Sun Hung Kai & Co. Limited (86) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to Sun Hung Kai & Co.'s 2022 Interim Results Investor Briefing. I'm Shirley Zhang, the company's Vice President of Investor Relations. This meeting today will be conducted in English. If you need translation, you may switch to the Chinese channel and mute the original audio. First, let me introduce the senior executives with us today, Mr. Brendan McGraw, Group CFO; Ms. Elsy Li, Group Treasurer, Head of Corporate Development and Investor Relations; and Ms. Lindsay Wright, CEO of Funds Management. In today's meeting, our management will talk about the company's business performance in the first half of 2022, outlook for the second half of this year and our future plans. After the presentation, there will be a Q&A session. [Operator Instructions] Now I will pass the floor to Brendan to start. Brendan, please.

Good morning, everybody. I'll start today by looking at our journey of transformation. The Sun Hung Kai heritage was founded in 1969 with the start of our brokerage business. Our assets have now grown to HKD 49 billion. In 2021, our funds management vehicle, Sun Hung Kai Capital Partners, was formally established with Type 1, 4 and 9 licenses. In that year, we also launched 6 partnerships/funds across diverse strategies. In 2022, a further partnership, GCO Asset Management, was launched along with Sun Hung Kai Capital Partners Private Access Fund; encouraging progress in increasing external capital of USD 165 million raised by partner funds, bringing the total assets under management to approximately $830 million. Looking at our business overview. Our business is split into 3 main pillars: financing, investment and funds management. Our financing business is very resilient and provides a steady cash inflow and organic growth. Through Consumer Finance and UAF, Mortgage Loans, Sun Hung Kai Credit and Private Credit. Our Investment Management business focuses on strategies with risk-adjusted returns across the diversified asset classes, sectors and geographies. This portfolio includes public markets, alternatives and real estate. The newest business segment, Funds Management, is fully licensed to manage external capital and brings additional revenue streams to the group. Taking a glance at the 2022 interim results. The first half of 2022 was a very challenging period characterized by extreme volatility across all asset classes and runaway inflation. In addition, the intermittent COVID-19 lockdowns resulted in sharp moves in markets and disruptions in business activities across the globe. Revenue in the first half of 2022 was HKD 2.1 billion and it consisted mainly of income from the financing business of HKD 1.9 billion. The attributable loss for the period was HKD 401 million, and this was largely the result of mark-to-market losses and slower exits from investment positions. Our book value per share was HKD 12.1, and our annualized ROE was minus 3.3% in the period. The group gearing ratio was 48.6% as at the 30th of June 2022. It remains healthy and within our comfortable range to improve capital efficiency and maintain strong liquidity amongst the volatile market conditions. The Board has maintained return to shareholders by declaring an interim dividend of $0.12 per share, which is the same level as the corresponding period in 2021. During the period, the company also repurchased 829,000 shares for a total consideration of HKD 3.1 million. Moving on to our balance sheet and capital structure. Our balance sheet remains strong with assets continuing to grow. Our cash balance at the 30th of June was HKD 8.2 billion. Our total loans of HKD 15.6 billion were mainly funded by borrowings. 54% of our borrowings were in PIK notes and paper at fixed rates and 46% of our borrowings were from bank lines. Our investment assets are mainly funded by our shareholder equity. Our robust financial position, high liquidity and diversified business have positioned us well to navigate through the continued uncertainties. Moving to the Investment Management section. The segment's total assets were HKD 20.3 billion at the end of the period. 70% was alternatives; followed by 19%, public markets; and real estate accounting for 11%. The first half of 2022 was a very challenging period. Global markets were extremely volatile and the economic outlook has been gloomy. Against such a backdrop, we have proactively adopted various hedging strategies to protect our positions. Nonetheless, our portfolio was not immune to this volatility in asset prices across the board. The division recorded a pretax loss of HKD 957 million for the period, and it's mainly contributed to mark-to-market losses of HKD 1.2 billion on the portfolio. The comparative drop in profits was further impacted by the fall in realized gains on financial assets and interest income, which were HKD 583 million in 2022 compared to HKD 1.6 billion in 2021. This was due to the reduction in the number of investment exits due to the market conditions. However, I would point out in the last 3 years, in 2019 to 2021, the cumulative total gain and interest income from this segment was HKD 7.1 billion. Out of this amount, HKD 5.5 billion had been realized and the 3-year total return was over 40%. Looking further at investment assets and return. Public markets delivered a positive return of 3.5%. For alternatives, the 6-month return was minus 4.7%. And for real estate, it was relatively flat with a return of 0.2%. I'll go into details in the next pages. Starting off with public markets. The Corporate Holdings segment consists of a mix of long-term strategic positions and other shorter-term positions. Derivatives and hedgings are used for both risk management and enhancing returns. In the first half of 2022, we started early in the year to diversify and further hedge our public positions, and we were wary of the complex dynamics of extreme inflation levels and central bank rate hikes. This segment recorded a positive return of 4.6% for the period. The rising interest rates and uncertain macroeconomic outlook also dampened global credit markets as well. Our public team started at the beginning of 2022 to actively put on more hedges to protect their positions. The Public Credit strategy was spun off in June 2022 and launched GCO Asset Management Limited, which is an independent partnership on our Funds Management platform. The Alternatives segment includes private equity and hedge funds. Private equity consists of our investments into external funds, core investments alongside such funds as well as direct investments. Amidst the increasingly challenging macro environment in the first half of 2022, the Private Equity segment recorded a loss of HKD 373 million or 3.7%. The loss mainly arose from the headwinds from interest rate hikes, the ongoing U.S.-China tensions and China regulatory tightening. These factors drove mark-to-market losses on the portfolio. We will continue to exercise prudence in capital allocation given the highly uncertain global economic outlook. Our multi-manager hedge funds portfolio consists of a group of selected external hedge funds that complemented our capabilities and extends our investment networks. Given the severe sell-off in the first half of 2022 as a result of central bank's monetary policy tightening and recession fears, we have been derisking and rebalancing towards more market-neutral strategies. Finally, to look at Real Estate. The real estate portfolio includes the group's interest in Hong Kong commercial real estate as well as hotel international investments in global markets. The segment had a valuation of HKD 2.2 billion at the 30th of June 2022 and recorded a 6-month return of 0.2%. The rising cost of capital and rapidly shifting preferences of end users of real estate have led to heightened uncertainty in global real estate markets. We are mindful of this, and we'll remain patient and adopt a cautious stance with respect to new investment opportunities. In the meantime, we are also in the process of selling some of our real estate investments, and we'll update investors when appropriate. Next, I'll pass the floor to Lindsay, and she will talk you through our Funds Management business. Lindsay, please.

Thanks, Brendan, and good morning, everyone. As Brendan noted, 2021 was the first year of the formal launch of the Funds Management business. We believe it's a key driver of growth over the medium term for the Sun Hung Kai growth. This will be driven by growth in the respective funds AUM and the revenue share of management fees and performance fees from our seeded partnership funds. In 2021, to recap, we launched 6 partnerships and related funds. We entered into partnerships with emerging managers and provided acceleration of capital to newly established managers. This is reflected in the established partnerships of E15VC, ActusRayPartners, Kernel and East Point. We also launched 2 of our own funds, being Multiple Capital Investment Partners and APAC Real Estate Loan Fund and SHK Capital Partners Latitude Alpha Fund, a global fund of hedge fund strategy. In the first half of 2022, we continued to expand our strategies. We further established both a partnership and an SHKCP Fund. The partnership was established with GCO Asset Management, which is an internal spinout from SHK & Co. It manages essentially the same strategy as was managed internally being a global credit opportunities fund. The new SHK Capital Partners Fund as SHK Capital Partners Private Access Fund collaborates with the Investment Management division to target specific alternative investment opportunities for our clients. The collaboration enables investors to have access to the group or its partners' proprietary deal-sourcing channels and alternative investment assets in an institutionalized manner. I'm pleased to report we have achieved encouraging progress in increasing external capital in the first half of 2022, albeit under challenging conditions. A total of USD 165 million was raised by our partner funds during the period, bringing total AUM of both our partners and SHK Capital Partners funds to over $800 million. Our ratio of total AUM to external AUM has reduced to 67%. In terms of the funds' performance, certain strategies have been performing well despite the challenging market conditions in this first half. In the second half of 2022, we will continue to focus on a distribution build-out, working with our partners to raise third-party capital as well as promotion of our own SHK Capital Partners Funds, at the same time, and I note very selectively, continue to source partnership opportunities with external managers to create a broader and more diversified platform to support the group's vision to build an Asian leading alternatives firm. With that, I will pass back to Brendan to talk about certain other activities. I'm sorry, passing to Elsy. Sorry.

No problem. Thank you, Lindsay, and good morning, everybody. Our Consumer Finance business is operated under UAF in Hong Kong and China. UAF has been a leading franchise and a household name in the region for over 30 years. It is also a consistent contributor to our group's revenue. As of June 30, 2022, UAF's total gross loan balance was HKD 12.3 billion, demonstrating an increase of 4.7% year-to-year. About 70% of our loans is coming from Hong Kong, about 29% coming from Mainland China. Over the past few years, our loan balance has maintained a healthy organic growth at a CAGR of 4.9%. Total revenue of UAF for the first half 2022 was $1.8 billion, up 1%. Pretax profit was HKD 645.4 million decreased 26% year-to-year due to the challenging business environment. The net impairment loss increased by 51% to HKD 312.3 million, mainly due to COVID lockdowns and stringent social distancing measures in first Q. Overall cost-to-income ratio was at around 37%, mainly driven by our increased investment into IT enhancement, our collection efforts, marketing campaigns as well as various promotional activities that we have launched. Here is the respective performance of UAF's Hong Kong and China business. For Hong Kong, our business remained resilient. The total gross loan balance increased by 1.5%. Overall loan yield remained stable at 30.1%. Net charge-off was 4.8%, and net impairment loss ratio was at 3.3%, which is a similar level to that of 2021. Hong Kong's first Q performance were impacted by the fifth wave outbreak of COVID. But with certain social distancing measures being relaxed, the drop in local infected cases, we have seen improvement in our business in second quarter 2022. In July 2022, UAF launched its first iconic robotic arm NFT adopting the blockchain technology. The limited edition 3D robotic arm NFT has spurred interest among NFT collectors. It is also a first-ever initiative among all the money lenders in Hong Kong. For our China business, both the impairment charges and loan origination were adversely impacted for the period due to COVID-related lockdowns in China and the economic slowdown. We have proactively managed the negative impact on our business through operating cost reductions and diversifying our portfolio mix. Overall loan yield reduced to 23.4% as a result of our effort to improve and shift to borrowers with better credit profile and increased contribution from our secured loan business. Gross loan balance increased by 13% year-to-year. Charge-off and impairment loss ratio increased to 7.5% and 8.9%, respectively. There was an increase in the net impairment, too, which was mainly driven by bad debt and general provisioning due to our conservative economic outlook for China in the second half. Our Mortgage business is operated under Sun Hung Kai Credit. Despite the backdrop of the fifth wave of COVID in Hong Kong in the first half, we were able to keep our gross loan balance at HKD 3.4 billion, a slight increase year-to-year. Over 90% were first mortgage loans. Revenue for the period was HKD 144.7 million, representing a slight decrease of 3.1% year-to-year. Net impairment loss recorded a reversal of $15.7 million for the period due to recovery of certain loans compared to a loss of HKD 12.5 million for the same period last year. Operating costs for the period were HKD 35.6 million, increased 31.9% year-to-year, primarily driven by the continuous investment into our IT infrastructure as well as the advertising campaign, which we launched end of the 2021 and lasted through early 2022. Financing cost decreased by 6.6% to $48.1 million as a result of our effort to diversify funding channels. Pretax contribution increased by 32.4% to HKD 78 million, and our LTV remained prudent, which is below 65%. Our Private Credit business provides tailored financing solutions to corporates, investment funds are high net worth individuals. All of these loans are secured. Given our continued effort in collection in the first half, our gross loan balance and net loan balances reduced by 40.2% and 66% year-to-year, respectively. Correspondingly, the revenue decreased by 52% to HKD 52 million. Net impairment loss decreased by 81% to HKD 21.2 million and pretax loss narrowed by 56%. Looking ahead, we will continue to actively manage our current loan book and be prudent and judicious in originating new business given the uncertainty in economic recovery and volatility in capital market. In addition to structural loans, Private Credit also includes LSS leasing, a B2B/B2C auto leasing business in Mainland China. Next, I'll pass to Brendan to talk about our ESG efforts and future plans. Brendan, please.

Thank you, Elsy. We're pleased to share with you some of the ESG updates. ESG investing is an essential part of achieving a sustainable future. We value a diverse workforce as it enables us to attract the best people, and we have signed up for the Racial Diversity and Inclusion Charter for Employers. Our Board includes a balanced composition of executive, nonexecutive directors and independent nonexecutive directors so that there is a strong element of independence on our Board. SHK & Co has also invested in a number of next-generation technology projects, which are ESG-related and provide solutions to global issues in recent years, such as sustainable buildings and electric vehicles. We envision contributing to the transition to a low-carbon economy and have signed up as a TCFD Supporter. Through Sun Hung Kai & Co. Foundation's support to Crossroads' Computer Refurbishment Programme, the program has donated 600 computers to underprivileged families in Hong Kong to ease their needs for online learning during this challenging COVID pandemic period. To wrap up, here is the business outlook and our future plans. Looking ahead, we believe it will continue to be extremely challenging given the decades high inflation rates, the markets' fear of a global recession, escalated geopolitical tensions as well as continued impacts from COVID-19 infection management. We remain highly vigilant about the various risks and challenges and will continue to act nimbly and insofar as possible, to mitigate the volatility in our business and our investment portfolios. With a strong balance sheet and liquidity position, we are confident in our ability to navigate the complex dynamics and capitalize on opportunities for further business development and growth. The particular focus for each of the 3 business lines in the second half of 2022 is as follows. For consumer finance, we are expecting to benefit from the relaxation of quarantine and social distancing measures in Hong Kong and any potential economic stimulus policies in Mainland China. We remain cautiously optimistic about business development in the second half. For Mortgage Loans, we will continue to exercise prudence in loan underwriting against increased downward pressure on Hong Kong property values and continued impacted demand while focusing on risk diversification, loan quality and profitability. For Investment Management, we are adopting a cautious approach to investing, tightening our return criteria, our risk management as well as placing a premium on liquidity. We remain confident about this business segment's future over the economic cycle. For Funds Management, we will be focused on distribution build-out, working with our partners to raise third-party capital and the promotion of our own Sun Hung Kai Capital Partners Funds. We will continue to source partnership opportunities with external managers to create a broader and more diversified platform. Lastly, as Elsy is departing Sun Hung Kai & Co. and will relocate to North America to focus on her family, I would like to take this opportunity to thank Elsy for her great contributions to the company during her tenure. Thank you.

Thank you, Brendan. And I would like to take the opportunity to thank everyone here for the strong support and partnership over the past 5 years. It has been a tremendous journey. With that, we will open the conference for questions. Emcee, please continue.

[Operator Instructions] Our first question comes from Kevin. He hasn't mentioned his company. For your Consumer Finance business, why did the return on loans dropped to 28% from 30%?

Thank you. Perhaps I'll take that question. The reduction in the gross yield is due to a change in our portfolio mix in China. We have a higher secured loan product in our China portfolio, which offer a lower interest rate given that it's secured. And currently, around 40% of our gross loans are as a secured loan product compared to 28% as of same period at the end of the year. So that contributed mainly to the reduction in the gross yield.

Thank you, Elsy. Next question comes from Ketan from Evaluate Research. His question is, despite the headwinds, the revenue has been resilient in the first half of 2022. Is the business being resilient as a result of shift to online from off-line? Would there be a greater focus and investment in technology to leverage from the online business from Hong Kong and China going forward?

I would assume the question is for Consumer Finance or for the group as a whole?

I think the question is for Consumer Finance business.

Okay. So perhaps I'll try to address it and see if Brendan can supplement. For our business in China, we have started our digital and online transformation about 5 years ago. So I think at the moment, in terms of customer and loan origination, most of our origination source in China has been through online other than the secure product, which we launched towards the end of 2021. Some of them are both online and off-line promotions. But in terms of the execution and the operation of our China business, it's mostly online right now. Similar for Hong Kong, right now, I would say our online and off-line is about 50-50, moving to a 55 online, 45 off-line mode. Yes, technology has helped us, and that's why we continue to invest in that to enhance our cost efficiency as well as sourcing new customers to ensure that we continue to strengthen our product base and deliver quality service to our clients.

Maybe just to supplement. Yes, the total revenue is dominated by interest income, so a lot of that coming from UAF but also coming from Sun Hung Kai Credit as well. We have also been active in investing in IT and technology as well. So the answer is, on both platforms, we are doing that.

Thank you, Brendan. [Operator Instructions] Okay. Thank you, Brendan, Elsy and Lindsay. And thanks for the questions. If you have any further questions, please feel free to contact us. This concludes the investor briefing today. Thank you, everyone, for joining us. You may disconnect your lines now. Thank you.

Thank you.

Thank you.

Thank you.