Shinhan Financial Group: Awaiting Announcement Of New Capital Return Policy

Summary

• The announcement of Shinhan Financial's new capital return policy has been deferred due to uncertainty brought about by the coronavirus pandemic.
• Asset quality is an area of concern, especially in relation to Shinhan Financial's credit card subsidiary, Shinhan Card.
• Shinhan Financial trades at 0.44 times P/B and 5.7 times consensus forward next twelve months' P/E, and it offers a consensus forward FY2020 dividend yield of 4.8%.
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Elevator Pitch

I maintain a Neutral rating to Korea-listed financial services company Shinhan Financial Group Co., Ltd. (NYSE:SHG) [055550:KS].

The announcement of Shinhan Financial's new capital return policy has been deferred due to uncertainty brought about by the coronavirus pandemic. Looking ahead, Shinhan Financial's new capital return policy will be a key re-rating catalyst for the stock. The new policy could potentially suggest an increase in dividend payout ratio and provide more details on the quantum and timing of share buyback and cancellation.

On the other hand, asset quality is an area of concern, especially in relation to Shinhan Financial's credit card subsidiary, Shinhan Card; Shinhan Card's delinquency ratio increased by +9 basis points in 1Q2020. Notably, South Korea's household debt-to-GDP ratio is the highest among Asian countries, and the current economic fall-out as a result of the coronavirus pandemic could potentially lead to higher credit card defaults.

Considering the above and Shinhan Financial's undemanding valuation, I think that a Neutral rating for Shinhan Financial is fair.

This is an update of my initiation article on Shinhan Financial published on February 14, 2020. Shinhan Financial's share price has declined by -8.5% from KRW37,900 as of February 13, 2020 to KRW34,650 as of June 4, 2020 since my initiation. Shinhan Financial trades at 0.44 times P/B, which represents a discount to its historical five-year and 10-year mean P/B multiples of 0.63 times and 0.66 times, respectively. The stock is also valued at 5.7 times consensus forward next twelve months' P/E and offers a consensus forward FY2020 dividend yield of 4.8%.

Readers have the option of trading in Shinhan Financial shares as ADRs on the New York Stock Exchange with the ticker SHG, or on the Korea Exchange with the ticker 055550:KS. For Shinhan Financial shares listed as ADRs on the New York Stock Exchange, average daily trading value for the past three months is decent at $6 million, but lower than that for the Korea-listed shares.

For Shinhan Financial shares listed in Korea, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Korea Exchange is one of the major stock exchanges that is internationally recognized, and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $74 million, and market capitalization is above $14.6 billion, which is comparable to the majority of stocks traded on the US stock exchanges. Institutional investors who own Shinhan Financial shares listed in Korea include BlackRock Institutional Trust Company, Norges Bank Investment Management, Lazard Asset Management, and Dimensional Fund Advisors, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.

Capital Return Policy

Shinhan Financial offers a historical FY2019 dividend yield of 5.3% and a consensus forward FY2020 dividend yield of 4.8%. The company's FY2019 dividends per share of KRW1,850 was equivalent to a dividend payout ratio of 25.0%.

A new capital return policy for the medium to long term is in the works, but Shinhan Financial has chosen to defer the announcement of its new capital return policy due to uncertainty brought about by the current coronavirus pandemic.

At the company's 1Q2020 earnings call on April 24, 2020, Shinhan Financial disclosed that, as part of the new capital return policy, "dividend payout ratio will go over 30%" and more details will be provided on the "timing and the size and treasury (share) buyback and cancellation size." The company added at the recent earnings call that it decided to "postpone communication with the market at the moment because in this crisis period, we need to secure more capital."

A key constraint on increasing Shinhan Financial's dividend payout ratio going forward is the company's CET-1 ratio, which stands at 11.4% as of March 31, 2020. In comparison, the CET-1 ratios for Shinhan Financial's peers KB Financial Group (KB) [105560:KS] and Hana Financial Group (OTC:OTC:HNFGF) [086790:KS] are relatively higher at 12.96% and 11.89%, respectively. Shinhan Financial is targeting for a 20 basis points improvement in its CET-1 ratio every year.

Apart from Shinhan Financial's new capital return policy to be announced in due course, there are also other signs that the company is trying to optimize its capital return strategy. On March 26, 2020, Shinhan Financial announced that the company will repurchase and cancel KRW150 billion worth of treasury shares in 2Q2020.

Shinhan Financial's acquisition of the remaining 40.85% stake in Orange Life Insurance, South Korea's sixth largest life insurance company, will be effected via a share swap, so Shinhan Financial's share buyback and cancellation will help to partially offset the share dilution resulting from the acquisition.

Asset Quality In The Spotlight

Shinhan Financial highlighted at its 1Q2020 earnings call on April 24, 2020, that its "key subsidiaries, the bank and the card company's asset quality remain stable at present" but noted that "we must be prepared for Q2 and beyond when the real economy will deteriorate in earnest." This brings Shinhan Financial's asset quality into the spotlight.

Household debt, more specifically credit cards, is a key area of concern when it comes to asset quality for banks. A May 25, 2020, Channel News Asia article noted that South Korea's household debt-to-GDP ratio is the highest in Asia, and that credit card spending as a percentage of GDP was above 40% in South Korea as compared to 18% in the US. While most of the other Korean banks also have credit card businesses, it is noteworthy that Shinhan Financial's credit card subsidiary, Shinhan Card, is South Korea's largest credit card company.

In 1Q2020, the delinquency ratios for Shinhan Bank (Shinhan Financial's banking arm) and Shinhan Card grew by +5 basis points and +9 basis points, respectively. Shinhan Financial noted at the recent 1Q2020 earnings call that the increase in delinquency ratios is only "showing signs of the COVID-19 effect partially" and "it is possible that the credit cost may go up" in 2Q2020 and beyond.

Update On Potential Lime Asset Management Exposure

In my initiation article on Shinhan Financial, I highlighted that Lime Asset Management, Korea's largest hedge fund, was under investigation, and Shinhan Financial made a KRW56.6 billion provision with regards to its exposure to Lime Asset Management.

Apart from Shinhan Financial, there are at least 15 other Korean banks and financial services companies with exposure to Lime Asset Management, including Hana Financial. According to a May 25, 2020, article published by InfoStock Daily, Shinhan Financial has the highest exposure to Lime Asset Management among the Korean companies involved, based on the amount of fund sales. With investigations still underway, it is not my intention to claim that any party is guilty or otherwise. Instead, my intention is to highlight the possibility of larger-than-expected provisions and other losses relating to Lime Asset Management going forward.

The CEO of Shinhan Financial's investment arm Shinhan Investment, Kim Byung-cheol resigned in late-March 2020, with the aim of helping the investment company "win back customer trust and get back on track to normalize business", as reported by The Korea Herald. On May 20, 2020, Korea JoongAng Daily reported Shinhan Investment will "return at least 20 percent of the principal to investors who lost money in the problematic funds managed by Lime Asset Management." There are also talks that Korea's Financial Supervisory Service has asked the financial services companies with exposure to Lime Asset Management to create a "bad bank" to acquire Lime Asset Management's funds; it is uncertain how the various companies' shareholdings in the "bad bank" will be determined as of now.

Valuation

Shinhan Financial trades at 0.44 times P/B based on its share price of KRW34,650 as of June 4, 2020. As a comparison, the stock's historical five-year and 10-year mean P/B multiples were 0.63 times and 0.66 times, respectively.

Shinhan Financial is valued by the market at 5.0 times trailing twelve months' P/E and 5.7 times consensus forward next twelve months' P/E. In contrast, the stock's historical five-year and 10-year average consensus forward next twelve months' P/E were 7.5 times and 8.0 times, respectively.

Risk Factors

The key risk factors for Shinhan Financial are the company's new capital return policy falling short of investors' expectations, a deterioration in asset quality going forward, and larger-than-expected provisions for Lime Asset Management in the future.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.