Shinhan Financial Group just posted stellar Q1 2024 earnings. Net income soared, topping 1.3 trillion won despite "large nonoperating expenses." Loan assets are growing, margins are stable, and the company is showering investors with buybacks and dividends. Everything seems rosy in Shinhan's garden... except for one small detail almost everyone seems to be missing.

Buried deep within the upbeat pronouncements of executives during their recent earnings call is an ominous phrase: "The trend of weakening asset quality is expected to continue for some time." That's corporate-speak for "we're sitting on a pile of loans that might go bad, and things could get ugly."

Shinhan is hardly alone in facing this challenge. A protracted high-interest rate environment, geopolitical instability, and lingering economic uncertainty are putting pressure on borrowers globally. But what's worrisome about Shinhan is the nonchalant tone the management team took when discussing this issue.

Instead of outlining concrete steps to proactively address this potential time bomb, they offer vague assurances about being "vigilant" and maintaining a "conservative stance." This lack of urgency is particularly concerning given that Shinhan's credit cost ratio, while currently manageable, is projected to rise.

Let's look at the numbers:

Shinhan expects full-year credit costs to land around 45 basis points, up from 38 basis points in Q1. This might seem like a modest increase, but it assumes that the current economic headwinds won't intensify. If inflation continues to bite, or if geopolitical tensions escalate further, that 45 basis point projection could quickly become wishful thinking.

Moreover, Shinhan's reliance on preemptive provisioning, while prudent, raises its own set of questions. While the company claims to have sufficient loss absorption capacity, relying heavily on future write-offs is a risky strategy, especially in a volatile market.

Shinhan's optimistic outlook for its global business, a key driver of its recent success, also warrants scrutiny. While Q1 saw strong performance, particularly from subsidiaries in London, Hong Kong, and New York, can these units sustain their momentum if global economic conditions deteriorate?

Perhaps the most glaring omission from Shinhan's rosy narrative is a clear plan to address the potential impact of deteriorating asset quality on its ambitious shareholder return program. The company seems intent on maintaining its 40% payout target, even hinting at raising it to 50% in the longer term.

But what happens to these generous payouts if credit costs spike, forcing Shinhan to divert capital away from dividends and buybacks to cover bad loans? Investors, lulled into a false sense of security by the company's current performance, might be in for a rude awakening.

It's worth noting that Shinhan has a history of overcoming challenges. Founded in 1897, the company has weathered numerous economic storms and financial crises. It's entirely possible that the management team's current calm demeanor stems from a well-founded belief in their ability to navigate the current choppy waters.

However, dismissing potential risks, especially when it comes to asset quality, is a dangerous game. Shinhan's leadership needs to provide investors with more than just vague assurances. They need to articulate a clear and detailed plan to mitigate the risks posed by deteriorating asset quality, especially if they intend to maintain their current shareholder-friendly approach.

The ghost in Shinhan's machine might be invisible for now, but ignoring it won't make it go away. The question is, will Shinhan's management act before it's too late?

Shinhan Financial Group Q1 2024 Earnings Call Transcript

You can find the full transcript of the earnings call here.

Key Takeaways from the Earnings Call:

Shinhan Financial Group - Key Data

Interesting Facts about Shinhan Financial Group

Founded in 1897, Shinhan is one of the oldest financial institutions in South Korea.

Shinhan Financial Group has over 20 subsidiaries, offering a wide range of financial services.

Shinhan Bank, a subsidiary of the group, is the largest bank in South Korea by asset size.