership? Second question is about your journey growth, because even excluding the ERP cost of 7%, which is quite high and we know that you have had a lot of cost going into the digital platform, but compared to your peers, it may seem that your digital platform costs are maybe a bit larger, is that a reason? Is there a special reason why it is quite high? And for this year, what is your expected growth for digital platform investment, I know that there was a high base last year. So do you believe that it will go down this year?

Operator, Operator

Thank you very much for your questions, Mr. Kim, and we will soon answer your questions. Please hold. Our Group CFO, Etaeg Young, will answer your questions.

Etaeg Young, CFO

You asked a question about our capital policy and for the quarterly dividend, we had been executing it since last year and for this year. We also want to make this routine with a fixed amount that was aforementioned. Regarding the share buyback, we will not make a comment now, but when we do, we will communicate this to the market. Of course, we will keep in mind the cancellation as well. For our G&A, we will hear from our Group CMO, Heo Young-Taeg, and then from our CDO, Kim Myoung-hee.

Heo Young-Taeg, CMO

I am Group CMO, Heo Young-Taeg. Regarding the G&A expenses, compared to the previous year, what was extraordinary is ERP. In the past, for ERP, it mostly took place at Banks. However, for the previous year, there were many subsidiaries, resulting in the ERP for the credit card, which takes place every two years, and at Life, there was a sizable ERP. From capital as well, we had the ERP, which was not something that happens often, so that happened often last year. So it might seem that we had a high growth in G&A costs. However, excluding all that, we believe that we can have disciplined management of the G&A expenses. We do not believe there are expected burdens on the G&A cost going forward.

Etaeg Young, CFO

For this year regarding investment in digital or new growth areas, we will make continuous investments. For CIR, we expect downward pressure, so the CIR ratio for this year is about 43.7% that we are forecasting. We will continue with our cost management.

Operator, Operator

Thank you very much. The next question is from Mr. Lee Byung Gun from DB Securities. Please go ahead.

Lee Byung Gun, Analyst

Hello. I am Lee Byung Gun from DB. Thank you for the wonderful results. I have two questions. This may be too narrow of a question, but earlier, you were talking about the investment products and you took care of the accounting, and I do appreciate that. However, there were some items that could not be taken care of accounting wise, and it could be KRW90 billion to KRW200 billion. So, what kinds are these and how will you take care of these? And the second question is about credit cards. Consumption is expected to recover, so we are seeing good signs. But we are concerned about the funding rate increasing, and with the DSR regulation in place, the loan assets will be affected in June and July. Because of the loan asset regulation, what is the amount of asset size that will be affected? So, the DSR and the loan contraction, how will you deal with these issues? Thank you.

Operator, Operator

Thank you very much for the questions. Please hold as we prepare for the answer. Yes. The first question will be answered by the CFO, Kim Song Hwan of Shinhan Investment.

Kim Song Hwan, CFO, Shinhan Investment

As for the provisions that can be possible accounting wise, we have done what we are required to do. However, we have to wait for the decision by the Conflict Settlement Commission, and we may see a change in the price of the underlying assets, and so the compensation might change. So, within the next three years, as was mentioned by the Group CFO, it is expected to be in the range of KRW90 billion to KRW200 billion. Thank you.

Moon Tung Gwan, CFO, Shinhan Card

I’d like to answer the questions you posed about Card. Looking at the financial institutions, it seems there are concerns about the Card business. The growing funding rate, regulations, and merchant fees are three challenges we face, which could present downside risks. However, Shinhan Card is developing necessary strategies. As for your question about the rise in the funding rate and the DSR regulations impacting income, it could be in the range of KRW200 billion. But over the years, we have anticipated these changes. As mentioned by the Group CFO, we are preparing for them and declared a vision in 2019 for sustainable growth and solid fundamentals. Our strategy includes diversification into new businesses. For example, within non-settle accounts, non-payment is supported, and 40.9% of the business involves non-settlement businesses, including card loans and cash advance services. The loan assets are being confirmed, with perceived figures for general assets reaching around KRW1.8 trillion and auto loans exceeding KRW8 trillion. Our earnings power in loan assets remains strong. We also have data sales and platform-based businesses generating actual profits. Last year, income from data sales allowed us to secure a contract worth KRW10 billion, thus turning visions into reality. Regarding our Group strategy, we're saving costs through digital platform enhancement, leading to a KRW100 billion saving from digital transformation and an expected additional KRW120 billion ARCC. These factors positively influence our financial trajectory. As for ERP, we have approached it very aggressively. Looking at the Global business, our subsidiaries proactively pre-empted losses in four overseas subsidiaries. We believe these earlier efforts will be evident this year. While this year poses challenges, Shinhan Card is distinguished among all card companies in Korea, as we made proactive preparations for the prior four years, thus illustrating our readiness against the challenges mentioned.

Operator, Operator

It seems that there are no further questions at this time. The next question is from JPMorgan, Josie Hung. Director Jo, you are on the line.

Josie Hung, Analyst

Thank you for the opportunity. In Q4, you mentioned that your provision preemptively reflected some COVID-19 related programs. However, compared to your peers looking at the increase in provisioning, it seems a bit low. As I understand, the government has been requesting that more provisioning be made. Regarding the differing macro assumptions or provisioning standards, I think they vary. Can you elaborate on the rationale behind your conservative assumptions and how you are provisioning? In March, there are claims of the termination of COVID-19 related forbearance programs. Could you clarify your exposure and how you plan to manage them, including your provisioning outlook as it pertains to the termination of these forbearance programs?

Operator, Operator

Thank you very much, Director Jo. We will soon answer your questions. Please hold. CFO, Etaeg Young will answer your question.

Etaeg Young, CFO

Thank you very much for your question. Regarding the comparisons you made, I believe you are referring to the NPL coverage ratio. Compared to other banks, the market probably perceives that we have a lower NPL coverage ratio. The NPL ratio represents provisioning against delinquent or potentially delinquent loans, and depending on the types of collateral, provisioning rates are different. Hence, it is crucial to distinguish between various types of provisioning since they pertain to different loan categories. Regarding the termination of COVID-19 forbearance programs related to financial support, within the balance for installment repayment deferrals, there is approximately KRW200 billion for high-risk loans. For the loans deemed to be at the highest risk, it’s about KRW50 billion, and the interest deferral amount is approximately KRW40 billion. We estimate our credit exposure to be around KRW56 billion. Overall, it totals roughly KRW100 billion, for which we have provisioned an additional KRW83 billion. Including our previous provisioning efforts, we have more than KRW140 billion set aside. Thus, even with the termination of the repayment deferral forbearance program, we believe we can sufficiently mitigate potential borrower deterioration. Concerning macroeconomic conditions, in 2020, we adopted a conservative provisioning approach, and we have maintained it into 2021. Our observation period ensures inclusivity for high default scenarios, which allows us to assess further delinquency possibilities among borrowers. In total, we have made preemptive provisioning for potential delinquencies. We believe we remain adequately covered in terms of provisioning. However, with rate hikes likely triggering broader economic impacts, there may be an increased burden on wages that could heighten the PD or overall portfolio risk, thus prompting a rise in provisioning relative to similar periods.

Bang Dong-Kwon, CRO

I am the Group CRO, Bang Dong-Kwon. Regarding your assumptions related question for SLC, I think you inquired about individual assessments and collective assessments. I will base my response on that, building on the minimum observation criteria you’ve asked about. The portfolio default rate (PD rate) is at present at the lowest level. If we utilize risk components on a moving level as done in the past, it remains low. For enhanced conservativeness, we revised the observation period to encompass financial crisis scenarios. Expanding this timeframe allows us to filter out write-backs or cost factors, ensuring we have ample preparedness for risk. Our assessments remain consistent with this larger timeframe.

Operator, Operator

Thank you very much. The next question is from Yafei Tian from Citi Securities. Please go ahead.

Yafei Tian, Analyst

Hi. Thank you for allowing me to ask a question. I have a few relatively quick inquiries. First, regarding the non-operating losses for this quarter, I might have missed it at the very beginning, but could you clarify the nature of those losses? Secondly, thank you for the comprehensive discussion on loan losses trajectory and asset quality. However, assuming no increase in delinquency with conditions remaining static, does this imply that loan losses this year might be lower than what we have observed over the past two years, in the absence of top-ups? Lastly, regarding the Life business of Shinhan Life and Orange Life, could you provide an update on the integration between these two businesses and your outlook concerning IFRS 17 implementation?

Operator, Operator

Thank you for the questions. Please hold. We will soon return with the answers. The CMO, Heo Young-Taeg, will first address one of the inquiries.

Heo Young-Taeg, CMO

Hello. I am Heo Young-Taeg, the Group CMO. I’d like to answer the question regarding the larger effect of Shinhan Life and Orange Life and the introduction of IFRS 17. Last year, Shinhan Life and Orange Life merged, and there were many one-time costs incurred. There were ERP costs for redundant workforce amounting to KRW56.6 billion and system integration costs of KRW40 billion. I mention these numbers because, in the long term, we must evaluate how the merger will provide returns in the ensuing years, and we had to reflect these costs last year. This year, the integration costs will decrease significantly. As for system integration, the amortization will incur less burden, and we anticipate operational efficiency post-merger, which should materialize this year. From a Group perspective, we will be able to share customers and foster additional business opportunities. The distinct business models of Orange Life and Shinhan Life, one involving younger FMFCs and the other with a PM organization, will lead to interactions yielding synergy, becoming apparent in 2023. Regarding IFRS 17, the integrated Shinhan Life will possess the industry’s best capital base, creating opportunities for it to transition to a profit-making entity. Given this, commence profit growth in Shinhan Life in 2023 will be advantageous for the Group.

Bang Dong-Kwon, CRO

I would like to address the question about asset quality and loan loss. I am the CRO, Bang Dong-Kwon. In terms of asset quality, we prioritize sound assets and consistently observe improvement in NPL ratios and delinquency ratios. Regarding loan losses, as the CFO mentioned, the credit cost ratio stands at 27 bps amid COVID provisioning challenges. We have conducted stress tests under various scenarios; the targets equate to slightly higher than the last year's 27 bps, which is our goal.

Operator, Operator

Yes. Regarding non-operating losses, we identified ourselves as a distributor of the investment product, which we recognized as a non-operating loss of KRW192 billion. Furthermore, the adoption of IFRS 17 and its effect on the Insurance business, I understand you are likely familiar with the accounting aspects. The integrated entity comprises a significant portion of protection-type and guaranteed insurance companies. Relative to competitors, we believe we will perform better, and while the capital may undergo some changes, we maintain sufficient capital buffers. In relative terms, our insurance business will be in a favorable position. I want to discuss numbers to be more specific, but I will keep it general. Overall, I expect positive results for both Shinhan Life and Orange. We are still waiting for additional questions. We have not observed any new questions at this time.

Mike Makdad, Analyst

Hello. This is Mike Makdad from Morningstar. Can you hear me? I have one question, which concerns your overseas subsidiaries. Until the pandemic, I understand that your strong overseas units, such as those in Japan and Vietnam, set Shinhan apart from other Korean banks, contributing 10% to 15% of profit. Of course, during the pandemic, Japan seems to be strong and I am aware of that, but Vietnam has been affected. I would like to inquire about the outlook for these overseas subsidiaries once the pandemic ends. Perhaps 2022 is too early to predict, but how do you envision Vietnam's recovery? Are there any plans for growth in other ASEAN countries?

Operator, Operator

Thank you very much for your question. Please hold. We will soon return with an answer. You will hear from our CMO, Heo Young-Taeg.

Heo Young-Taeg, CMO

Thank you for your question. I am CMO, Heo Young-Taeg. You are correct that we faced challenges in Vietnam due to COVID-19 lockdowns. However, globally we have seen net income of about KRW390 million, demonstrating robust performance. For Myanmar, losses were preemptively recognized in Yangon, estimated at around $25 million collectively. Despite all these challenges, last year we experienced around a 25% increase in profitability compared to the previous year. For this year, emerging markets like Vietnam and Indonesia are expected to rebound significantly, as there is an ongoing trend of lifting lockdowns which we anticipate will lead to strong growth momentum. Both countries play pivotal roles in the global supply chain's recovery will likely unfold. For the advanced markets in the GIB sector, we are making strides, particularly in IT business and achieving notable results. Overall, we are confident this year will afford us tangible results, enabling us to capitalize on opportunities that have been deferred over the last two years. Additionally, we are pursuing inorganic opportunities, which will be subject to government regulations among other factors, so we will need to see how those develop. In comparison to our competitors, we believe Shinhan's prospects for global business growth in 2022 remain favorable.

Operator, Operator

The next question is from Mr. Sin-Young Park from Goldman Sachs. Please go ahead.

Sin-Young Park, Analyst

Hello. Thank you for the opportunity. I have one question. This year, as well as last year and the year before, a conservative stance has prevailed concerning wealth management and product booking. Is there a point when we can expect a reversal, and what will dictate the scope? What is the expected timeframe and conditions for any potential reversal?

Operator, Operator

Please hold. We will be right back with the answer. Yes, the CFO, Etaeg Young will answer.

Etaeg Young, CFO

Related questions continue to arise with specific figures, but we want to be transparent about our current situation. There are some funds that have recovered, as well as funds we anticipated losses against. We did want to provision accordingly even when reports indicated no issues. However, we can't promise exact timelines or conditions for reversals. We estimate that loss provisions may total about KRW100 billion and could extend as long as five years due to protracted disputes, with possible figures reaching as high as KRW200 billion. This range is not based on precise calculations. By the end of 2021, we conducted assessments accounting for private reconciliations. We anticipate a positive outcome.