Union Bank of the Philippines (UBP) Earnings Call Transcript & Summary

[Presentation] Hello, everyone. Welcome to our analysts' briefing. Today, as part of our great transformation and ongoing efforts to improve the delivery of our briefings, we are going to report the outlook, financial performance for the first half of 2023 and strategy of our publicly listed company, Union Bank, and its subsidiaries. But first, here are the house rules. [Operator Instructions] The briefing will be recorded for documentation purposes. By joining this session, you consent your name, voice, image and chat comments being recorded for use in dissemination. If you do not consent to the foregoing, please do not join the session. Our program will flow as follows. To present our macroeconomic and industry outlook, we will have Mr. Johnson Sia, our bank's Treasurer and Head of Global Markets. To present our financial performance, we will have Mr. Dmi Lozano, our bank's CFO. And finally, to present our strategy updates, we will have Mr. Manoj Varma, our Head of Consumer Banking. At the end of the presentations, we will conduct a poll. To encourage everyone to participate. We will raffle away 2 Hamilton tickets to 1 winner. To be qualified for the raffle, you must answer the poll at the end of our presentations. At the end of the poll, we will conduct a Q&A session. And at the end of the event, when the Zoom platform closes, a pop-up screen will appear, which will allow you to provide feedback regarding the event. And now on to our presentations, beginning with a short video. [Presentation]

And now I will turn you over to Mr. Sia.

Good afternoon, ladies and gentlemen. For this portion of the presentation, I will give our outlook of the interest rate scenario, both in the U.S. and locally for the next [ quarter ]. So let's go to the first slide. We start with the U.S. as the actions of the Fed continues to drive a lot of things these days. So the Fed raised interest rates by 25 basis points last week in a widely anticipated move. The focus of investors have shifted to whether this is already the last hike of the cycle. Fed Chair Powell painted a more balanced picture saying that the Fed could either hold or move in September. While the headline inflation has declined recently, persistently elevated core inflation has given ammunition to the hawks in the central bank to argue for higher rates. Economic conditions have also remained healthy, dissipating fears for a hard landing or a recession. What people are asking really is, is this finally the end of the rate -- of this cycle of rate hikes? So to answer this, let us take a look at what the futures market is telling us. Next slide, please. So the orange line there is what the Fed has actually done this year, and the dotted line show what the market via the futures market is predicting. Now you will recall at the start of the year, that's the gray line, that is what the market was pricing. So therefore, the market has been wrong, right? The market has predicted that the peak would have happened sometime in the middle of the year, and we -- and the Fed would have started to cut rates. If you look at what the Fed governors themselves said at the start of the year, which is the black dots there, they were actually much more hawkish than the market but less hawkish than what actually happened, right, because the actual projection is for still a higher hike -- higher rate. So now what is the market looking at now between now and end of the year? The market is pricing a slight chance of a rate hike. The Fed governors, being conservative as they are, are pricing in perhaps a full -- one more hike, right? But it seems that both the market and the Fed have already agreed that the peak is likely to happen at the end of the year and rate cuts will happen next year. So the next question is now what is the implication to interest rates in the Philippines? Like the Fed, the BSP has risen rates quite aggressively last year. And like U.S. inflation, Philippines CPI has also moderated in the last few months. However, one additional factor that has played a key role in the determination of peso rates has been the U.S. dollar to peso exchange rate or more specifically, the impact of the interest rate differential between the U.S. and the local currency rates. So let us look at the next slide. And you will see that the interest rate differential between U.S. rates and peso rates has a big impact of the FX rate. If you look at -- it's a bit of a busy slide. But if you look at the light blue line at the bottom, that represents the interest rate differential, and the red line at the top of the chart shows the FX rate. You'll notice that when the differential went to a low of 25 basis points last year, that's when the dollar-peso hit an all-time high of PHP 59. That led the BSP to start its own version of rate hikes, and they kind of said that the 100 basis point differential between dollar and peso rates is kind of a comfort level that maintains a -- that is required to maintain a stable peso. So can the BSP afford to have the differential go below 100 basis points? Because with the rate hike last week with -- of the Fed, the differential has now narrowed to 75 basis points. Now we think the answer is yes. So if you go to the next slide -- and this is, again, largely because of the -- it's just because of the FX factor. The U.S. dollar strength has dissipated. The DXY index, which peaked at around 114 last year, has gone down even to below 100 before recovering to 102. The peso, which was -- which [ traded at ] a high of 59 last year, has gone to as low as breaking 54 early this year. Even CNH, which was kind of a laggard given the issues that the Chinese economy has faced, has also kind of strengthened in conjunction with dollar weakness. And the next slide shows that the peso has remained in a comfortable and rather narrow trading range. In fact, if you look at the range -- if you look at peso's performance this year, it is the second strongest currency in the region after the Indonesian rupiah. Therefore, given the relative strength of the peso, we are of the view that the BSP does not necessarily have to match the Fed point by point and can afford to have a narrower interest differential without causing excessive peso weakness. So let us now go to the specific developments in the Philippines. So we have a new central bank governor. And based on his initial comments, there will be significant continuity in the policy, although he does come across to be a bit more hawkish compared to the previous governor. He has all but ruled out the cut this year and signaled the willingness to hike in case inflation continues to persist. Because while headline and core inflation continue to come down, like in the U.S., core inflation continues to be stubbornly high. The new governor's vigilance is a good thing. Cutting prematurely can prove -- can actually bring worse things. And having a central bank that is committed to fighting inflation is much better off for the market in the long run. And finally, we also have the Bureau of Treasury announcing a higher borrowings this month from 25 -- this quarter from PHP 25 billion a month to PHP 30 billion a month. We do note, however, that there are 2 fairly large maturities this quarter. So we read that this increased issuance is a [ cash ] management-driven exercise rather than a fundamental shift on funding strategies. So how has the government bond market reacted to all this? The next slide, please. In our last update last May, we observed that the government yield curve is inverted, as shown by the gray line. And that was because the market was pricing in a rate cut both by the Fed and by the BSP by the end of this year. Now with the hopes of a rate cut dash, the market has corrected a bit, leading to a steeper curve as you can see in the orange line. So if you look at some of the tenors, they are already above the policy rate, although the short end remains lower due to the unique situation that we have [ in DBS ]. Now given the outlook of rate cuts finally happening next year, however, we view the steepening to reverse at some point and invert once again before the rate cuts will finally cause the short end to collapse. Then finally, we look at the liquidity situation. The next slide, please. We know that the BSP delivered on its promise to cut the required reserves, or RRR, down to single digits, to 9.5%, and it did so last June. The actual liquidity feel, however, was considerably less as the cut coincided with the expiration of MSME concessions that was given during COVID. Nevertheless, the system remains very liquid as the chart -- as you can see from the chart. The low end there was pre-pandemic. There was a huge spike in liquidity given the intervention that the central bank did on the government bonds. And even though some of the liquidity has gone, it still continues to be near the highs achieved during the pandemic. And furthermore, we expect further reserve requirement easing by the central bank as our required reserves remain to be on the high side compared to our peers. So in conclusion, given continued moderation in inflation, the weakness in the U.S. dollar as well as favorable liquidity conditions, we expect rates to be steady in the next quarter. And we will see the market price in a more aggressive -- price in more convincingly rate cuts by the end of this year. So that concludes my presentation. I shall now turn over to our CFO, Dmi Lozano, for our financial performance.

Yes. Good afternoon, everyone. Let's jump into the financial performance of Union Bank. For the first 6 months of 2023, Union Bank delivered PHP 6.4 billion net income, which is 6% higher year-on-year. Our profitability this year is largely coming from core recurring revenue as net interest income and fees both jumped significantly. Net interest income increased driven by the expansion of our earning assets as well as better yields resulting from our focus on consumer loans. The higher yields in the consumer sector compensated for the impact of rising funding costs and allowed us to expand our NIMs. Fees and other income more than doubled now that we have over 12 million individual customers for transacting in various channels. In terms of return on equity, we're at 8% now largely because of the onetime integration costs associated with the acquired Citi consumer business. If we normalize for onetime costs, our ROE would be around 11%. Now looking closely at net income -- net interest income, this was up 41% year-on-year because of the expansion of earning assets. As can be seen in the bottom right chart, the earning asset expansion is largely driven by loan growth. We have a diversified consumer lending portfolio plus the acquisition of the Citi consumer business that has helped us deliver significantly higher yields. As a result, our net interest margin expanded by 60 basis points to 5.2%. Funding costs, though, increased by 171 basis points, but the better margins coming from the consumer business more than compensated for the rise in funding costs. As can be seen in the left chart, interest income increased from PHP 20 billion to PHP 36 billion, which is more than enough to cover the almost PHP 9 billion increase in funding costs. This shows that the focus on consumer business will provide us the margin and buffer to generate recurring income and recurring net interest income moving forward regardless of where funding costs are. As you can see in the left chart here, all our loan segments are growing by double digits. I wish to highlight that our consumer business is growing faster than our institutional or wholesale loans, hence, better margins for the bank. Even if you take away the impact of the acquired Citi business, our consumer portfolio still expanded at a robust growth of around 30%. More importantly, we have a very well-diversified consumer loan mix. It's largely divided as 1/3 in cards, 1/3 in mortgages and 1/3 in salary loans. And we have 3 fast-growing products, namely: personal loans from acquired Citi business, digital loans through UnionDigital and motorcycle lending business in City Savings Bank that will challenge these ratios as well moving forward. On the funding side, over the last 3 years during the pandemic, we posted record CASA growth because of the shift of corporates and consumers towards digital. We have been targeting to replicate this in 2023. But because of the rising time deposit interest rates, this has been quite challenging. That's why CASA growth became a challenge not just for Union Bank but also across the whole industry. Despite this, our CASA growth has been in the mid-teens and 16% year-on-year. We also saw improving balances. For example, we are seeing increasing deposit balances from our customers who opened an account purely online during the pandemic, or what we call a digital account-only, or DAO. DAO account balances have increased from 6,800 in 2019 on average to close to 12,000 by June 2023. We expect the trend to continue as we launch more features in our mobile app moving forward and as we continue to increase the proportion of DAO customers. Noninterest income more than doubled year-on-year. We had good trading gains, and we also recognized gains on repossessed assets that were sold. But more importantly, I would like to highlight that the recurring income base, which is fees and other income, more than doubled because of large customer transactions, credit card transactions, digital transactions and other fee income coming from our key subsidiaries. We believe we can sustain this given the rapid increase in our customer base, which has increased to over 12 million customers versus less than 5 million pre-pandemic. As I have mentioned earlier, there are onetime integration costs plus the transition service agreement that we have since we are running on 2 platforms as we complete the migration of the acquired Citi consumer business. These are costs that we expect, at least the majority of which, will no longer be there next year. If we exclude the impact of these onetime expenses amounting to PHP 2.4 billion in the first half of 2023, our cost-to-income ratio would have been less than 60%, and the growth in OpEx would be in line with business volume. Our NPL ratio appears to be higher than industry because of the larger proportion of consumer loans in our portfolio versus that of the industry. And you can see that here in the pie charts on the right. If we isolate the consumer segment, you will see that our consumer NPL ratio and NPL cover are well within the industry's averages. So we'd really like to highlight that our focus on the consumer segment does not necessarily mean taking on significant amount of risk. In fact, if you look at the industry NPL ratio, this has been consistently going down over the last few quarters, and Union Bank's consumer NPL ratio is even below the industry averages. And frankly -- sorry, just to complete that. Basically, if you bring in the right data, the right technology and the right marketing approach, you can manage the risks quite well, which is what we've been seeing with our consumer business. Our capital ratios, moving on to this slide, are well above regulatory limits. In fact, it is trending upwards following the additional PHP 12 billion stock rights offer in the first quarter this year. This means that our retained earnings can support our earnings asset growth, and we do not expect any need for capital in the short term. This ends my report on the first half 2023 financial performance of the bank. But before I move on, just recall that in the previous analysts' briefings, we presented to you our Go for Gold 2025 aspirations, which is to become the largest and most profitable bank by 2025. Our next speaker is Mr. Manoj Varma, who is at the helm of the consumer banking group of Union Bank. He formerly headed the Philippine consumer business of Citi before our historic deal last year. The consumer banking group plays a central role in our Go for Gold objectives. Manoj is here to present to you the progress thus far of the consumer business as well as updates on the integration of the acquired Citi portfolio into Union Bank. Thank you. And on to you, Manoj.

Thank you, Dmi. Good afternoon, ladies and gentlemen. Thank you all for taking the time to join us today. I'm pleased to be sharing with you the key updates on the consumer business integration and the business performance, just to add a little bit more flavor to the numbers that Dmi shared. The Citi portfolio integration is off to a good and, might I say, a promising start. Today actually marks the completion of the first anniversary of legal day 1, the day Union Bank legally acquired Citi consumer portfolio. So a good time to review how the first 12 months have gone. We started the integration from a start point, that was already bigger and higher than what was originally estimated at the time of valuation. Starting with a sizable majority of staff, more than 90% of them of the consumer business team of Citi, including 100% of the senior management team crossed over to Union Bank on August 1 last year. On the customer front too, we saw lower-than-anticipated attrition, resulting in higher-than-expected customer base on legal day 1 itself. As a consequence of which, portfolio balances, which includes loans, deposits, assets under management were all higher than what was originally modeled. Since legal day 1, as you will see on the page, the legacy Citi portfolio has achieved record high drivers and has consistently outperformed internal targets and our annual budget expectations. We have actually accelerated our new account acquisition on credit cards. And as for the TransUnion data, we now contribute 1/3 of all new accounts originated in the market. In other words, 1 out of 3 new card accounts opened in Philippines, in the last few quarters has been a Union Bank credit card. As you can see, all key business drivers are growing nicely and a double-digit year-on-year growth rates perhaps with the exception of the wealth management assets under management, which largely reflect the overall market conditions, which too by the way, has actually improved in the last few weeks as the markets have turned around. Not just business volumes, the portfolio of credit quality too continue to improve with past due loans coming down by over 30 basis points in this last 12-month period from 4.15% to 3.85% on the Citi portfolio. As you would have seen in Dmi's presentation, the combined consumer business is now driving an increasing portion of the overall balances and profitability of the bank. The financial performance continues to outperform our expectations. And like Dmi said, once integration costs are out of the way, and through the upsides that we are seeing on revenues and cost synergies, we expect to deliver even stronger financials in the quarters to come. Amidst the strong business momentum that I shared with you, we have continued to provide our customers the best digital and customer experience. Customer complaints have seen a decline with a 22% decrease compared to the previous year at the same time. On the other hand, the customer Net Promoter Score has improved by 6.5% blended across the different products compared to what they were pre legal day 1. We have also remained focused on our risk and controlled metrics and consequently, our environment and key control metrics remain very robust. As a result of all these, we have garnered recognitions as an integrated team, including multiple awards from Visa as well as the best retail bank recognition in the Philippines 2023 from the Asian Banker. So what's next for us? Clearly, our priority for the rest of the year is to make sure that we complete the platform migration and that remains the #1 priority. I'm happy to share with you that starting July 2023, this year, just the last month, all new customer onboardings have already transitioned over to the Union Bank systems. We have spent a significant amount of time working on UBP core systems to make sure that the products and functionalities are what our customers were accustomed to at Citi, in fact, even more than that. The migration of existing customers to the Union Bank platforms is slated in the coming quarters. The other key priorities or growth priorities remain on leveraging the large greater Aboitiz network for cross-selling and deepening customer relationships with our clients, poaching new partnerships to augment our acquisition strategies for greater efficiency. Applying the learnings from both sides of the house, and there's quite a few of those to make sure that we can open new segments and tap into those. We would like to continue to innovate and digitize to provide the best-in-class products and services to our customers who have now become accustomed to that. In an address to our Citi clients on legal day 1 last year, our President and CEO, Mr. Edwin Bautista, made a commitment to our customers that we will not let them down. He assured them that our customers can continue to expect and enjoy what they're experiencing today and even more. After all of the team's hard work in the last 12 months, I'm pleased to be unveiling to you, the wealth management and credit card brand transformation. The idea here was to harness the strength of both UBP and Citi brands and elevate the experience for our clients with Union Bank being a digital Trailblazer and innovator in the financial solutions space and Citi strength in globality, wealth management and top-notch customer service, we can undoubtedly deliver elevated and best-in-class experiences for our clients. On the wealth management side, Citi Gold, as you see on the page, has been rebranded to Union Bank Elite and Citi priority product has been rebranded to Union Bank Access. The rebranding does not only boost a new and premium aesthetic but also new offerings that our Citi clients can enjoy ranging from real-time account opening, free ATM withdrawals around the world, not only from Citi ATMs but real-time funds transfers and a vaster network of local branches and ATMs that they can access at their convenience. Our credit card products have also gone through a rebranding transformation. Keeping all things that our clients love about their credit card and even more. Our credit card customers will also enjoy upgrades in the current product propositions from introducing our first fully metallic card more airport lounges and frequent flyer programs and being able to pay using their points anywhere across the world. The rebranding is just a new -- is the start of a new and exciting initiatives you can expect from the consumer products team. And we hope you look forward to the market launches we have planned for the coming months. Unbelievable isn't it? But I want you to believe it. In conclusion, the Citi consumer business integration into Union Bank has been progressing well, as is evidenced by the commencement of acquisitions of all new customers already using Union Bank platforms and Union Bank brand beginning July this year. We are continuing the strong business momentum and are determined on beating our records in acquisitions, sales and balances in the first half of the year. For the rest of the year, the team is focused on migrating the Citi legacy portfolio into UBP systems and platforms and are continuing to implement the growth initiatives and synergies we have in our plan. The consumer business is contributing more and more to the overall growth of the bank. And we are excited to continue on this journey and take the consumer bank from being the best to the greatest consumer bank in the coming years. Thank you once again for your time this afternoon, [Foreign Language]

Thank you, Manoj. And thank you, gentlemen. [Operator Instructions] Now on to our Q&A. We have received advanced questions. We will take them up now. If we have time, we will address questions raised live on the platform. So for our first question. Can you provide guidance for provisioning credit costs? Anyone can answer this?

I'll take that. I'll take that, John.

Okay Dmi..

Yes. So this really depends on the proportion of consumer to total loans and also what type of consumer loans drive this, right? But if we retain the mix that we have now, we're generally around 1.5% to 2%.

Thank you. Thanks for that. Our next question, what is the breakdown of the card portfolio between revolvers, transactors and installment?

So the breakup of balances between revolvers, transactors and installments is approximately revolvers represents about 30%, transactors about 20% and installment balances the remaining 50%.

Thank you for that. Next question, may we confirm that ROAE is about 8%. What is the normalized 1Q and 2Q and 1H ROE excluding expenses associated with the Citi acquisition?

Yes. So that's correct. We presented that earlier. It is about 8%. And we also -- without the one-offs, this goes up to close to 11% for the first half.

Thank you for that Dmi. Next question. How much is the OpEx associated with the integration on an annual basis? Can you break this down between the TSA and other incremental expenses?

We expect this to end up the year with about PHP 4 billion to PHP 5 billion or close to PHP 5 billion, and the TSA is roughly about PHP 3 billion of that annualized thankfully.

Next question. What is management's outlook on NIMs moving forward, given that NIMs were flat quarter-on-quarter in quarter 2, 2023. Is it right to the [ juice ] that NIMs have peacked?

I don't think so. I think at worst, we expect this to be flat or even improve. We're seeing yields actually improving and loan yields, especially as we're able to reprice already or some of the loans have started to reprice. But what seems to have peaked, as Johnson mentioned earlier, is funding costs, right? So if the second half shows a 25, 50 basis point reduction in funding costs, and we sustain or grow the loan yields, then we might actually be able to expand the yields further -- the NIM, sorry, the NIMs further.

And the mix will help.

And the mix, yes. So the mix alone should improve the loan yield. So if we can get the mix right, reprice some of the loans that were -- that had been fixed for a while and get the funding costs start trending downwards. I think there's still a lot of improvement potential for the second half.

Thanks for that. Next question. Excluding the acquisition of Citibank's local consumer business, what would have been the organic year-on-year loan growth of Union Bank for the first half of 2023?

The legacy loan business of Union Bank would have grown at around 20% or did grow by about 20%, of which the consumer portion grew at around 30%.

Thanks for that Dims. Next question. If my calculations are correct, Union Digital's incremental loan bookings were at around PHP 1.3 billion per month in quarter 2 2023 around the same or slightly less compared to the monthly bookings in quarter 1, 2023. Are we expecting the pace to accelerate in the second half of 2023? Any specific targets you could share with us as to the loan book target by end 2023 for Union Digital?

Well, Union Digital has been disbursing over PHP 2 billion new loans per month. So maybe the PHP 1.3 billion is an average of the last 10 months. But lately, it's already been over PHP 2 billion. I do note that the tenure though of Union digital loans are usually less than 1 year. So this means that the balance sheet -- for the balance sheet to grow, they need to keep that disbursement level quite high. And it's definitely more than the runoff. So we're not expecting any slowdown. In fact, we talk to Henry and good he is actually pushing the team to grow quite significantly still for the second half. There is sufficient pipeline to continue the momentum subject to the approval of our capital infusion, which probably you guys have read the PHP 900 million additional capital that Union Bank is putting into UD. And part of the reason we are putting that is the expectation that the loan book will continue to grow. We cannot provide any target. But having said that, there are -- we are ahead of the volume targets already, both on the loans and the deposit side. So we expect the second half to continue to be quite strong for Union Digital.

Thank you for that Dmi. Next question. For OpEx, what is the reason for the quarter-on-quarter increases in integration and one-off expenses? This is now at PHP 1.4 billion in quarter 2 2023 from only PHP 1.0 billion in quarter 1, 2023 and PHP 0.7 billion in quarter 4 of 2022.

Yes. So this is really mostly a timing issue. So the higher OpEx in the second quarter is really due to the booking of consultancy fees, IT related fees and other things related to the bills for the Citi integration.

Okay. Thanks for that, Dmi. Now we have our next question. At what NPL coverage would that be comfortable? With every move to bring this up closer to those of other big banks?

We're actually quite comfortable with the ratios that we have, and I mentioned that earlier, right? It's really not an apples-to-apples comparison. We have a lot more consumer loans, which tend to obviously have a higher NPL expectation and also NPL coverage ratio. So -- but we are very comfortable with the risk modeling that we have. We have a very strong ECL model that we use and we work with our auditors as well. So I don't think our numbers will be moving closer to the big banks just because we have such a different loan composition. We have -- as I mentioned, we have a greater proportion of consumer loans to total loans. And you can see the lower coverage ratio is a factor of our consumer loan mix, which consumer loans as an industry, tend to have much lower coverage ratio than the large corporate loans. So if we isolate our consumer portfolio, the coverage ratio is well within the industry average. So we're still quite comfortable where we're at.

Okay. Well, gentlemen, I believe this is our -- this was our last question. Dmi, the questions we received on the chat box were already answered -- and so if any of our guests, and we have a record number of attendees for this specific session of Union Bank. If you think of more questions to ask, please send them to us, and we will get back to you as soon as possible through the Union Bank Investor Relations team.