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

Good afternoon. Welcome to the 2024 First Half Earnings Results Briefing for Union Bank. My name is Jacqui De Jesus and I will be the moderator for today's briefing. Before we began, please allow me to go over the house rules. [Operator Instructions] By joining the session, you consent your name, voice, image and chat comments being recorded for use in dissemination. If you do not consent, you may leave the session. For today's earnings call, we will kick off with Dominic Banal, the bank's Trading Head for global markets, to present our macroeconomic and industry outlook. And then to present our financial performance, we will have Dmi Lozano, our bank's Chief Financial Officer. We will have our Q&A after the presentations. Let us begin the session with a short video. [Presentation]

And now let me turn you over to Dominic.

All right. Good afternoon, everyone. Let's go to the first slide, please. In terms of the short-term interest rate outlook, market is firmly priced in a 25 basis point cut by the BSP in the August 15 Monetary Board meeting. This was articulated well in advance by both BSP Governor, Remolona, and DOF Secretary, Recto. With the Governor now offering up a [ base ] case of 50 basis points cut for the year, which he said was still on the table. So aside from global events, much of the increased dovishness is due to the lower rice tariffs, which would help shift CPI risks to the downside. One slide forward, please. Speaking of CPI, current reading is at 3.7%. On Tuesday, August 6, the July number will come out with expectations of 4% year-on-year and a 0.3% month-on-month number. And that puts us firmly on the upper bound of BSP's 2% to 4% target range. Next, however, with aforementioned the lower rice tariffication, which would be lower tariffs from 35% to 15%, market is expecting to see a significant relief in the CPI number because rice alone has kept CPI at elevated levels. It's important to note that CPI ex rice is just at 1.7%. In addition to that, high month-on-month readings in August and September last year will come off in 3 months' time, adding to BSP's confidence that CPI will be firmly below the 4% upper end of their target. Next slide, please. As a result, bond markets have rallied in the past month 30 to 50 basis points lower. However, that still leaves us around 15 to 20 basis points higher from the start of the year levels. Next slide. So on to FX, the dollar has performed well against regional currencies for the year, and the peso is around middle of the pack against Asian currencies, depreciating by 5% year-to-date. Next slide please. But so far, the 59 figure has provided a significant resistance for dollar-peso and despite the BSP potentially cutting earlier than the Fed. We do expect this 59 peso level to hold. In international news, next slide, Fed Chair, Jerome Powell, commented that they could cut the rate as soon as the September meeting. And this is in stark contrast to Fed speakers talking down cutting chances at the start of the year. So this time around, there seems to be consensus by both the Fed and the market on a cut in September. Next, slide please. In terms of what rest of the year will look like, markets are currently pricing in 3 cuts for 2024. With the Fed not talking down these chances, we feel that their general view does not deviate materially from the market implied scenario. And last slide please. So as a result, bond markets have rallied as well with yields lower by 25 to 45 basis points in a bull steepening move. This brings us to around 10 to 30 basis points from start of the year levels. For context, we started the year levels as much as 7 cuts were priced in, so -- which in hindsight, was already optimistic. So that's it for the macroeconomic outlook. I now turn it over to our CFO, Mr. Dmi Lozano for the financials.

Good afternoon, everyone. Starting off with a quick snapshot of some of our key drivers. We continue to gain traction in growing our retail business and recurring revenues. Our customer base has increased by 2 million year-on-year, bringing the total now to 15 million customers. Our margins have improved by 55 basis points, which is 150 basis points above the industry average. Majority of our revenues now comes from recurring income. This demonstrates our successful shift towards an accrual-based business, business model driven by our retail banking operations. As a result, our net revenues to assets ratio continues to rise, fueled by our consumer business. Looking at our first half net income, which is PHP 5.1 billion. The banking group's net income is lower year-on-year with Union Bank delivering PHP 5.1 billion in net income and a single-digit ROE of 6% in the first half of 2024. The parent bank and its subsidiaries grew by PHP 1 billion year-on-year, but the decrease in net income is primarily due because of losses incurred by UnionDigital. The decline in the performance of UnionDigital was affected by credit deterioration in the 2023 [ loan ] vintages. Please note that as early as fourth quarter 2023, when these issues were identified, the bank immediately paused lending experiments. And the portfolio did not grow from the fourth quarter of 2023 up to the first quarter of 2024. Since then, we have been addressing these issues. In addition to the discontinuance of high-risk lending experiments, we have worked on improving our credit collection efforts through multiple auto debit arrangements, revisions of terms and conditions and the expansion of our collection agents. Simultaneously, we revisited our credit strategy and are now focusing on lower risk, shorter-term, smaller ticket payroll [ loans ]. Overall, these credit issues are now contained and we expect UnionDigital to narrow the profitability gap in the second half of 2024. While annualized net income translates to 6% ROE in the first half, please note that we expect this to improve towards the end of the year. And the improvement will be coming from the following: Higher recurring income from our retail business, improved portfolio performance of UnionDigital and continued reduction in expenses, particularly in IT, since we have completed the migration of Citi consumer portfolio end of March this year. Our net interest income continues to reach record highs, with the bank recording a net interest margin of 5.7%. As mentioned earlier, our net interest margin continues upward and an upward trend due to the bank's higher proportion of consumer loans to total loans. Consumer loans typically have higher yields. Therefore, we are able to offset the higher cost of funds brought by the impact of the policy rates over the last couple of years. Earning assets on a day -- average daily balance grew by 6% year-on-year. But please note that the growth is largely coming from higher-yielding consumer business, which I will discuss in the succeeding slide. You will see here that our gross loans and an outstanding balance are relatively flat year-on-year. Having said that, if you look into the right part of the slide, you can see that we manage the growth of our institutional lending portfolio. We've allocated most of our capital to the growth of the consumer business, particularly credit cards and CitySavings net debt loans. Both of them are higher yielding and among the better performing loans in our portfolio. As a result, our loan mix in terms of consumer loans to total loans is now at 59% or probably close to 3x the industry average. In terms of funding, the bank's low-cost deposits grew by 4% year-on-year, which is in line with industry growth. The growth in CASA deposits are attributable to 2 things. Corporate volumes have grown, coming from our cash management business, and we now have close to 5 million active users of our online banking app. Our total deposits have declined year-on-year, and this is partly due to the growth in CASA, but also because we have shifted some of our funding from high-cost deposits towards alternative solutions, such as interbank borrowings [ reports ] and currency swaps. This initiative by our treasury team is aimed at managing the impact of our rising cost of funds. Next slide, please. On to the noninterest income. Our noninterest income has declined year-on-year at the group level, primarily due to the lower trading income, fees and other recurring income, which has also declined by 2%. However, if you look at the right side of the chart, you'll see that the decline in fees is largely attributable to UnionDigital. As mentioned earlier, we have paused and reduced the lending portfolio from the fourth quarter of last year to the first quarter of this year, which impacted their fee income. The parent bank's fee income, however, continues to rise, increasing by close to PHP 1 billion year-on-year. This growth is primarily driven by expanding customer base, which, as I mentioned earlier, has grown to 15 million users this year. On the OpEx side, operating expenses have declined by 2% year-on-year from PHP 21.8 billion to PHP 21.6 billion. Notably, our one-off business expenses related to the integration of the acquired Citi consumer business have decreased by 45%. Recall that in the first quarter analyst briefing, we mentioned we successfully completed the integration at the end of March. As a result, we have been saving approximately PHP 300 million per month since April. The reduction in integration costs was partially offset by the growth in volume-related expenses, which increased also by the PHP 1 billion year-on-year. This increase is attributable to customer acquisition efforts that will support future earnings and includes intermediation costs related to business growth. On the right-hand side of the slide, you can see that our cost-to-income ratio continues to trend downward. This improvement is due to our high top line revenues and the reduction in operating expenses. In fact, if you normalize for the impact of our integration costs, our cost-to-income ratio would have been 54%. We remain optimistic that this will improve next year as we will have the full year benefit of our exit from the TSA, the Transition Service Agreement. As mentioned earlier, we hade to recognize additional credit reserves for UnionDigital, resulting in an annual credit cost increase of 77 basis points. This growth is entirely attributable to UnionDigital. However, we do not expect this elevated credit cost to persist throughout the year, as we've already recognized close to 70% of this credit reserves for UnionDigital 2023 vintages. Furthermore, the portfolio performance of UnionDigital is expected to improve in the second half 2024, given the improvements we've made in our credit models. For the parent bank and other subsidiaries, our credit cost is relatively flat. We anticipate some growth in credit costs due to our focus on the consumer space, particularly the unsecured credit card business. Additionally, we reported in our first quarter '24 analysts briefing that we had to book onetime charge for a legacy account in the first quarter, this year. On to the next slide. Our NPL ratio is trending upwards with our focus on the consumer segment, particularly the underserved market through UnionDigital. If we isolate the parent bank, our NPL ratio is on par with the industry and our coverage ratio is higher than the industry average for the consumer sector. In fact, our credit card business is fully provisioned with a coverage ratio above 100%. Our capital ratios as of June 2024 improved significantly versus the prior period. This was brought about by the PHP 10 billion SRO, which we concluded last May. Our CET1 is higher than industry average and obviously above regulatory minimums. In summary, I would like you to note the following takeaways and outlook. We continue to record strong top line revenues, now primarily driven by recurring income. Our NIMs are up by 55 basis points. Parent customer transactions are driving fee income, and our customer base continues to grow on a regular basis. As a result, we expect to maintain our new-to-bank customer acquisition rate, which will be an incremental source of revenue in the coming years. Based on our experience, new-to-bank clients take about 1 to 2 years to generate their full potential for revenue, particularly on the lending side. Therefore, the customers we have acquired over the last few years will continue to contribute to the profits -- in growing profits in the succeeding years. Our operating expenses have stabilized and are now trending downwards, following the completion of the Citi consumer integration. However, we will continue to invest in growing our customer base. This means that volume-related expenses will continue to increase and the growth in our top line revenues will exceed the growth in operating expenses moving forward. While net income is down year or near, the performance of the parent bank is strong and exceeding expectations. The decline in profitability at UD is now contained. We continue to book the appropriate required reserves, enhance our collection efforts and focus on improving the portfolio's performance. As a result, we expect the second half to show improvements compared to the first half year. And lastly, we concluded SRO last May, which has helped us significantly with our capital ratios. And now our capital ratios are above industry trends, and we have the capital to fund the future growth that we are looking forward to. Thank you.

Before we move on to Q&A, we would like to request our audience to complete a poll that will pop out of your screens right now. [Voting]

Okay. Thank you for answering. So for our Q&A session today, we will be joined by Dominic, Dmi, as well as Johnson Sia, Union Bank's Treasurer and Head of Global Markets; and Carlo Enanosa, Union Bank's Investor Relations head.

So we will start off with the questions we received in advance. [Operator Instructions] Okay. So the first question is -- was sent in by CLSA. The question is really about financial performance, and I would like to address this to Dmi. What is the outlook for Union Bank in the second half of 2024 in terms of earnings? Is the second quarter of 2024 earnings a new run rate moving forward?

Thank you. [ So that's ] another policy, as you guys know this, we don't provide forward-looking financial targets. But however, clearly, for us, we anticipate 2024 -- second half of 2024 to be better. The drivers of performance will be better. And definitely, we don't think the first half is the new run rate because several things, we expect UD's performance to improve in the second half, while revenues will continue to grow for the parent bank. We also expect that -- not expect, we know that our cost because of our operating costs and IT expenses will be going down because of the completion of the Citi integration as well. There can be other upsides, especially with the growing customer base. However, our treasury earlier reported that interest rates are expected to go down. So that also should be a positive for us as well. You all know that we have a large consumer portfolio. And the yield of the consumer portfolio, many of them are fixed or capped. But as the rates start to go down, then the funding costs will mostly decline. Hence, margins can further improve in the near future, and we think this will be quite significant for us, especially in 2025.

The next set of questions is mainly on Union Bank's outlook. Maybe I will address this first outlook question to Dmi as well. What is the outlook for loan growth and deposit growth? What is the CASA ratio now of Union Bank?

On the loan growth, we still anticipate probably on the high single-digit growth as we are still managing our institutional loans. On the other hand, on the opposite end of the spectrum, we expect consumer loans to continue to grow in the mid- to high teens. On the CASA ratio, we stand at 64% today. We anticipate deposit growth to align with industry trends. We have earlier reported our loans and deposit growth as well as the CASA ratio. The expectation's that we can sustain this loan momentum moving forward, particularly on the consumer front. We also expect to grow our institutional business coming from the SRO. We have ample capital to support this growth in our balance sheet. So we believe we're quite well positioned moving forward.

That was very clear. The next question I would like to address to Johnson. What is the outlook for NIM, credit cost and OpEx for Union Bank?

Yes. Maybe I'll take the question on NIM and Carlo can address the issues on credit cost and OpEx. For NIM, we cannot provide specific numbers. From a risk profile, we will benefit when interest rates go down. The models show that we will -- our accrual income should go up by around PHP 1.3 billion a year for every 100 basis point drop in the interest rates. And unless something really goes wrong, we know that rates will go down starting as early as this month. So again, there are many moving parts based on the model. And if [ parallel ] shift happens when the authorities start cutting the rates, that is the sensitivity that we are looking.

On the drivers of credit cost moving forward, I think Dmi reported that UnionDigital, more or less recognized close to 70% the required provision of their legacy accounts. This means that, of course, we cannot use the same annualized credit cost that was presented earlier. There should be some significant improvement. More importantly, if all the collection efforts materialize, so I think credit costs would likely decline. Operating expense, we all know that we exited from the TSA, or the transitional service agreement, for the Citi integration at the end of the first quarter. And our expectations are around PHP 300 million to PHP 350 million of IT savings per month, and we've seen that in the second quarter. So the second half should also be better in terms of OpEx.

So while I have you here, the next question I'd like to address to you. How many branches do you have now? And what is the outlook?

The parent bank has 197 branches as of the end of July. In the last couple of years, this has remained stable and this even declined, I think our high was little over 200. We expect the branch count to remain within this level, at least in the near future. But on a consolidated level, we are at 394. And the difference is really coming from our subsidiaries, particularly CitySavings because they have presence where the regional offices and schools are.

The next question is also on operations, mainly. How many clients do you have now? And what is the percentage enrolled on your digital platform?

Dmi reported earlier that our customers have grown from 13.2 million to 15.2 million year-on-year. So that's a 2 million growth over the period of a year. Out of the 15.2 million, close to 6 million or a little over 5.5 million of those clients are enrolled in the Union Bank [ account ]. And approximately 80% of those enrolled in the Union Bank have -- are actively using it . So that's the one driving the transaction volumes.

Okay. And then the next question, maybe I'll address it to Dmi. When will recarding of credit cards be done?

That's a good question. It's within -- it's ongoing right now. These are the Citi cards being recarded to Union Bank buyers. And we are trying to get most of them done by end of September. But even if there's a delay, this should all be completed before end of the year.

The next question, I would like to address to Carlo again. Could you talk about any new initiatives that the bank has done in the last year?

Well, for this year, the main focus is really to complete the integration of the acquired Citi consumer business. And we also have to complete the recarding of the former customers and the new Union Bank customers that move to us. In terms of long-term strategic initiatives, it will remain to be the same. It will revolve around our retail bank aspirations. Therefore, all of our investments, at least in the near term, should translate into growth in our NPL customer, growth in recurring income and as well as improvement in costs.

So the next few questions will be on UnionDigital, UD. On UnionDigital, how will the change in CEO affect the strategy of the digital bank going forward? Maybe Dmi can take this question.

I don't expect any major change in strategy, because for one, we are already looking at pivoting and looking at more -- in more care on the credit side as well as on the collection side since the beginning of the year or even late last year. And Henry was a part of all of these discussions and strategizing. So we were already working on this thing before Henry left, and that will continue to be the focus of the new management team.

Still on UnionDigital, are there any updates on the experimental shift in loan book strategy? Have the past due accounts been successfully recovered? If they have, what kind of strategies have proven effective? Maybe Carlo can take this one.

We have mentioned earlier that we have improved in the credit underwriting side. We have shifted our focus on short-term tenders, smaller ticket, lower risk decile segment in the payroll segment. And this is still largely in the underserved mass market sector, although in the lower risk decile. We also applied stricter rules in our credit scoring, which looks into attrition, historical credit in accounts, month on books, among other things. We have seen a significant amount of reduction in delinquency rate upon implementation of these new rules. On the collection side, we're working on the recovery of legacy accounts. We prefer not to disclose the specific strategies that we have implemented. But I think one of the more successful ones would be the automation and enhancement of settlement processes that are largely event driven. So it's mostly in the IT operations.

So the next 2 questions are mainly on provisioning. What is the status of the corporate accounts acquired -- that required spillover provisioning in the first quarter? What is the current coverage levels? Maybe Dmi can take this.

Okay. Yes. Let me just look at some of the numbers here. So we are booking required reserves for corporate accounts based on what we know today. If further deterioration happens, and we will recognize the required provisions. So we have a very robust ECL modeling, done by our risk team, and we follow that strictly. However, we do not expect any more material wholesale provisions required within the year. So the bulk of the first quarter -- first half, as I mentioned, a big chunk of that came from UnionDigital.

And then I guess, a related question to that one, do you have updated guidance on provisioning or credit costs for Union Bank on a consolidated basis?

On a consol basis, expected to go down. So portfolio performance of UD is expected to improve already in the second half of 2024. As we mentioned earlier, the bulk of our provisions in the first half came from the 2023 loan vintages, which have already been contained, and a credit group that we're targeting has already been much lower risk for the year 2024. So we expect that to improve significantly in the second half.

Thank you so much. We have questions from the Q&A box. The first one, I'll read out is from Maybank, [indiscernible]. What is the outlook in terms of NPL? Would it accelerate, given our consumer loan growth outlook, which seems to remain high to -- mid- to high teens? Also, the recent SRO, can we say that we are not looking to raise capital in the next 12 months?

[indiscernible] can jump in as well. So on the SRO, no, there is no expectation as we showed that CET1 is actually quite healthy, and we expect to end the year with still very strong CET1 and other capital ratios. So no SROs in the works or additional capital raising. On the NPL or reserves for the second half of the year, as I mentioned, the bulk of the reserves in the first half of the year were 2 things that we had one particular account that we booked in the first month of [ the year ] -- the first quarter of the year, which we don't -- which will not be recurring, and we also book quite a bit of reserves for Union, all of it in reference to their loans in 2023. So that's already because of the paused lending beginning in the fourth quarter or late last year and early this year, means that we won't be seeing the same volume for -- of provisions for UD as well in the second half. So definitely, between -- those 2 areas will show improvement in the second [ half ].

I see that [ Joanna Soriano ] has raised her hand. Joanna, go ahead.

Hello, sorry that I was muted. But just on UnionDigital, what is the profile of the UD accounts that turned into NPLs? And in the second quarter, what was the stand-alone NPL ratio and coverage of UnionDigital? Based on the last BSP disclosure, it was around 43% in the first quarter.

We can't provide the exact details yet. We have to wait for the official disclosure of the NPL ratio. Having said it, [ Joanna ], we don't see it to be far from the first quarter disclosure because it's the same [ when ] we paused lending operations in the fourth quarter up to the first quarter. And when we started lending in the second quarter, the focus is on the shorter tenure, lower risk [ assets ]. So it would most likely be remaining within the same [ pattern ].

Sorry, just to confirm, you de-started lending operations or restarted lending operations in the second quarter?

Yes, late March in the second quarter.

Okay. And separately, on the use of cross-currency swaps, [ may we ] request for the normalized net interest margins and the comparable figure in a year-on-year and Q-on-Q basis?

Sorry, [ Joanna ], can you repeat that?

Normalized NIM, if you were to impute the FX charges associated with the cross-currency swaps?

Yes. We think that the alternative funding will probably account for around [ 20 ] basis points improvement in the funding costs. But we don't expect that to be a one-off. It's not going to be like -- it's not going to disappear right away. I mean, both of them.

Understood. Lastly, may we also get an update in terms of the average yield and duration of the book? I think based on the first quarter, it was around 4.7 years -- sorry, 5.7 years and 4.4% average yield.

You're talking about the investment portfolio, right?

Yes.

No, we haven't really made changes in that. So it should largely be the same.

There is another question from the Q&A box from [ BPI's Jamie Olivia ] [indiscernible]. Of the 2 million new clients, how much were onboarded onto the app?

We don't have the data with us today with -- we can get back to you on this. But offhand, just to give you some ratio, we have 15 million customers, 5.5 million or around 5.75 million are onboarded into the app. So that's the ratio. So I'm guessing that the 2 million new clients would more or less follow that kind of [ takeup ].

Okay. That is clear. I no longer see any questions on the Q&A box. I also don't see any raised hands on that and this list. [Operator Instructions] Okay. I don't see any more questions coming in. So maybe we can wrap up already. So thank you -- sorry. Okay, sorry, there's one more in the Q&A box. So to read out loud high, just curious as to what the parent bank's plans for corporate loans are going forward?

Let me try to answer that, right? So one of the things that we've been doing is really looking at a 360 view of the customer base, right, on the corporate side. So we want to make sure that the corporates that we're providing -- the institutions that we're providing loans to are also working with us when it comes to CMS, deposits, et cetera. So our goal is to continue to strengthen the 360 relationship and look for the customers where we will be able to get the best -- I guess, we provide them the best service, especially on the CMS side, but also the best overall relationship when it comes to other products, services, deposits, et cetera. So we will be growing that again with the additional the funds that we raised in the SRO that will give us a bit more ammunition on that side. But again, the bulk of our focus really, overall, has been to grow the consumer. So we are more cautious on the institutional side and again, focusing on the 360 view, the customer profitability.

Thank you so much, Dmi. So one last call, Okay. So I think with that, we can wrap up Q&A. Thank you, Dmi, Johnson, Dominic and Carlo. Before we close this meeting, a survey form will pop out of your screens again for you to type any additional feedback. For the benefit of those who missed the earnings call or would like to rewatch the event, we will upload a recording of this call on the website. On behalf of Dmi, Dominic, Johnson, Carlo, and the entire presentation development team, we would like to thank everybody for joining us. See you all again for the third quarter briefing in November. Good afternoon.

Thank you.