Elevator Pitch
I downgrade my investment rating for Shinhan Financial Group Co., Ltd. (NYSE:SHG) [055550:KS] shares from a Buy previously to a Hold now.
I stressed that “shareholder capital return improvement” is the “key catalyst” for SHG in my prior write-up for the company published on March 2, 2023. But regulatory headwinds might prevent Shinhan Financial from raising the company’s shareholder capital return ratio as per earlier plans.
On the flip side, SHG’s Q2 2023 results announcement in late-July could throw up positive surprises, as I expect Shinhan Financial’s banking business to witness a turnaround in the second quarter.
In my view, Shinhan Financial deserves a Hold rating. The potential upside for SHG’s shares is capped by the fact that the shareholder capital return improvement catalyst might not materialize. But the expected turnaround of Shinhan Financial’s banking business in the next quarter should limit the downside for the stock.
Future Shareholder Capital Return Could Be Affected By Regulatory Factors
At its recent Q1 2023 earnings briefing (call transcript sourced from S&P Capital IQ) on April 27, Shinhan Financial acknowledged that it is “reviewing continuing quarterly buybacks” as the company tries “to align ourselves to the (new regulatory) direction.”
Earlier in mid-March, Korea’s Financial Service Commission issued a press release highlighting that there are “plans for bolstering capital adequacy and loan loss reserve requirements” to “improve (Korean) banks’ loss absorbing capacity.” In this press release, Korea’s Financial Service Commission cited data which showed that the average CET1 (Common Equity Tier 1) ratio for local banks in South Korea decreased from 12.99% as of December 31, 2021 to 12.26% as of end-Q3 2022, which was much lower than the mean CET1 ratios for UK (15.65%) and European Union (14.74%) banks, respectively.
Shinhan Financial’s CET1 ratio declined by -48 basis points YoY and -25 basis points QoQ to 12.5% at the end of Q1 2023, as indicated in its first quarter results presentation slides. SHG mentioned at its most recent quarterly earnings call that it aims to “improve our capital ratios” going forward on expectations that Korean financial regulators will “continue to streamline and enforce tighter capital adequacy requirements” for domestic banks.
I noted in my March 2 update for SHG that Shinhan Financial’s goal to deliver on a “30%-40% shareholder capital return ratio” for FY 2023. As a comparison, Shinhan Financial’s actual shareholder capital return ratios for fiscal 2021 and 2022 were 26% and 30%, respectively. In the first quarter of 2023, Shinhan Financial spent KRW274 billion and KRW137 billion on dividends and share repurchases, respectively. This meant that SHG achieved a 29.6% shareholder capital return ratio for Q1 2023, which is line with its full-year target.
Nevertheless, it is reasonable to be concerned whether Shinhan Financial is able to sustain a shareholder capital return ratio of 30% or higher in the subsequent quarters of 2023 and beyond. Based on a review of SHG’s management commentary at the Q1 2023 results call and Financial Service Commission’s March press release, there is a high probability of more stringent “capital adequacy requirements” being imposed on Shinhan Financial and its peers. This implies that SHG’s ability to return more capital to its shareholders via buybacks and dividends in the future could be potentially constrained by regulatory factors.
A Turnaround Of The Banking Business In Q2 2023 Is Expected
Shinhan Financial’s banking business underperformed in the first quarter of this year, but SHG’s banking business is expected to deliver a better set of results for the second quarter of 2023.
As indicated in its Q1 2023 results presentation, Shinhan Financial’s interest income declined by -10% QoQ from KRW2,822 billion in the final quarter of last year to KRW2,540 billion for the most recent quarter.
SHG’s KRW-denominated loans amounted to KRW281.5 trillion as of March 31, 2023, which was almost unchanged as compared to its KRW-denominated loan balance of KRW281.4 trillion at the end of 2022. In the first quarter of 2023, a +1.0% QoQ growth in corporate loans was perfectly offset by a -1.0% QoQ decline in retail loans. A year ago in Q1 2022, Shinhan Financial had delivered relatively faster corporate loan growth (+1.9% QoQ) and a narrower retail loan contraction (-0.8% QoQ). The net interest margin for Shinhan Financial’s banking business contracted by -8 basis points from 1.67% for Q4 2022 to 1.59% in Q1 2023.
There were short-term headwinds which affected SHG’s banking business in a negative manner for Q1 2023 that shouldn’t persist in Q2 2023.
At its most recent quarterly earnings call, SHG also noted that it is “on a rising trend” in terms of loan growth since March. More importantly, Shinhan Financial has left its end-2023 KRW-denominated loans guidance of KRW10.5 trillion unchanged, which translates into a +2.6% growth as compared to its loan balance of KRW10,232 billion as of December 31, 2022. Separately, household loans for Korea witnessed positive growth in April 2023 after three consecutive months of contraction in Q1 2023, as reported by Korean media Pulse News.
Shinhan Financial also shared at the company’s first quarter results briefing that “high interest deposits were procured” due to a “liquidity crisis” in Q1 2023, but it emphasized that “margins (on deposits) have come down” by late-April.
Based on the factors mentioned above, it is realistic to expect SHG’s banking business to report positive loan growth and a higher net interest margin in the second quarter of this year. Shinhan Financial is expected to announce its Q2 2022 financial results on July 20, 2023.
Concluding Thoughts
I see Shinhan Financial Group Co., Ltd.’s banking business reporting above expectations results and metrics in Q2 2023, which will be a potential tailwind for the company’s shares. But it might become tougher for SHG to increase the proportion of capital allocated to buybacks and dividends in the future, as the Korean regulatory authorities demand a larger capital buffer for banks. As such, a Hold rating for Shinhan Financial Group Co., Ltd. is warranted.
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