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

Good afternoon. Welcome to the Union Bank earnings results briefing for the first 9 months of 2024. My name is Jacqui De Jesus and I will be the moderator for today's call. Before we begin, please allow me to go over the house rules. [Operator Instructions] Lastly, this briefing will be recorded. By joining this session, you consent to your name, voice, image and chat comments being recorded for use and the dissemination. For today's earnings call, we will kick off with Dominic Banal, our Trading Head for Global Markets to present our macroeconomic and industry outlook. He will be followed by Union Bank CFO, Dmi Lozano, to present the bank's financial performance. And now let me turn it over to Dominic.

Let's go to the first slide please. So the monetary policy cycle has officially turned both here and in the U.S. BSP got the ball rolling with a 25 basis point cut in August 15 and another 25 basis point cut in the October 16 meeting. In the meeting they announced 250 basis point reserve requirement ratio cut as well. Although BSP Governor Ramona's comments seemingly aim to caution the market from pricing in too many cuts going forward, saying that the base case is just a 25 basis point cut in their December '19 meeting. This all positively impacted local markets. In addition to this, the BTR fourth quarter borrowing schedule was seen by market players as relatively light compared to previous quarters. One slide forward, please? A lot of impetus to cut was from increasingly favorable inflation readings. CPI has broken through the bottom end of the BSP's target range of 2% to 4%, although this may be a temporary break lower due to base effects. BSP also recently warned that inpatient risks in 2025 and 2026 have shifted to the upside. The next slide, please. For the quarter, the peso yield curve saw a significant rally. Aside from the factors mentioned earlier, global bonds also rallied in September after the second quarter bond market drop. Given the latest BSP comments, we expect one more cut for 2024 and 3 cuts for 2025. Next slide, please. So the dollar was much stronger against emerging market Asia in the last month and peso is in the bottom quartile of Asian FX on a year-to-date basis. Dollar experienced significant strength in October despite also cutting rates, mostly due to a reversal of overly aggressive rate cut expectations. Next slide. Dollar peso currently at PHP 58.22. We do expect the peso to hover at around these levels as we near the U.S. elections. Short-term range that we're seeing is a firm resistance at the PHP 59 level as well as some support at around the PHP 57.50 level. Next slide, please. So on the dollar side, which seems to be driving the bulk of global interest rate expectations, the Fed came out firing with a 50 basis point cut in their September 19 meeting. They are still expected to cut in the 2 upcoming meetings despite recent economic data coming in a lot stronger than expected. Next slide. As it stands, market is pricing in 1.6 more cuts for 2024 and 3 more cuts in 2025. And this line up roughly flat to 25 basis points higher against the most recent [Fed dot plot]. Next slide. Bond markets have erased the September rally, and we're now back to July levels. We do see some value at these levels, but with the elections coming up, we also -- with the U.S. elections coming up, we also expect significant volatility in the coming days across all asset classes. Next slide. So after the sell-off in the long end and the cuts in the front end, the U.S. treasury curve is significantly less inverted than what we saw earlier in the year. And with emerging market spreads stuffed in, there's a yield pickup in the emerging market credit space against overnight rates. And last slide, please. So now we wait for the U.S. elections, which will be tomorrow U.S. time. While the race seems neck and neck according to the recent polls, betting markets have Trump as a slight favorite. We expect that regardless of the outcome, the Fed will still cut 2 times this year. Bond markets may sell off around 20 to 40 basis points in the -- until year-end in a Trump win scenario and rally by 10 to 30 basis points in a Harris win scenario. That's it. And now I turn it over to [indiscernible].

Okay. Good afternoon. We can begin. We continue to gain traction in growing our retail business and recurring revenues, as you can see in the slide above. Our customer base has increased by 2 million year-on-year, bringing the total to more than 15 million customers. This includes close to 500,000 new credit card clients this year and our growing digital customers of 5.6 million from just 4.7 million last year. On a quarter-on-quarter basis, our net revenues have demonstrated consistent improvement. This is supported by above industry net interest margins, which is also up by 58 basis points versus last year. Additionally, our ability to contribute -- our ability to generate fees from our expanding client base has also contributed to this growth, resulting in a net revenue to assets ratio of 6.5%. This is fueled by increasing transactions from credit cards, InstaPay, bills payment and other transaction banking services. Majority of our net revenues comes from recurring income, while our trading income continues to improve as macroeconomic backdrop becomes more favorable. Union Bank delivered net income of PHP 8.6 billion for the first 9 months of 2024. In the third quarter of 2024 alone, net income was at PHP 3.5 billion, an increase of 76% versus third quarter of last year and 15% up versus the previous quarter. The parent bank continues to exceed expectations and serves as the main driver of net income, delivering a net income of PHP 10.5 billion, up 45% versus last year. The increase in consolidated net income is primarily due to losses incurred by Union Digital. And on a positive note, we see continuous improvement in Union Digital with its third quarter losses now down to PHP 300 million from PHP 900 million in the first quarter of 2024. We've addressed the credit and operational challenges that have been plaguing them earlier this year. Union Digital is now focusing on lower risk segments by offering shorter tenors and lower ticket size loans. Our ROE improved to 6.1%, and we anticipate further improvement moving forward. Netting out the TSA and other one-off credit provisions, our ROE would have been better at around 7.4%. Our net interest income continues to reach record highs with the bank recording a net interest margin of 5.9%. As mentioned earlier, our net interest margin continues an upward trend due to the bank's higher proportion of consumer loans to total loans. This will be beneficial for the bank moving forward as interest rate environment becomes more favorable. Our earning assets grew by 3% year-on-year. However, if we further dissect our earning assets, you can see that the higher-yielding consumer portfolio has significantly increased, and I will discuss this further in the succeeding slides. Our gross loans are relatively flat year-on-year as we deliberately managed the growth of our institutional lending business and allocated most of our capital to the higher-yielding consumer business. Our consumer portfolio grew by 8% year-on-year. This is mainly driven by the growth of our credit cards, which are up by 21% year-on-year and CSB or Citi Savings, which is up by 9% year-on-year. On Union Digital, we see a significant decline due to the pause in our lending activity since the latter part of 2023 as we address the credit and operational challenges we encountered in the business. Moving forward, Union Digital will focus on shorter tenor, lower ticket sizes and the lower risk decile segment. With this, we see lower loan disbursements upon resumption of operations, and we should expect a softer growth projection on this business segment moving forward, but with improving profitability. As a result, our loan mix in terms of consumer loans to total loans is now at 60% or close to 3x the industry average. The bank's low-cost deposits are growing in line with the industry at 4% year-on-year. Our total deposits have declined year-on-year though this is partly due to the growth in CASA -- sorry, this is partly due to the growth in CASA, but also because we have shifted some of our funding from higher cost deposits towards alternative sources such as interbank borrowings, repos and currency swaps. The group's strategic decision to fund the assets through alternative sources has introduced -- has reduced our dependence on high-cost deposits. Next slide, please. Our noninterest income has declined year-on-year, and this is attributable to the lower fees of our subsidiaries. Looking at the right side of the chart, you'll see that the decline in fees is largely attributable to Union Digital. As mentioned earlier, they are now targeting a low-risk segment by offering shorter tenors and lower ticket sizes. As a result of this, this also lowers the loan portfolio impacting the fee income. The parent bank's fee income continues to go up, though, increasing by close to PHP 1.1 billion year-on-year. This growth is primarily driven by expanding customer base and which has grown from PHP 13 million to PHP 15 million this year. Next slide, please. Operating expenses have declined by 2% year-on-year from PHP 33.5 billion to PHP 33 billion. Notably, our one-off expenses related to the integration of the acquired Citi business have decreased by 63%. Recall that in the first quarter analyst briefing, we mentioned that we successfully completed the integration in March. As a result, we have been saving approximately PHP 300 million per month since April. The increase in our OpEx is due to our continued investment in customer acquisition, service delivery and client engagement that will support future earnings. Overall, our cost-to-income ratio has improved to 57% versus 63% in the same period last year. If we normalize for the one-off expenses, cost to income would have been closer to 55%. We remain optimistic that in the coming years, we can achieve the 50% mark that we have set for ourselves. As mentioned in previous analyst briefings, the increase in credit cost has been mainly attributable to Union Digital. This resulted in an annualized credit cost increase of 73 basis points. We also mentioned that we do not expect this elevated credit cost to persist throughout the year as we have already recognized most of the required credit reserves in the first half of the year. Overall, the credit and operational issues in Union Digital have been contained, and we expect this to improve moving forward. For the parent bank and other subsidiaries, our credit costs are relatively flat. We anticipate some growth in credit costs due to our focus on the consumer space, particularly in the unsecured credit card business. Additionally, we reported in our first quarter 2024 analyst briefing that we had to book a onetime charge for a legacy account in the first quarter this year. Next slide, please. Our NPL ratio is trending upwards as we focus on the consumer space, as I mentioned earlier. If we isolate the parent bank, its NPL ratio is on par with the industry and our coverage ratio is higher than the industry average. In fact, our credit cards personal loan business is fully provisioned with an average coverage ratio of above 100%. Next slide, please. Our capital ratios as of September 2024 have improved significantly versus the prior period. This is brought about by the PHP 10 billion SRO, which we concluded last May, and we have sufficient capital to fund the growth that we expect in the future. In summary, I would like you to note the following takeaways and outlook. We continue to record strong top line revenues, mainly driven by solid performance from the parent bank. Our NIMs are now at 5.9%. Parent customer transactions are driving fee income higher and our customer base continues to grow. Our balance sheet is well positioned for a low interest rate environment. This will enable us to maintain our higher yields, while funding sources are expected to decline, resulting in NIM expansion. Our OpEx has stabilized and is now trending downward coming from the completion of the integration of Citi. However, we will continue to invest in business growth and customer acquisition. This means volume-related expenses will continue to increase and the growth in our top line revenues will exceed the growth in our operating expenses moving forward. Yes, I think that's -- we can move on to the Q&A now.

Thank you so much, Dmi. To our audiences, we would like to apologize for the technical difficulties earlier. We will make sure to upload our full presentation materials on the website after this call. So before we move on to our Q&A, we would like to request our audience to complete a poll that will pop out on your screen right now. [Voting]

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

We will start off with the questions we received in advance. [Operator Instructions] So our first question today is on the net interest income margin. The question is, how sensitive is Union Bank's net interest income margin to every 100 basis point reduction in reserve requirement ratio and to every 25 basis point reduction in policy rates?

Okay. Perhaps I can take that. So for the reserve ratio cut, we project that based on our liability profile, a 100 basis point cut will free up around PHP 5 billion from -- of liquidity. So assuming a policy rate of around averaging 5.5% next year, we expect to benefit -- we expect pretax benefit of anywhere between PHP 275 million to PHP 300 million per annum. As to the rate cuts, given the earnings and risk profile of the bank, we expect also another PHP 300 million for every 25 basis points straight cut.

The next question is on transfer fees. How does zero transfer fees affect Union Bank's P&L?

Maybe I can take this. Well, the bank is generating close to PHP 50 million a month in fund transfer fees. So that would be the impact.

Thank you, Carlo. The next 2 questions would be on Union Digital. The first question is, could you provide an update on Union Digital? What is Union Digital's loan growth, deposit growth, net interest margin and asset quality as of September 2024?

So loan volumes expected to go down, have already been going down as we've adjusted the type of loans and markets that we have been targeting. Union Digital has revised its strategy to slowly build its loan portfolio by focusing on these lower-risk deciles. We have also been using shorter tenors. So now it's 1 to 3 months versus the longer tenors that we were looking at previously and also lower ticket sizes. So as a result, monthly loan disbursements have naturally been going down. We expect that the full year balance in 2024 will be closer to PHP 5 billion by the end of the year. This may go down further in 2025. Deposit levels will be in line with loan growth. We will not be aggressively growing higher cost of deposit or the high-cost deposits without an equivalent earning asset as well. Net interest margins will still be higher since loans are still in the unsecured personal loan segment. Asset quality should improve and has been improving since earlier this year as we -- especially over time as we write off the 2023 legacy loans and grow the lower decile segments that we've been working on since the middle of this year. Offhand NPL should be in the mid-teens. That's the target that we have set.

Thank you so much. Next question on Union Digital would be, what is the bank's guidance on Union Digital? When Union Digital will turn a profit? And what is Union Bank's and Union Digital's target NPL in 2024 and in 2025?

Well, our target right now is we should be reaching breakeven probably by end of next year or early 2026. So we're taking things slowly. We don't want to grow the portfolio too quickly, but we also need the scale to achieve this -- the breakeven profitability. So as we scale up conservatively, ensure that we hit the right targets, we should start achieving the profitability. So right now, we're looking at end of 2025, early '26.

That's very clear. The next question is on asset quality -- sorry, and credit costs. What is Union Bank's outlook on asset quality? And could you provide credit cost guidance?

As mentioned in the presentation, our asset quality was affected by the NPLs -- on a group basis was affected by the NPLs coming from the 2023 loans of Union Digital. We've already changed the credit strategy on Union Digital, and they are now focusing on these lower segments, the lower risk segments that we've been discussing. So we do expect NPLs should be going down in the succeeding quarters. Having said this, our loans are still largely coming from consumer. We're now at around 60% and probably higher levels in 2025, in which credit cards and personal loans will comprise the large portion, the proportion of this -- of these loans. So as such, NPLs will be higher in general versus the peer banks. But again, because of UD's loans being under control or NPLs under control, we should be able to see some improvements already by next year. We've already provided the credit -- provided for the credit losses of Union Digital. So we will not see this recurring in 2025. And the trend will be downwards and start to stabilize as we close -- as we stabilize closer to our credit card cost today, which is excluding the impact of UD, which is around 2.6% to 2.7%.

Thank you so much. I see 2 questions on the Q&A box, both actually relating to credit card loans. So the question is, what is Union Bank's NPL ratio for credit card loans for the latest period? And what is your outlook for its trend in the coming periods?

The NPL ratio for credit cards is very, very low because we really have a write-off policy. I think it's averaging around 5%, 6%. And the outlook is similar to that. And the same ratio also applies to the industry. So our -- the NPL ratio of our credit card segment is not far from industry.

Thank you, Carlo. I see that Rachel Cruz has her hand up. Rachel, go ahead.

Sorry, I pressed the wrong button. I don't have any questions. Thank you.

Okay. [Operator Instructions] I don't see any hands raised as of the moment. I also do not see any questions on the Q&A box. Okay. So this question is from Charmaine Co. Could you share what credit cost was for Union Digital in 3Q?

This is part of our presentation. I think compared to the total loan book, the credit cost of Union Digital is at 0.9% of total group's loan books. So I think we can give you the exact credit cost relative to Union Digital's loan books separately, we can send [indiscernible].

Thank you, Carlo. [Operator Instructions] Joahnnas Foriano has a question. Thanks for the RRR and policy rate cut guidance. Maybe also request for sensitivity in terms of BP, in terms of basis points.

Okay. So for the RRR, we said it's going to be PHP 300 million for every 100 basis point cut. So that's PHP 3 million for every basis point. And for the rate cut, it's also PHP 300 million for every 25 basis points. So that would come out to be...

Thank you for that Johnson. Again, last call, can we check for anybody who has questions [Operator Instructions] I don't see any open questions right now. So last call. Yes. There's another question from Rachel Cruz. Given the stabilizing outlook for Union Digital, will the unit still be -- still need parent support?

Well, we already approved earlier about a month ago, an infusion of PHP 1.6 billion, of which PHP 950 million has already been infused. So we are already anticipating an additional PHP 650 million, which has already been approved for 2025.

I don't see any questions now. Sorry. There's one question from Ralph Jonathan [indiscernible]. Some of the banking peers were able to book large trading gains this quarter. Would you be able to provide any color how different is the position of Union Bank?

Well, for Union Bank, there is, of course, a shift of strategy to consumer, people to consumer. So therefore, we haven't been as aggressive in taking positions in the balance sheet. I haven't had a chance to review the trading gains of the other banks, but it's possible that these are from some of the investment portfolio. But in the last 2 years, a conscious strategy of the bank has been to shift towards a consumer portfolio rather than in trading assets.

Thank you for that, John. Again, we'd like to remind everybody that we just sent through a copy of the presentation via e-mail to all of the participants today. I don't see any more open questions. Last call, final call for our audiences today. So if none, I think we could wrap up today's briefing. Thank you, Dmi, Johnson, Dominic and Carlo. Before we close this meeting, a survey forum will pop out for you to type out any additional feedback that you may have. And for the benefit of those who missed the session or would like to rewatch the event, a recording of this briefing will be uploaded on our website. So on behalf of Dmi, Dominic, Johnson, Carlo and the entire presentation development team, we would like to thank you for joining us today. See you again for a full year briefing in March next year, and good afternoon.