Aareal Bank AG

XETRA:ARL

Earnings Call Transcript 2018-Q1

[Operator]

Ladies and gentlemen, thank you for standing by. My name is Emma, your Chorus Call operator. Welcome and thank you for joining the Aareal Bank Conference Call. [Operator Instructions] I would now like to turn the conference over to Jürgen Junginger, Managing Director and Head of IR. Please go ahead, sir.

[Jürgen Junginger, Managing Director Investor Relations]

Good morning to everybody. Welcome from sunny and really bright sky of Wiesbaden. We're here to present our Q1 figures. Opposite of me sits Hermann Merkens, our CEO, he's going to hold the presentation and later hopefully answer interesting question from your side. So, Hermann, please?

[Hermann Josef Merkens, Chairman of the Management Board]

So, thank you very much Jürgen, I will answer the questions [indiscernible] I hope.

[Jürgen Junginger, Managing Director Investor Relations]

Let the questions come.

[Hermann Josef Merkens, Chairman of the Management Board]

Okay. So, maybe we start on Page 3 of the presentation. I think you've been through the various bullets. Maybe one additional comment, which we do not have here, it's the IFRS 9 project and the capital effects out of IFRS 9, which are as indicated, low double-digit. And the IFRS equity, we had minus 27 and in the common equity Tier 1 on a regulatory basis, we had minus 17. So, I reconfirm our best guess from last calls that the IFRS 9 effects will be low double-digit.On the other IFRS 9 items and especially change in line item recognition, I will walk you through a little bit, but there are certainly more than we could touch in this call. So, clearly, on that, we are happy to take your questions afterwards.Group results at a glance on Page 5. EUR 139 million net interest income. And here for the avoidance of doubt, we put into the net interest income line item the derecognition result. And you may have noticed that in the official reporting, we had to split both line items into a one net interest income and the other one derecognition results. Derecognition, EUR 6 million and net interest income EUR 133 million. I'll come back to that later on.Allowance for credit losses, 0 and Q1 2017 EUR 2 million, which is more or less the same story. Here again, we are confirming full year target which means that unfortunately, so far, we can't simply at 4x 0 to come up with the full year forecast. Net commission income EUR 50 million, Aareon is still on track and I will comment on that later on.Admin expenses, EUR 128 million, including European bank levy and the cost for deposits scheme. The splits here is some EUR 16 million for European bank levy, some EUR 4 million for deposit protection scheme which adds up to EUR 20 million, EUR 4 million transformation costs and some reversal of restructuring cost of EUR 3 million. And here is a slide later on, which explain that in detail as well. So, overall operating profit is EUR 67 million, and which leads to earnings per share, which is slightly up compared to Q1, 2017 of EUR 0.65.If we move now on to Page 7, which is new business and commercial real estate segment. As last year, we've been able to do quite good and margin attractive business. The first quarter, as last year is somewhat mirroring the high share of U.S. business, average gross margin is above 250 basis points. The full year number is clearly lower, as we continue to do European business and clearly, we can't simply halt the U.S. business here at that level. So, it has to be expected that we will see, as we see last year somewhat margin reporting decline, but that is already anticipated in our business planning.The real estate portfolio itself is on a quarter-on-quarter basis, EUR 25.9 billion, that is a little bit overestimating the average portfolio size in Q1, which has shown a fairly relative low start in January and February and we [ caught up ] at the very end of Q1. So that is one explanation of why the net interest income is somewhat lower than expected, the other one is simply the February effect with some less days where we could recognize interest income.On the page, you see North America is somewhat here is 67%, if I have that correct, the number should be 68%, but more or less around 68%, 67% share on new business.On Page 8, Consulting and Services, so we are very pleased with the results of Aareon and I will give you some more details on that. The overall turnover of Aareon business is EUR 55 million compared to EUR 52 million on a year-on-year basis for the first quarter. The digital business has gone up from EUR 7.8 million to EUR 9.2 million, which is clearly recognizing the increasing share of digital business.The ERP business is up by EUR 1 million from EUR 37.3 million, which is reflecting our 2 acquisitions, [indiscernible] and the [ MSE ] business in 2017. But this line item has to be -- expect to be more flat in the upcoming years, whereas the digital business will grow on a more or less constant basis.If I compare the budgets, the full year budget, it's some EUR 220 million in 2017 for the turnover compared to some EUR 239 million for the full year 2018. A predominant driver here again is digital business, up from [ EUR 36.5 to EUR 44.2 ] which again indicates that the driver for growth in the Aareon business is the digital business.In the first quarter itself, we had some one-off's, I will comment on a little bit later, on the cost side, so it's not fully reflected in the EBIT, so far, but from a turnover line items -- revenue line items, I think we are on the right way with the business.On the deposit business, more or less same story as always, driven by the low-interest rate environment. Clearly, we are doing some investments here, which is hurting somewhat the admin expenses, but more or less the general picture remains as we've discussed in the previous calls.So, net interest income on Page 10, as explained [indiscernible] EUR 139 million and a little bit more flavor on the EUR 6 million as I explained in the previous calls, with the EUR 6 million derecognition and progress of question of volume, early prepayment and [ pick ]. The volume of the early prepayments was as we planned, so no surprise on that end. The [ pick ] was a little bit back-loaded, meaning that we being repaid with loans is fairly low small remaining maturities, 1 year to 6 months, which indicates nothing but explains why the derecognition result is so low. Simply, if I do it have a 5-year loan and I have been repaid on after 2 years, 3 years remaining commission income has to be reflected in this derecognition result, if I'm repaid in year 4 or 4.5, I have to show remaining 6 months or 12 months. So that's the explanation for the low result in this derecognition income.And you've seen a similar effect in Q2 last year, it was EUR 7 million in that line item. So, nothing one would -- one should we really worried about at that point in time, if it remains that we will be repaid on loans this fairly low maturities, clearly then we have to readjust our outlook, but so far, I do not see any reason to do that at that point in time, hence, we could confirm our full year target. Allowance for credit losses, nothing to report on that.Net commission income, Page 12, I've already explained a little bit the composition of the revenue line items. And again, we are very pleased with the track we see on the Aareon's business.On Page 13, admin expenses. As explained, the EUR 128 million of perfectly in line with our expectations. Just to remind you, we set out full year 2018 target in 2016 of EUR 450 million and the math is as follows; EUR 450 million plus EUR 13 million, which has been not foreseen in 2016, EUR 13 million acquisition on the Aareon side and EUR 25 million transformation costs which will lead you to our full year guidance. So perfectly in line with our planning, the admin expenses are clearly showing that we are right on track even on that line item, it is Aareal 2020 program.Page 15, balance sheet structure, IFRS, nothing specific to report on that, which leads us to the capital ratios on Page 16. Clearly reflecting the portfolio developments on the Basel IV and with a small increase, 13.4%, up to 13.5%. So, maybe a little bit on the Footnote #1, which is hard to read, but on the other hand, I will give more details on that, where we are and what we've seen. And you see further comments on Basel IV, TRIM, EBA on Page 38.The first, the Basel IV number should be not affected by all this TRIM or EBA efforts, but it's there to be seen how the EU Commission implement Basel IV into the euro area. So still an ongoing process, but we are steering our business again with those Basel IV number, this is the main steering number.On the other hand, clearly, we have moderate portfolios, which are subject to the TRIM and on the other hand, EBA, new ideas on how to model things and especially commercial real estate portfolios. And as I indicated in previous calls, it can't be ruled out, that we will see significant RWA effects on the moderate RWAs. And as indicated in previous calls, I do not expect those effects to be higher compared to the Basel IV inflation. To give you an idea of numbers just to calculate something and something means I do not have any insights, but just to show you some sensitivities, our model portfolio, the main model portfolio, the EUR 24.5 billion commercial estate portfolio is representing RWA density of 23% or a factor of 0.23. If one would go up to a density of 32%, that would add some EUR 2 billion RWAs if one go up to a density of 40%, that would add up additional EUR 2 billion of RWAs, which leads to higher or -- not higher, but higher RWAs. And it's model [ cum ] CET 1 numbers, but as I said, it's not overshooting the overall Basel IV effect. How that will end up? To be honest, I don't know. The only thing I know is that the plan is that the TRIM exercise will end up earlier than the EBA exercise, don't ask me whether it makes really sense because after the TRIM, do you have to remodel the entire internal model words to comply with the upcoming EBA guidance. So -- and that will be followed by another look into whether you have modeled that correctly. So, I would say we will see an ongoing model exercise, and the visits from the ECB, starting with TRIM ending up with the EBA models and that will catch up a lot of capacity, internal capacity over the next upcoming years, that's [indiscernible]. But the more important thing is, as I said, I do not expect that the RWA inflation at that point in time will be higher than the Basel IV and clearly if we have some insights on TRIM for EBA, we will report on that accordingly.So, on Page 17, refi situation is still solid and the competition is a little bit more and more shifting towards deposits and [indiscernible] comment on that. Unlike others which are looking to attract deposits via margins and Internet, here we are talking about transactional deposits, so we increased a number of institutional housing clients using our mass payment systems and it's not just banking mass payment system which is up to date, it's also a combination between the mass payment system and booking logic. So, the combination makes it very attractive for clients to use our systems and we rolled off of that into the energy sector as well. And more and more clients in that sector are recognizing that the system as such is attractive and maybe more useful compared to other banking payment systems in that area.And additionally, we are looking into new products like the 3 months deposits [indiscernible] with the housing industry to do have automatic process on that as well. That share is increasing as well. So, it's a kind of [indiscernible]. On the other hand, with respect to overall margin situation, clearly, the general view on that is, yes, we are charging to a certain extent negative interest rates and we're constantly monitoring and looking into that. And if markets are moving into the direction to do more on that, we will really follow the market trends.Overall asset quality, Page 19, not that much to report on that.Page 20, it's not a mistake that you have difficulties to find Turkey, it's simply that Turkey is now below EUR 300 million and recognized in the [indiscernible] others and hence we've been very successful to run down the portfolio. They are without any additional costs and hence now Turkey is reported under the line item or bracket, others. Overall LTV 60%, one comment on that. We switched from 59.4% to 59.5% or to 60% and that we are correct, we are now summing up to 60% and not to 59%.On NPLs, a little bit more on that. And if you are interested in the various NPL definitions, please look into the Pages 39, 40 and 41, increasing number of NPLs to extend the same thing, but unfortunately we now have one constant look into that, which we are providing here, the "old IFRS 39" definition of NPLs and you will clearly see that we are moving in the right direction with respect to the overall NPL portfolio. On the other end, we do have, under IFRS 9, a little bit of other definition of forborne assets/NPLs, which we're showing on Page 41 and clearly we are providing the numbers of our regulatory reporting as well, which is a little bit different at that point in time, again compared to IFRS 9. So, just a hint that you find more explanations on the NPL, as I said. The overall summary is, we are moving in the right direction with respect to NPL ratio.Credit portfolio, nothing to report on that.Outlook 2018. Yes, we could simply confirm the outlook, so to speak nothing specific to report on that. My comments to net interest income remains, we calculated some EUR 48 million, some EUR 50 million from derecognition results, which is indicating that with the EUR 6 million, we are not on a pro rata basis in line with the overall business forecast, but on the other hand, as explained, we've seen more or less the same figure in Q2, 2017 as well. So, nothing one should be very worried about at that point in time, but if it remains that we are repaid on loans with fairly low maturities, then we have to look into that. On the other hand, if we're repaid on that end, we are happy to keep the other ones on board, which -- and that still remains that the commissions we achieved have been to split over lifetime of the loan even under IFRS 9. So, no other comments on that line item. So, we were, so of speak, full on track. Very strong on capital, we could have our [indiscernible] is going moving in the right direction, especially with digitization effort and more or less the main and important message is we are confirming full-year targets.So, Jürgen and I, we are happy to take your questions and Jürgen expressed the hope that there will be some. Thank you very much.

[Operator]

[Operator Instructions] And the first question comes from the line of Benjamin Goy with Deutsche Bank.

[Benjamin Goy, Research Analyst]

Two questions from my side, please. First on net interest income and then secondly on fees. On net interest income, the underlying Q1 result was EUR 133 million considering the US dollar depreciation and the day count effect. Sounds like almost stable Q-on-Q, have we now come to a stable run rate or is there still some decline expected going forward as in the last quarters? And then secondly on fees, yes, you were up 4% year-on-year, which is basically the run rate you need to get to your [indiscernible] low end of your fee guidance for 2018 and you had a strong Q4 last year, so wondering whether you've seen acceleration across initiatives, in particular, the digital ones and yes, how to make the guidance?

[Hermann Josef Merkens, Chairman of the Management Board]

Thank you, Benjamin, for your questions. Fees, you're absolutely correct. The Q4 will be even stronger, if I may so, that's our expectation for Q4 2018, simply given that our family has grown by 2 companies last year, which usually have high fee recognitions in Q3, Q4 as well. And you have some pick up of fees in mind, more towards the end and hence that makes us comfortable, we're clearly looking with comfort into those numbers and as I indicated, the overall revenue, total revenue line will and should pick up from EUR 222 million to somewhere EUR 239 million, EUR 9 million and most of that will be recognized in Q4. With respect to net interest income, correct as well so should be flattish around EUR 130 million, EUR 133 million, should stabilize in that area. Even for the next upcoming years, we should not see so high declines in net interest income compared to previous years because we intent to keep our portfolios relative -- our portfolio, relative stable on the EUR 26.5 billion number. So, as always, the one prerequisite, markets should be somewhat not in the very shaky models or the competition should be as high as we expect. So, we do not intend to do a low double-digit margin business on that. But leaving that aside, as indicated, we are aiming for more flattish net interest income in the next upcoming years. With the repayment fees or derecognition result, as I explained, it's always a little bit a mixture between volume and pick, which is hard to forecast to a certain extent. But if I look back into the last years, it was always a little bit of mix. The most important thing is whether our forecast on prepayment volumes is, so to speak, correct and that has been the case in the first quarter. So, remaining question is the pick, so to speak. Hopefully, I could answer your questions.

[Operator]

The next question comes from the line of Britta Schmidt with Autonomous.

[Britta Schmidt, Partner, Spanish and German Banks]

I've got 2 questions, please. One is on the cost. Could you just confirm, I think you've mentioned that the plan includes EUR 25 million of transformation costs, this quarter we had a booking of 4 and a release of 3, so the EUR 25 million, is that EUR 25 million minus EUR 4 million or is that still EUR 25 million including the 3 release? My second question relates to the provisioning numbers. There has been a decline in provisioning kind of on a like-for-like basis on the IFRS 9, with some higher write-off. Could you perhaps explain as to what you've seen there, where we've seen these write-offs, and also give us a little bit of indication about what the main drivers will be for the loan loss provision outlook for the next couple of quarters?

[Hermann Josef Merkens, Chairman of the Management Board]

Yes. If I may start with your first question, the minus admin expenses, so the plus, so to speak, has been a little bit a surprise. So that's "somewhat one-off" the EUR 25 million minus EUR 4 million, that should be the run rate for the -- to compare or to look into whether we are really ending up this EUR 25 million or whether the number is lower. And could you repeat your second question, because I didn't get that fully.

[Britta Schmidt, Partner, Spanish and German Banks]

I think if I look at the reporting, I think the starting provision number for the end-period provisions was closer to EUR 600 million, decreased to EUR 540 million. And as far as I can see, outside of any other IFRS 9 effects, I think there has been higher write-offs this quarter, or maybe you can just explain what happened to the movement in the NPL provisioning and give us a bit of an idea what the drivers will be for the loan loss provisioning going forward?

[Hermann Josef Merkens, Chairman of the Management Board]

I'm a little bit struggling with higher write-offs this quarter, because as far as I remember out of my head, we had a balance of 0, but last but not least, there has been some reversals and some write-offs, I think it was some EUR 12 million and EUR 12 million or 12 million and EUR 11 million, and EUR 1 million separate effect. So that's why [ you're ] seemingly a little bit struggling with the question. But maybe that we could answer that after the call, if you don't mind?

[Britta Schmidt, Partner, Spanish and German Banks]

Sure.

[Hermann Josef Merkens, Chairman of the Management Board]

Yes, okay. At EUR 12 million EUR 12 million balance to 0. So what I have in my head, and maybe the details, if we could be provide with those after the call, if you don't mind.

[Operator]

The next question comes from the line of Johannes Thormann with HSBC.

[Johannes Thormann, Global Head of Exchanges and Analyst]

Yes, Johannes Thormann, HSBC. Just a follow-up because I didn't understand, on your NPL portfolio, what is driving the provisioning needs this year as it really seems even fully provisioned, why do you stick to your guidance of EUR 50 million to EUR 80 million? And the second question is, you highlighted an 11% EBIT margin at Aareon, which is pretty sub average compared to other software companies especially if they run with a market share of 50% to 60%. Will it ever be possible that this business earns a decent EBIT margin in the range of 25% to 30%? Thank you.

[Hermann Josef Merkens, Chairman of the Management Board]

Yes. Johannes, thank you for your question. If you compare the Aareon business with other software companies, it's always the question which type of service you're providing. So, if I may start with the 11%, yes, that is really affected by some one-offs we've recognized in or had to recognize in the first quarter. The one is that we do this large transition from GES to Wodis Sigma [indiscernible] and for one specific project, which is a very large one, otherwise we wouldn't see that in the numbers, we have to hire external consultants because our internal consultant capacity has been fully booked for new business and that has cost us some EUR 1 million in the first quarter. The other effect was that we've been able to unload new business, which has been recognized in the revenue line item with the license fees, unfortunately the implementation project has been shifted from the first to the second quarter, hence the consulting capacity has been, from a capacity standpoint [indiscernible] has been used on the low end but the admin expenses are suffering by additional EUR 1 million at that end as well. The overall EBIT margin that we are planning, somewhat 16%, 16.5% at year-end, which is much closer to the 17.5% which is the EBIT margin target. And if you compare the EBIT margins across software companies, you always have to look into whether they are doing consulting business or whether they're doing no consulting business. Consulting business as such is offering compared to other parts or other business types lower EBIT margins, how the composition of the product is, whether you have a kind of [indiscernible] product like we have with the ERP business which is on one hand good, because we could scale a digital add-on product and other products into the client base without doing too much trial and error on new digital products. On the other hand, really if you have more or less constant EUR 170 million of revenue line item, you don't "see the nice pick up" on digital business, which is indeed double digits. So, it's kind of diluting the growth in the digital business. All in all, with the setup that we have, we have a really good point compared to other companies that is that we are not just offering digital products. So, we are able to offer the digital products and the add-on product and could make sure for our clients that those products could be implemented in the ERP systems at the same time, which is a disadvantage for start-ups or other companies, because -- I'm always saying somewhat yes, you are winning on the front end, but you're losing on the back end, what do I mean is that, if you look into other companies, which are offering those digital products, often the case that the result of these products are transported via email to the respective department in the respective company and they have to be implemented manually into the ERP system. So, we are offering a, so to speak, pull-through process from the digital product into the ERP system. And the main drag, if you like, if you compare that to [indiscernible] or others is really type of business and composition of business including this consulting business, on the other hand it's more stable and I think we do have a really good approach, even with SAP you can't compare this, totally different story, because as you know, SAP outsource, so to speak, the entire consulting business, they are simply concentrating on pure IT products play, more or less standardized products. So, it's -- but we could go through that in more detail if you like.

[Benjamin Goy, Research Analyst]

And the provisioning needs?

[Hermann Josef Merkens, Chairman of the Management Board]

Okay, sorry not to forget the provisioning needs, it's an important number. Now, the question, if it's a provisioning and that's what [indiscernible] presenting the preliminary full year results. It's a little bit and that will be a learning type of thing for us as well, how will the Stage II element of the IFRS 9 will really work through. So, the thing is that you have to identify trigger events, you have to implement trigger events, where loan moves from Stage 1 to Stage 2, which would indicate that under the Stage 2, we have to recognize the full lifetime expected loss. So, we do not have any experience with that. In our guidance number of EUR 65 million, there's some part of Stage 2 moves that we do expect, but there are some remaining quarters provisioning for Stage 3 effects as well. So, it's a composition of Stage 1 to Stage 2 and remaining Stage 3 effects. With a pure Stage 3 and that is, I think very important, I would expect that we should end up in a number, which should be not higher than EUR 55 million or something like that on an average basis, which is fairly lower compared to previous year's numbers.

[Operator]

The next question comes from the line of with Michael Browne with Martin Currie.

[Michael Browne, Fund Manager of Europe]

My question on net interest income has already been answered.

[Operator]

Next question comes from the line of Philipp Häßler with Equinet Bank.

[Philipp Häßler, Director of Research]

Philipp Häßler from Equinet. I have 2 questions, please. Firstly on the NPLs, you reduced the Turkey and the Netherlands. Maybe you could comment on this a little bit more, I assume those were disposals. And could you perhaps also give us the volume of the Turkey exposure, it's below EUR 300 million you said, but maybe you could -- a little bit more specific on this. And then just a question of understanding, the coverage ratio is down to 40%, is this comparable with the 46% you published for Q4 or can't we compare those figures because of IFRS 9?

[Hermann Josef Merkens, Chairman of the Management Board]

If I may start with the last question, so far you could compare the figures, but maybe over time that you can't compare the figures that's simply driven by the fact that there might be NPLs which have to be recognized on a full fair value basis, which do not show loan loss provisions. So, that's, unfortunately, an IFRS 9, or potential IFRS 9 effect, so far, the portfolio on the full fair value is really fairly, fairly small. The portfolio in Turkey is now down to EUR 252 million. Yes, we had some exits in Netherlands and Turkey but we do not disclose details on those, but I think we've been relatively successful on those exits. And there was a question with the average -- what was it, the 40%?

[Philipp Häßler, Director of Research]

Yes, the 40%, the coverage ratio. So whether it's comparable to [indiscernible] answered that one.

[Hermann Josef Merkens, Chairman of the Management Board]

The coverage ratio is up from 39% to 40%.

[Jürgen Junginger, Managing Director Investor Relations]

So the coverage ratio just of the specific allowances, these are not [indiscernible].

[Hermann Josef Merkens, Chairman of the Management Board]

And as I said, they are fully comparable, so to speak, so far.

[Operator]

There are no questions registered at this time.

[Hermann Josef Merkens, Chairman of the Management Board]

Okay. So if there are no other questions, thank you very much for joining the call. So, we are fully on track with our 2020 program, clearly some regulatory headwinds hit on the model-based portfolio, but as I explained, hence we are -- while we are steering our bank towards Basel IV, should not affect our business so much. And last but not least, we are confirming our full year targets on all line items, and hopefully I could explain a little bit the new composition of the IFRST 9 P&L and balance sheet. There's a little bit more I could have reported, but we are happy to take your questions on that afterwards. Thank you very much for your attention.

[Jürgen Junginger, Managing Director Investor Relations]

Thank you. Bye-bye.

[Operator]

Ladies and gentlemen, the conference is now concluded, and you may disconnect the telephone. Thank you for joining and have a pleasant day, goodbye.