Daiwa Securities : Q&A at 3Q FY2022 Telephone Conference

Q&A at 3Q FY2022 Telephone Conference

This presentation may contain forward-looking statements about the Daiwa Securities Group. You can identify these statements by the fact that they do not relate strictly to historic or current facts. These statements discuss future expectations, identify strategies, contain projections of results of operations or of financial conditions or state other "forward-looking" information. These statements are based on currently available information and represent the beliefs of the management of the Daiwa Securities Group. These statements are subject to numerous risks and uncertainties that could cause the Daiwa Securities Group's actual results, performance, achievements or financial condition to differ materially from those described or implied in the forward-looking statements. The Daiwa Securities Group undertakes no obligation to publicly update any forward-looking statements after the date of this presentation. These potential risks and uncertainties include, but are not limited to: competition within the financial services industries in Japan and overseas, our ability to adjust our business focus and to maintain profitable strategic alliances, volatile and sudden movements in the international securities markets, foreign exchange and global economic situations affecting the Daiwa Securities Group.

Date: Monday, January 30th, 2023

Speaker: Eiji Sato, Executive Managing Director, CFO

Q1. On the subject of the revenue environment for FICC, you indicated that the revenue environment recovered significantly on improved volatility but is it that the December policy changes implemented by the Bank of Japan have a positive effect on revenues? Or, did the market move based on observations made prior to policy changes? What in your view represents a revenue opportunity? Also, please indicate your outlook on the revenue environment moving forward?

• While the policy changes implemented by the Bank of Japan on December 20 did not have a direct impact, JGB was able to expand revenues thanks to the favorable revenue environment driven by increased volatility in interest rates that was already occurring. Since the policy changes by the Bank of Japan, volatility has remained high and the revenue environment has improved significantly.
• With Credit as well, the current environment is one of a trend towards increased needs among investors for portfolio restructuring. If primary and secondary markets gain stability moving forward, then we expect to see further improvements in the revenue environment.
• As for Retail customer bond investments, which impact performance by the Wholesale Division, customers who had not been engaging in transactions when the market saw ultra-low interest rates are beginning to demonstrate strong demand for bond investments thanks to increased bond yield.
• Overall, the revenue environment for FICC has improved significantly.

Q2. My question is concerning cost reductions. The disclosure materials released on November 25 indicate reductions of 5 to 10 billion yen for GM on top of 6.5 billion yen in additional cost reductions. Can you please provide an update on current progress and the status of validating that 5 to 10 billion yen figure?

• As is indicated on P22 of the disclosure materials released on November 25, GM first started working to achieve additional cost reductions of 5 billion yen. At present, we have outlined concrete measures for over 4 billion yen. However, there is a time lag in terms of the materialization of these reductions. As such, the reduction effect for the current fiscal year will be limited. We will see roughly 80 percent of the full benefit of these efforts next fiscal year, with the remaining 20 percent to become evident in the following fiscal year and beyond.

• A portion of this more than 4 billion yen in reductions overlaps with the 6.5 billion yen in additional cost reductions indicated on P6 of the disclosure materials released on November 25.
• Total cost reductions excluding the overlapping portion are 9 billion yen (roughly 6 billion yen through FY2023 and 3 billion yen in FY2024 and beyond).
• As there is a time lag until the materialization of these benefits, we will provide further updates in the future concerning our progress.

Q3. Do the total cost reductions of 9 billion yen mean that the previously disclosed figure of 6.5 billion yen was revised upward to 9 billion yen?

• That is correct. The figure 9 billion yen represents the total for the 6.5 billion yen indicated on P6 of the materials disclosed on November 25 and, the cost reductions for GM indicated on P22 excluding the overlapping portion.

Q4. P9 indicates that your total exposure amount increased as of the end of 2Q. This may have declined at the end of 3Q, but your balance sheet indicates that derivatives increased significantly at the endof September. I assume this is driven by FICC but can you indicate which operations these figures reflect?

• The main factor behind the increase in total exposure is that total assets reached a record high of 31 trillion yen. This is mainly due to position increases for JGB and overseas sovereign bonds so it is not the case that we took on credit risk.
• Derivatives fluctuates by market movement including interest rate rise, so the increase is due to market factors.
• Total assets as of the end of December decreased to 28 trillion yen, so we expect a mild increase in leverage ratio.

Q5. The percentage of the increase in consolidated ordinary income (QoQ +8.3bn yen) represented by increases in ordinary income for Other/Adjustments (QoQ +4.1bn yen), which is not included in major segments, is significant. Among elements attributed to Other/Adjustments, which were factors that contributed to increased income?

• Various income and expense items are recorded under Other/Adjustments. This includes the performance of some 30 Group companies not included in major segments as well as consolidated adjustments and expenditures not attributable to any specific segment. If examined on a quarterly basis, you will see fluctuations.
• For example, compared to 2Q, performance for Group companies such as Daiwa Next Bank and Daiwa Institute of Research improved. As indicated in the materials disclosed on November 25, we also saw contributions from revenues from securities including strategically retained funds. As such, this represents an extremely vast number of items, which makes it difficult to specify individually. However, the total represents the indicated difference.

Q6. Daiwa Next Bank income increased some several hundred million yen QoQ, which appears to have been due to a significant impact by strategically held funds. It also appears that the recording segment for the ESG fund you are currently selling is GIB. Besides these, is there a significant amount of income being recorded under Other/Adjustments and which are not being included in any specific segment?

• As you pointed out, Daiwa Next Bank income for 3Q increased by roughly 270 million yen compared to 2Q. On a per-company basis, this is not a significant amount but it does reach a certain scale when totaled for some 30 Group companies.
• Also, just as you indicated, management of the ESG fund in Europe is positioned as part of the M&A business, so the reporting segment is categorized as GIB.
• As we indicated in the materials disclosed on November 25 of last year, our investment has reached a certain scale including fund investments related to the capital alliance with IP Bridge and ACA, as well as a fund through an alliance with WiL. However, we do not disclose balances for these items.

Q7. My question is concerning cost reductions. Next fiscal year, do you expect that cost reductions will be enough to offset personnel cost increases that are being reported in media? Is it correct to assume that cost reductions will exceed the burden related to wage increases during FY2023?

• I think you are referring to a reported 4% wage increase but we are current evaluating relevant matters, including the scope of increases. As such, we have not yet outlined concrete policy related to this matter. We are currently evaluating amounts and the scope of applicable Group companies and are unable to provide details on next fiscal year at this time.
• As reference, during FY2022, we increased wages by 3.5% through salary raises and the issuing of special allowances. As an annual amount, this was equivalent to roughly 2.5 billion yen for the year.

Q8. Since you are selecting low-risk portfolios as part of your fund wrap balances, structurally speaking, what percentage of customers will see commissions that exceed returns?

• There are multiple ways to define performance but the average retention period for fund wraps exceeds 10 years. Over the past 10 years, average annual returns after deducting commissions have been approximately 3.5% for conservative products, 5.9% for balanced products, and 8.2% for aggressive products. Customers retaining fund wraps for longer periods of time enables us to engage in stable, efficient management by benefitting from compounding interest and balanced asset management. These results indicate strong performance even after deducting commissions.
• Looking at the past 10 years, performance has been impacted by Abenomics but even looking over the three-year period of the COVID-19 pandemic, annual returns have been 1.2% for conservative, 3.3% for balanced, and 5.4% for aggressive.

Q9. Concerning the Wholesale Division GIB, please discuss your view of the pipeline for ECM and DCM, and appetite among issuers. ECM appears to have potential transactions but the overall PO market feels sluggish. DCM appears to be in a wait-and-see mode due to uncertainty regarding monetary policies by the Bank of Japan but what is your outlook for next fiscal year and beyond?

• Compared to the 1H, 3Q ECM is showing favorable trends, increasing in terms of both number of deals and amount. There is growing popularity for deals showing potential for growth, and we are also seeing changes in investor risk appetite.

• The number of potential deals in the IPO pipeline is on par with FY2021 levels but the number of actual listing will depend on the market going forward. Also, our view is that the status of revenue will change depending on whether or not some relatively large-scale, mid- and large-sized deals, come to fruition. At the same time, the pace of buildup for our PO pipeline has been somewhat slow.
• Currently, there is a lack of transparency concerning the interest environment after the appointment of a new governor to the Bank of Japan. As such, for DCM, both issuers and investors have firmly settled in a wait-and-see mode, resulting in a slight decrease in our pipeline. However, as we enter next fiscal year, the launch of the structure under the incoming BOJ governor will ease this lack of transparency. We also expect to see traditional corporate bond procurement needs and procurement needs driven by expectations of higher interest rates. We anticipate these factors will drive pipeline growth.
• As for M&A, our global pipeline will be on par with the previous fiscal year in terms of the number of deals. Amounts are also growing steadily. Domestically, the number of deals is largely unchanged while amounts are increasing. Overseas, both the number of deals and amounts are transitioning favorably compared to the previous fiscal year, during which we had one of our strongest pipelines ever.

Q10. My question is concerning the Retail Division. Since January, other companies have made some major moves related to stock investment trusts, including establishing large-scale funds. Please discuss your approach to product strategy.

• Our focus is on making moves that are aligned with our customers. Instead of focusing on pushing products, we strive to propose optimal portfolios that meet the needs of our customers. Under this approach, we examine the market environment to assess current needs.
• In terms of current sales, the market environment and customer needs is resulting in a focus on stock funds and bond funds. We are focusing on accumulated-type investment trusts, which are based on time diversification.

Q11. What was the objective behind the sale of equity in ESG-related funds? Please indicate the transaction amount and why you chose this timing to make the transaction. Also, Wholesale Division ordinary income for 3Q was 2.4 billion but did you post a profit or a loss if excluding gains on the sale of the ESG fund?

• As indicated on P33 of the 1H FY2022 Management Strategy Update in the materials disclosed on November 25 of last year, ESG-related funds were started from the prospective of strengthening the M&A business in Europe. The fund was established mainly by former DC Advisory banker, and we used our M&A expertise and networks to conduct LP investments serving as seed money for funds mainly in the infrastructure sector.
• We are not disclosing the amount of the transaction. We received an offer from an external investor seeking to acquire our equity, and decided to make the deal. We are planning to follow up the first fund by establishing a second fund. Our focus with this type of ESG-related fund is to secure investment returns while increasing synergy for the M&A business.
• Matters concerning the amount of gains on sale are not disclosed for individual transactions.

Q12. You explained that the environment for JGB is favorable in Japan but liquidity is limited and

hedging is difficult. Also for credit, the issue of subordinated credit has stopped and the environment is becoming difficult to secure revenue.. Is it safe to assume that, despite such a unique market environment, income will increase if volatility increases?

• Purchasing operations are being conducted by each maturities, resulting in the depletion of liquidity. However, we are securing income through rising volatility and flow order from investors including global investors.
• Whether or not an increase in volatility leads to an increase in income will depend on risk control and position management. We are managing these factors successfully.

Q13. Will the postponement of earning announcement for Samty have any impact on the past or future earnings of the Daiwa Securities Group?

• As indicated in the press release announced by Samty, our equity method affiliate, the company is undergoing an investigation by a special investigation committee. As such, it is presently difficult to ascertain the scope of any impact. While we cannot speak with certainty, if based on the scope of transactions indicated in the press release, then we believe any impact on our performance would be limited.

Q14. My question is concerning the bank's unrealized gains and losses. Looking at the entire Group, the BS seems to indicate firm unrealized gains. However, when looking solely at Daiwa Next Bank, unrealized losses have increased recently. Are you engaged in measures to optimize your portfolio? Also, if you record losses as part of efforts to maintain stability, would there be any impact on the Group's overall dividend strategy or payout policy?

• Daiwa Next Bank's margin is increasing with the rise in interest rates on global financial markets.
• Amid this environment, we are constantly engaged in portfolio optimization to ensure stability. That is why improvements in revenues versus expenses have been mild for Daiwa Next Bank. However, at present, there is no change in our dividend policy and our promise of dividend returns equivalent to 50% or higher of quarterly net income.

Q15. The Medium-Term Management Plan outlines the goal of 200 billion yen in consolidated ordinary income by the end of FY2023. I understand that you are implementing various measures to GM, which is facing a particularly difficult environment but what is your outlook relative to this goal? Will you reassess or should this be viewed as the market environment? There appears to be a significant divergence from the goal of an ROE of 10% but will you continue to outline this as a goal of the Medium-Term Management Plan? Also, please indicate what measures you plan to implement.

• The goals of 200 billion yen in ordinary income and an ROE of 10% outlined in the Medium-Term Management Plan reflect various elements, including capital costs and market expectations.
• Our plan calls for the Wholesale Division, particularly GM, to generate ordinary income of 69 billion yen. In other words, over one-third of our consolidated ordinary income goal of 200 billion yen. While this is certainly a challenging goal, when viewed as an overall Group, we have a diversified portfolio and certain sectors are outperforming expectations. As such, at present, we are not considering giving up on our goal of 200 billion yen.