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

Good morning, ladies and gentlemen. Welcome, joining our 2023 interim results investor presentation. This presentation will be conducted in English. Alternatively, you may switch to the Chinese channel and mute the original audio if you need translation. I'm Shirley Zhang, the Investor Relations Vice President of Sun Hung Kai & Co. The senior executives here with me today are Mr. Brendan McGraw, Executive Director and Group CFO; Ms. Lindsay Wright, CEO of Funds Management. In today's meeting, we will talk about the company's business performance in the first half of 2023, the outlook for the second half of this year and our future plans. After the presentation, we will answer questions from the participants. If you would like to ask your questions, please type your questions into the Q&A box at the bottom of the screen and please make sure you include your name and affiliation. I will read the questions out after the presentation. Before we start, we would like to take the opportunity to remind you that today's discussion will contain forward-looking statements, which are based on assumptions and factors that are beyond the control of the group and are not necessarily indicative of the group's future performance nor are the guarantees of future performance. Now I'd like to pass on to Brendan to start the presentation. Brendan, please.

Good morning, everybody. I'd like to start, first of all, by looking at our business overview. Our core business is built around 3 pillars: Financing, Investment Management and Funds Management. Our lending business conducted through UAF, Sun Hung Kai Credit and Private Credit provides us with recurring and resilient cash flow. Our Investment Management business leverages the group's internal expertise, external network and strong financial position to seek attractive risk-adjusted returns across diversified asset classes, sectors and geographies. Our Funds Management business is fully licensed to manage external capital including through the new Family Office Solutions and distributing third-party hedge funds, which aims at diversifying and enhancing the group's revenue streams. Let me now share with you how we plan to optimize our capital allocation to enhance our shareholder value and drive sustainable business growth. In our Financing business, we will leverage our new credit card platform to outreach to new customer segments, in particular, younger generations to drive organic growth of our consumer finance business and generate recurring cash flow. For the mortgage business, we will continue to enhance returns and diversify funding channels, contributing steady and meaningful profit. In our Investment Management business, we remain cautious on capital deployment against highly uncertain macro backdrop. However, we will continue to enhance risk management systems and infrastructure to further institutionalize the business, and further explore synergies with the Funds Management arm to lead our corporate transformation. For Funds Management, this business initiative increases revenue streams and provides complementary asymmetric returns to our group. We will continue to focus on growth with a priority on diversification to deliver resilient amid volatile markets, extend our client reach through FOS and expand the distribution efforts to raise third-party capital. We will maintain our strong financial position and position for long-term sustainable business growth. We will also maintain our proactive capital management strategies through a consistent dividend policy and continued share buybacks. Moving on to the 2023 interim results. In the first half of 2023, our results were impacted by the continued volatility across various asset markets, the challenging macro picture as well as ongoing interest rate rises. We remain focused on navigating these challenges through our diversified businesses, enhanced risk management, improved cost efficiency as well as robust balance sheet and ample liquidity. Revenue remained fairly stable at HKD 2 billion, consisting mainly of interest income from our financing business. Pretax contribution turned to a profit of HKD 36.5 million from a loss position in the first half of last year, mainly due to smaller mark-to-market write-downs on our investment assets. After taxation and noncontrolling interest, our attributable loss was HKD 287.5 million, which was an improvement year-on-year. Our book value per share and gearing ratio remained healthy at HKD 11 and 37.2%, respectively, mainly reflecting our strategy of derisking and improving liquidity in turbulent times. Further improvement in operating efficiency drove a decline in our cost-to-income ratio to 34.9%. We remain committed to returning value to our shareholders. The Board declared the first interim dividend of HKD 12 per share, unchanged from the first half of 2022. We repurchased 770,000 shares for a total net consideration of HKD 2.3 million in the first half of 2023. Moving on to our balance sheet and capital structure. Our balance sheet remains robust with total assets of HKD 41.4 billion as of the 30th of June 2023. Our net cash balance increased to HKD 6.7 billion from HKD 5.9 billion at the end of 2022, mainly driven by net cash inflow generated from investing activities. Total loans were HKD 13.6 billion, primarily funded by our borrowings with 43% in notes and paper at fixed rates and 57% from bank facilities at floating rates. We continue to fund our investment assets by our own equity. In the first half of 2023, we repurchased an aggregate principal of USD 28.1 million of our 2x expanding MTNs. Our net debt decreased 17% to HKD 8.1 billion as of the 30th of June 2023, as we have been deleveraging to mitigate risk and improve capital efficiency. Moving now to the Investment Management segment. The total assets of our Investment Management business were HKD 16.3 billion as of the 30th of June 2023 with alternatives, public markets and real estate comprising of 71%, 15% and 14%, respectively. The year-on-year decrease in assets was partially driven by exits and distributions from alternatives as reflected in the improved cash flow and also by mark-to-market changes in investment value. The alternatives and real estate segments substantially narrowed the unrealized losses from HKD 1 billion to HKD 99.5 million in the first half of 2023, driving the year-on-year improvement in pretax results. Realized loss of our alternatives and real estate portfolios was HKD 135 million in the first half of 2023, primarily reflecting our strategic decision to derisk by reducing certain exposures, downsizing hedging positions and a decline in the number of investment taxes. During the period, we continued to augment our investment team's capabilities, enhancing risk management systems and make infrastructure improvements to further institutionalize our Investment Management business. Looking at the investment assets and returns. Blended return for the investment management business was minus 2.3% for the first half of 2023. With the subsegments, Real Estate gained 6.7% while Public Markets and Alternatives lost 7.4% and 2.5%, respectively. Corporate Holdings segment recorded a return of minus 8.1% for the first half mainly due to losses on hedging instruments in the U.S. and on some strategic positions in listed Chinese companies driven by market volatility. We have been employing hedging instruments to mitigate risk and enhance returns and this hedging strategy did derive gains in 2022. With the U.S. markets starting to recover in this year, we have reduced hedging positions. We remain aware of the risks to U.S. economic outlook, and we'll continue to maintain some of the hedging exposures against our U.S. positions. It's worth noting that we have seen some recovery in public losses in the first month following the period end closing as a result of ongoing volatility in the market. Moving on now to Alternatives, Private Equity. The Private Equity segment recorded a loss of minus 1.5% in the first half of 2023. This segment generates risk-adjusted returns by leveraging our proprietary deal sourcing, domain expertise and global mandates. Diversification allows us to manage risk effectively minimizing the negative impact of market volatility. We realized some losses on hedging instruments, which were employed to reduce the private books exposure when U.S. markets started to recover this year. This loss was partially offset by the gains on underlying investments. On exits and Distributions, we continue to receive regular distributions from fund managers, providing a net cash inflow in the first half of 2023. Alternatives and Hedge Funds. The Hedge Fund portfolio recorded a return of minus 5.7% in the first half of 2023. The loss was mainly because allocations in long equity loan biased and global credit encountered losses. A portion of the losses has been realized as the exposure was derisked. On the other hand, gains on allocations to other diversified holdings is partially offset with losses. We have increased our allocation to stable managers with a lower correlation to the broader markets. We expect to position the portfolio more conservatively going forward, given the expectations for ongoing market uncertainty. Finally, on Real Estate for this segment. The Real Estate portfolio recorded a 6.7% gain in the first half of 2023, primarily driven by the robust business recovery of our hospitality investment in the EU, offsetting weakness in Asia. We continue to adopt a cautious stance towards new investment in this rising interest rate environment. Our near-term focus is on credit investments, taking advantage of the market dislocations where we see opportunities to generate equity-like returns with a downside protected risk profile. Next, I'll pass to Lindsay to walk you through our Funds Management business.

Thank you, Brendan, and good morning, everyone. Our Funds Management business is organized into 3 groups: Firstly Fund Partnerships. Second, SHK Capital Partners Funds and Investment Solutions and Family Office Solutions. In line with the market conditions, we remain very cautious on capital deployment with no new funds ceded or launched that we ceded in the first half of 2023. The quality and diversity of our AUM have mitigated the downside impact from volatile markets. This was particularly evident in the market mutual strategy of ActusRayPartners, which delivered strong performance in the first half. Our APAC Private Credit Fund multiple capital real estate has maintained its disciplined approach to underwriting. Our SHK Latitude Alpha Fund also recorded solid performance against benchmarks with a range of managers within that portfolio performing extremely well in a volatile public market. We continue to develop our distribution footprint, working with our partners to raise third-party capital and with a select group of hedge funds to distribute their funds. In Q4 of 2022, we entered into distribution agreements with a number of high-quality hedge funds, which are well known to Sun Hung Kai Capital Partners. Over time, such arrangements will drive revenue growth and enhance diversification. The build-out of Family Office Solutions post the launch in Q4 of 2022 is developing well with AUM of USD 45 million as at 30 June 2023. Now looking at our business performance. Total AUM was USD 865 million as of 30 June 2023. The decrease in AUM [ 1H ] 2022 was principally due to 2 one-off events. Firstly, the full redemption and the subsequent closure of the fund launched by GCO Asset Management; and secondly, we sold the rights to receive the seeded capital fee of East Point equity long short fund to Regal Partners and Australian ASX-listed alternative asset manager. This resulted in a USD 100 million decrease in AUM. The share of external capital increased further to 57.8% of total AUM as of 30 June 2023 from 46.5% at the end of 2022. Total income increased by 125%, primarily benefiting from the sale of East Point Asset Management revenue share rights to Regal Partners. Cost optimization resulted in a reduction in operating expenses of 39.3% year-over-year in the first half of 2023. Pretax contribution to a profit of HKD 16.3 million from a loss position for the same period of last year. We will continue to focus on growth with a priority on diversification to deliver resilience and an ongoing investment across our platform, but particularly in the Family Office Solutions business. And let's take a closer look at Family Office Solutions. This provides customized alternative investment solutions that creates long-term value from a limited number of private clients, family offices and institutions. It leverages our experienced in-house team and internal investment capabilities. In relationship to hedge funds, FOS provides private clients and institutions with bespoke advisory and discretionary managed portfolios of hedge funds. The approach is dedicated to selecting best-in-class hedge fund managers with a focus on generating idiosyncratic sources of alpha and employing strategies uncorrelated to broader risk assets. Family Office Solutions also provides access to exclusive direct market investments across regions, industries and capital structure, either on a deal-by-deal, funds or co-investment basis. The flexible approach allows for innovative deal structuring that capitalize on prevailing market and deal dynamics. I'll now pass to Shirley to talk about the Financing business.

Thank you, Lindsay. Our consumer finance business, which is operated under UAF in Hong Kong and Mainland China continues to generate recurring and steady cash flow growth. Total gross loan balance was HKD 11.2 billion as of June 30, down by 9% year-over-year, mainly reflecting our strategic decision to scale down unsecured loan business in Mainland China and focus on secured lending in the market in response to the challenging economic and business environment. Loans from Hong Kong and Mainland China accounted for 81% and 19%, respectively. In line with the smaller loan book, total revenue of UAF decreased by 7% year-over-year to HKD 1.6 billion. Cost-to-income ratio improved by 4.4 percentage points to 32.7% in the first half of this year, mainly due to the reduced loan collection expenses and the cost rationalization activity initiative in Mainland China. Net impairment losses decreased 6% year-over-year as the drop in our Mainland China loan balance allowed us to write back some of the impairment allowance. As a substantial portion of our finance costs were hybrid based, it increased along with the sharp rise in hybrid in the first half this year. As a result, UAF pretax profit was HKD 554 million, down 14% year-over-year. Let's take a look at UAF Hong Kong and Mainland China business. UAF Hong Kong took advantage of the economic rebound to grow its business in the city. Gross loan balance increased to HKD 9.1 billion as end of the first half, which is a record high level. Loan yield remained stable at 30.1% despite the new interest recap as loan contracts signed prior to the amendments will be amortized over time. Charge-off ratio was 5.2%, remaining at mid-single-digit level, and we continue to see gradual improvement throughout the first half. We were pleased to report that the soft launch of UAF's new credit card business, SIM card has achieved satisfactory results. For Mainland China market, as we mentioned, we decided to scale down our unsecured lending business, but reallocate resources to expand the secured lending business in the market, which provides stable returns and are backed by adequate platforms. In the first half, UAF also rolled out comprehensive growth cost rationalization initiatives in Mainland China, and this initiative is expected to complete by year-end. We believe the shift towards secured lending with a well-managed credit risks will generate meaningful returns with a lower cost base for the remainder of the year. Turning to our mortgage business, which is operated under Sun Hung Kai Credit, continued to deliver meaningful pretax contribution of HKD 72 million for the period. In the first half, we remained cautious in loan underwriting considering the challenges faced by Hong Kong property market, and we put a strong emphasis on mitigating risks and ensuring our returns. As a result, the gross loan balance decreased by 27% year-over-year to HKD 2.7 billion. Over 90% of the loan balance were first mortgage loans and the LTV ratio was maintained at below 70%, which is a healthy level. Revenue increased by 1% year-on-year to HKD 146 million, and the loan return increased by 1.8 percentage points to 10.1%. Cost-to-income ratio improved by 3.7 percentage points, mainly due to our improved operating efficiency. Finance costs increased by 7.7% year-over-year to HKD 51.8 million as a result of elevated interest fees, which is partially offset by a smaller amount of bank facilities we utilized. Moving to our private credit business. We continue to focus on managing existing loan portfolio and remained prudent in deploying new capital. Therefore, gross loan balance reduced by 12% year-over-year to HKD 1 billion. The decrease was also attributable to our strategic shift to deploy capital via MCIP, which is our APAC real estate loan fund. The reallocation is in line with our corporate strategy of developing a leading alternative investment platform. Correspondingly, revenue decreased by 69% year-over-year to HKD 16 million. Net impairment loss increased by [ 21% ] year-over-year to HKD 26 million as we made extra provisions considering the changing mark-to-market value of collaterals in order to reflect the potential impact on the loan repayment. The segment also includes LSS Leasing, our B2B and B2C auto leasing business in Mainland China. Next, I will pass to Brendan to give you an update on our risk management, ESG updates and future plans.

Just an update on risk management. In terms of our continuous risk management efforts in the first half, we have consistently improved our investment policies and risk metric limits in response to market dynamics. We have also enhanced the quality of our risk registers, conducted comprehensive internal control reviews and enhanced our cybersecurity protection by implementing new controls and policies in line with the NIST framework. Going into the second half of 2023, we aim to heighten staff awareness by providing comprehensive training, improve the quality of risk reporting with a particular emphasis on emerging risks and enhanced risk controls through vigilant monitoring of existing measures and adopting new controls as necessary. In the first half of 2023, our ESG initiatives included the following: First, SHK & Co. and Crossroads Foundation officially launched the Trail of World Need project. The project was supported by a HKD 1 million donation made through SHK & Co. Foundation and especially to help people come, care and then change the world for those in need. Second, SHK & Co. came together with its subsidiaries UAF and SHK Credit to support the annual community service of the Serve-a-thon 2023 by volunteering staff to sort recycled plastics with elderly workers. Third, both SHK & Co. and SHK Credit have demonstrated their commitment to environmental sustainability by participating in Earth Hour 2023. Finally, SHK & Co. Sustainalytics ESG rating was improved from 29.2% to 25.2% in the first half of this year after further work on ESG policies and ESG actions as described above. Finally, I will end on the business outlook and future plans. Looking into the second half, we will continue to take a prudent approach to managing risks and a cautious stance towards growing our portfolio. We will also maintain strong liquidity, and position ourselves to capitalize on emerging growth opportunities should we operating environment resuming to a steady recovery trend. In the Financing business, UAF Hong Kong is expected to benefit from economic recovery and the new credit card business. In Mainland China, we will focus on secured lending. We will focus -- we will cautiously grow loan portfolio, maintain prudent risk management and ensure profitability for our mortgage loan segment. In Private Credit, we will continue to manage our existing loan portfolio and cautiously originate new opportunities. In the medium term, our consumer finance business will leverage the new credit card platform to tap into new and distinct customer segments, thereby generating additional revenue stream and driving cross-selling of personal loans and other products and to mitigate the impact of the reduced interest rate cap. In the Investment Management business, we remain prudent in capital deployment and to manage market volatility proactively by actively managing our investment portfolio and hedging. The Investment Management team will further cooperate with the Funds Management division to lead the ongoing corporate transformation into a leading alternative investment platform. For the Funds Management business, our strategic focus involves collaborating with partners to raise third-party capital to drive AUM growth, expand revenue streams through hedge fund distribution, and extend client outreach to high net worth individuals and family offices by actively promoting the Family Office Solutions. We strive to produce strong risk-adjusted return and further create synergies across the 3 business lines, driving the group to become a leading alternative investment platform with a more durable and profitable business mix. Thank you.

Thank you, Brendan and Lindsay. We will now proceed to our Q&A session. [Operator Instructions] Our first question comes from Thomas from Revenue Capital. The question is what differentiates your Family Office Solutions from other solutions currently available in the market? What kind of growth do you expect in AUM? And how will it contribute to the revenue and your bottom line trend?

Thank you, Shirley. I'll take that. In terms of our Family Office Solutions, as I mentioned, we launched that business in the fourth quarter of 2022. There's been strong progress to date and as announced, we're up approximately USD 45 million of AUM at this time. In terms of our differentiation, it's a focus around a range of things. Firstly, it's about a focus on alternatives. It's a focus on collaboration with our very strong internal investment management teams in bringing diversified and bespoke investment opportunities to clients. And thirdly, it's about clients having direct access to these investment management professionals.

[Operator Instructions] Next question comes from Ketan from Evaluate Research. Is the strategic shift from unsecured to secured lending in Mainland China a part of the long-term strategy? Or is it only due to the high interest rate scenario? I believe Ketan's question is about our UAF business in Mainland China. So I will take that and see if you -- if Brendan has anything to add. So like we mentioned in our announcement, we currently, as a response to the local economic and business environment, will shift from unsecured loans to secured lending in Mainland China, as secured lending is -- we have like sufficient collaterals to cover the credit risks and also to ensure the profitability of the loans. So that's the reason we have the shift. And also from the long-term perspective, I would say that we have -- we started business in Mainland China since 2007. And in Hong Kong, we have 30 years' history. So we have experienced different cycles of the economic development. So we have -- we have been nimble. So in the long term, in China, we will just say that we will continue to monitor the economic situation and will react in terms on gain response to different economic data or situation. So if the economic situation improves going forward, we may expand our unsecured loan in the market. So the next question comes from -- our next question is how will the interest rate environment impact to your Investment Management, Fund Management and Financing business in the near term. This question hasn't -- we haven't identified the name of the participant who asked these questions, but we are happy to take it.

So it's basically how interest rate environment affects each business line?

Yes.

Okay. Okay. So maybe I'll take that to begin. So clearly, for the Financing business, we can see from the first half results, it does have an impact. We've seen a substantial increase in HIBOR in the first half of this year. What I would say is that what's been pleasing for us anyway in the first half is how resilient our businesses have been. So we're still maintaining a healthy net interest margin in these businesses and have been able to manage or navigate this increase that we've seen in the first half of the year. In terms of the Investment Management business, for sure, there is some correlation between when interest rates go up and equity valuations going the other way. I think we've seen a lot of that in 2022, and we're seeing a continuation of it in 2023, but at a slower pace or a slower impact. And maybe for Fund Management, I'll let Lindsay.

Yes. No, I think, Brendan, -- from a funds perspective, obviously, the stronger demand by clients or less equity-biased strategy. So we're well positioned with our MCIP private credit fund. So we've seen significant deal flow and activity in that business, and particularly, that's providing stronger and more attractive returns for investors. And in our more diversified Latitude Alpha fund, the ability to diversify further into broader credit and macro strategies is attractive to investors as it is giving them exposure to those strategies, which benefit from higher interest rates.

Thank you, Lindsay. Next question comes from Linda from CMB Wing Lung Bank. She has 2 questions. The first 1 is, may I know the percentage of Mainland China real estate investment. The second 1 is an investment plan in this year or any schedule in exit current PE investment.

Okay. So maybe I'll take the first one. Yes. So if you look at the geographical split of our real estate investment. We don't have exposure to China. We basically, Hong Kong and Europe are our main exposures, so we don't actively get involved in China real estate investment. The second part is whether we have a plan to exit from -- on the PE side. Of course, we're always monitoring and looking when it's the right time to exit investments. And our investment management teams will judge that and act accordingly. That's probably what I would see on this stage.

Thank you, Brendan. Ketan from Evaluate Research has a follow-up question. What are the opportunities that the company is trying to unlock with the launch of the credit card business? And in what ways can it help the core lending business? So it's about our credit card business. And so I will take and Brendan have anything to add. So basically, as we mentioned, we have been in Hong Kong for 30 years. We have a very able presence in the additional or traditional market. And so basically, we are seeing like we have different loan products, both offline and online. In the past 2 years, we have been seeing the increase in our online products or the eCash product growth. So we are trying to facilitate or to make it more convenient for our customers who use cash products. And also with the launch of credit card business, we will be able to tap into a different market segment. We have observed in the first half after the soft launch of this product. So we are seeing that the credit card customers list of profiles different from our existing customers and also the young generation customers, the numbers are increasing. So we -- basically, that's the different market segments and also for the card business will provide a different like revenue streams and will add to our revenue streams. And in terms of the synergies or -- with our core lending business, as we mentioned, we are seeing like -- actually, our e-cash loan product, the customers has been like -- has been increasing and also it will facilitate our customers to use more like online channels to have our services. And also going forward, like after the commercial launch of credit card in the second half of this year, we will be able to cross sell the different loan products with our credit card customers. I hope that answers your question, Ketan. So the next question comes from Roni from Income Partners. Any plans for Investment Management segment to lower exposure in Mainland China assets in public or private equity? Do you have plans to continue repurchasing '24 or '26 bonds in the rest of this year? Any plans for addressing the November 2024 bond maturity?

Okay. Okay. I'll take those questions. Okay. So I think -- in terms of investment, the first question which is around about in public and private investment in China. I think probably the thing to emphasize which we continue to emphasize is that we are long-term investors. So therefore, we are seeking sectoral trends where we look at areas, health care, TMT, et cetera, where we see strong long-term growth. So we will obviously be looking to stay in investments where those sectoral trends still make sense and provide a long-term return to the company. The second question is do we continue to plan to repurchase. Yes, selectively, where we can. We will continue to look to see how we can repurchase where it's appropriate for both 2024 and 2026. And I think the final question is, do we have a plan for the 2024 bond maturity? Yes, we are actively assessing this. We clearly have a lot of cash on the balance sheet, as you can see, but we're also looking to see what direction rates go and how the window will look in 2024.

Thank you, Brendan. Our next question comes from Thomas from Reliant Capital. The question is, how do you expect the funding cost and asset quality to trend going forward. This is a follow-up question from Thomas from Capital. How do you expect the funding cost and the asset quality trend going forward?

Okay. So maybe I'll take this more generally. I mean, like everybody else, we are watching what the Federal Reserve will do in terms of funding costs and what impact that will then have on HIBOR here in Hong Kong. I think if you listen to market commentators, I think it's a little bit split at the moment in terms of some people think we've already reached the peak. Some people think that we're near the peak. We believe that we're coming close to the peak, but we're still vigilant that there could be more increases in the pipeline, and we will plan on that basis. In terms of asset quality, yes, I mean if you look at the impairment ratios that you can see from the first half results, we haven't really seen any deterioration. In fact, we've seen a slight improvement in some areas. But of course, we do remain vigilant that if interest rates go higher than that could have impacts.

Thank you, Brendan. Next question is from Ketan. He has a follow-up question. For Funds Management business, what's in your pipeline and how will you deploy your fund across different strategies in the rest of this year?

Thank you, Shirley, I'll take that question. Obviously, our pipeline for seeded partners remains robust. As I mentioned in my earlier comments, we remain very cautious on deployment. So we'll continue to evaluate and may provide that information to the market. Our focus is very much currently working with our existing partners and our hedge funds that we're doing distribution for in terms of working with them, with gaining AUM for clients. So that's our focus for the rest of the year.

Hopefully, we don't have any further questions. Okay. Thank you, everyone, for joining today's earnings conference. Please feel free to reach out to me or [indiscernible] for any follow-ups. You may disconnect now. Thank you.