2016. 10. 28 Securities Brokers(OVERWEIGHT) Looking toward real estate ● We believe securities brokers under our coverage will post a combined net profit for 3Q of KRW231.1b, down 2.8% q-q and in line with the consensus of KRW233b. Brokers, amid a prolonged industry downturn, are striving to diversify profit sources, with a key target being real-estate. We advise selecting stocks with viable investment themes rather than taking a sector-wide approach. WHAT’S THE STORY? Net profit to meet consensus: We believe brokers we cover—Mirae Asset Securities, NH Investment & Securities, Merit Securities, and Daishin Securities—will post a combined net profit for 3Q of KRW231.1b, down 2.8% q-q and in line with consensus of KRW233b. We attribute the solid result—which came despite a decline in average daily trading value and a hike in market yield—to improving trading gains, namely: 1) a q-q surge in early redemptions of ELSs and DLSs; 2) a decline in ELS/DLS hedging costs; and 3) one-off gains (eg, NHIS’s KRW40b gain from disposal of a Korea Exchange stake). Targeting real-estate financing: Brokers, realizing limitations of the agency model and striving to diversify profit sources, are targeting real-estate financing, with that business ranging from simply earning commissions by brokering PF financing deals to fully participating as a turnkey developer. Brokers are taking a differentiated approach—eg, Meritz Securities is a leader in structured real-estate financing; Mirae Asset Securities is striving to better use capital and expand its customer-base via strength in overseas real-estate; and Daishin Securities is looking to become a full-scale real-estate service provider. Structured financing: Korea’s real-estate financing market had been dominated by banks, savings banks, and constructors. Since the 2008 financial crisis, however, constructors’ portion of the market has fallen sizably, while that of securities brokers has soared. We attribute brokers’ expanding role to constructors’ falling credit ratings and efforts to cut contingent liability, deregulation and brokers’ profit source-diversification, and the rise of specialty firms such as Meritz Securities. The latter firm has proven its differentiated risk-management capability by collecting loans it extended under commitments linked to poor pre-sales. Expansion overseas: Domestic financial firms—searching for higher returns—have diversified by moving into overseas real estate, with such returns averaging 6-7%, or 4-5%pts higher than KTB yields. Product-sourcing capability has become increasingly important amid growing competition, yet only a few large players should stand out as it requires: 1) capital power; 2) cooperation among PI, IB, and WM units; 3) a well-established overseas network and knowhow developed through experience; 4) a well-informed managerial team employing a simple decision-making system. NPL market: NPL sales at domestic banks accounted for KRW5.3t (or 23.8%) of last year’s bad debt clean-up, while NPLs have risen an average of KRW5t-6t pa since 2012. UAMCO and Daishin F&I have a combined market share of over 70% in this market, which is led and protected by their unrivalled presence in terms of assets/capital, annual NPL purchases, NPL analysis, and experience. Still, we expect the market’s competitive landscape to change as new players arrive, including NPL specialists and small non-banking financial institutions—eg, asset management and capital firms. Sean Chang, CFA Analyst sean_chang@samsung.com 822 2020 7790 David Lee Research Associate ml27.lee@samsung.com 822 2020 7768 Sector Update AT A GLANCE Mirae Asset Securities (037620 KS, KRW23,000) Target price: KRW28,000 (21.7%) NH Investment & Securities (005940 KS, KRW10,250) Target price: KRW11,500 (12.2%) Meritz Securities (008560 KS, KRW3,420) Target price: KRW4,200 (22.8%) Daishin Securities (003540 KS, KRW10,700) Target price: KRW14,000 (30.8%) Securities Brokers 2016. 10. 28 2 3Q preview and investment strategy Sector net profit in 3Q likely dipped 2.8% q-q We believe the brokers we cover—Mirae Asset Securities, NH Investment & Securities, Merit Securities, and Daishin Securities—will post a combined net profit for 3Q of KRW231.1b, down 2.8% q-q and in line with consensus. We attribute the solid q-q result—which came despite a 6.1% q-q decline in average daily trading value—to: 1) an 86% q-q hike in early redemptions of derivatives (eg, KRW11.5t for ELSs and KRW3.5t for DLSs) amid stabilizing underlying assets; and 2) the base effect of heavy ELS hedging losses in 2Q. The magnitude of growth in trading gains was likely limited by a hike in market yield—eg, the 1-yr KTB yield rose 1bp q-q to 1.31% (vs a 19bp decline q-q in 2Q). • Mirae Asset Securities: The broker’s wealth management and principal investment operation