Aareal Bank AG

XETRA:ARL

Earnings Call Transcript 2018-Q2

[Operator]

Ladies and gentlemen, thank you for standing by. I am Haley, your Chorus Call operator. Welcome, and thank you for joining the Aareal Bank Q2 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.

[Jürgen Junginger, Managing Director Investor Relations]

Good morning, everybody. Welcome to our conference call regarding our Q2 figures. And to make it short, I'll just hand over to Hermann, our CEO. He gives a brief presentation, and later, we're going to answer your question. Hermann, please?

[Hermann Josef Merkens, Chairman of the Management Board & CFO]

Hello. Good morning, everybody. Thank you for the swift and fast switchover, Jürgen. So maybe to start with is Page 3, as you know, our highlights or summary. I think that we've been able to present to you a very robust operating performance with our EUR 62 million result in operating profit. And one remark maybe. At the very start of the conference, someone's asked me in the Q1 presentation where our engagements in Turkey and -- are in the presentation and how large the exposure is. I'm, so to speak, proud to present a portfolio of now net EUR 110 million, further down from Q1 into that number, which I pretty much think is a very manageable number at least, and that includes -- and we had this question on our press call, that includes our NPLs in Turkey. So gross portfolio some EUR 130 million; net portfolio, some EUR 110 million, clearly demonstrates the ability to manage portfolio down even in a volatile environment and despite the fact that we are talking about CRE business.So now further on in the presentation on Page 5, a short summary of our group results. The next important number is net interest income with EUR 141 million. I will elaborate a little bit in detail on another slide. Loss allowance, EUR 19 million, which is within expectation. Net commission income in Aareon, I will comment on that on another slide. Admin expenses EUR 109 million, clearly helped to deliver the operating profit of EUR 62 million.Segment performance. In the Structured Property Financing, so we had a quite good run and the Q2 delivered some EUR 2.4 billion new business, which has been more spread across our investment universe compared to the Q1. As you remember in Q1, we delivered basically U.S. business with a EUR 1 billion new business. And in Q2, it's a more mixed picture from the business origination. So let's put it that way, more half-and-half, half U.S., half other countries like U.K., France and even Southern Europe. Hence, the average margin in the Q2 is clearly mixed as well, as you'll see on the slide, with 190 basis points.So last, but not least, we pretty much think that we are able to achieve our full year guidance margin-wise despite the mixed picture across the different countries, and we clearly stick to our new business guidance.On Page 8, Consulting/Services, which is clearly affected a little bit by the Aareon results. And I commented on that in Q1, that we do have 2 -- 3 projects which are running not along with our expectations. And in Q1, I said that I do have hope that we may catch up the effects. But to be conservative, on the one hand, and realistic on the other hand, we now decided to readjust the full year target to EUR 33 million to EUR 38 million, which is clearly a very nice up compared to the last year. And as you remember, we delivered EUR 34 million, but clearly below our expectations. Reasoning for that are 3 projects which are, so to speak, affected. So it's a real true one-off. It's nothing which should hold through the last couple of years. The one comment -- the other comment, our total sales revenues are in line with business targets. So we are targeting a total sales revenue of some EUR 238 million for the full year. And we do not have any revision on that, which clearly demonstrates that we are able to deliver on those efforts, so on sales, et cetera. But we have a drag in 3 projects and, hence, we adjusted our targets.The other part of the consulting business are the deposits, they're in line with our expectations, and no further comment on that. Overall group results, I'm now on Page 10, EUR 141 million. Clearly, it's a little bit of light and shadow, if you like. The light is with the EUR 136 million, clearly demonstrating that we are able to manage our portfolio, a, size-wise, so we are now up to EUR 26.5 billion; b, margin-wise. And we are a little bit above our -- or my expectation which I delivered last -- in the last call with a somewhat EUR 130 million to EUR 135 million "run rate," a little bit above. Clearly, the income or the derecognition results or income is -- again was EUR 5 million behind our expectations. But as I've explained many times, it's not in our hands. The sheer pure volume of repayment is in line with our planning, but still we are repaid on loans which are coming due. So it's more towards the end of the lifetime of the loan and not in the middle of the lifetime of the loan. Still, that is the case, and hence the derecognition result is lower than we originally planned. And if we look back into the year 2017, that has been more or less a similar picture. We've been in the first full -- in the first half year 2017 with EUR 17 million. We are now with EUR 11 million and the catch-up started last year in Q3 and Q4. So we will see how that will adjust as a reminder, if we had so far the -- more or less the same pattern in 2017.Loss allowance, nothing to comment on that. Hence, we've not had any comment on that slide. Net commission income on Page 12. And as I said, with respect to total sales revenue, we [ have serviced ] EUR 238 million. And adjust with the ERP business, where the 3 projects are allocated in that business line, we've been downward revision from EUR 170 million down to EUR 167 million, which is clearly in line with a more or less a EUR 3 million adjustment of the full year target. Rest of the business is doing, in one aspect, a little bit better. In the additional product, it's now at 27. Digital Products is EUR 44 million; last year, EUR 37 million, well in line with our growth target. And as we had to revise the ERP business, the EBIT is reflecting that, so to speak.On the other hand, midterm targets should be and are totally unaffected. So we pretty much think that we are on the way to deliver the overall growth plan of 4% per year. Hence, we should see above EUR 40 million target in 2019 and well above EUR 40 million in 2020. More on that, as you know, during the Q1 call.On Page 13, admin expenses, a little bit hard to read maybe in that respect what the run rate really is because in Q2 2018, we had again a reversal of restructuring provisions of EUR 4 million and more or less the same in Q1, EUR 3 million. So admin expenses in the first half are benefiting from that. Second remark with respect to transforming costs, EUR 4 million. If you may remember, we had a full year target of EUR 25 million. So there's more to be expected in Q3 and Q4 on the transforming cost side. And unfortunately, I do not think that we will see a reversal of restructuring provisions again in Q3 and Q4. Just a comment to make life easier with respect to calculations.On Page 15, balance sheet. It's simply the picture that you know. No major comments on that.On Page 16. And you may remember, last time I referred to Page 38, that page switched now to Page 43, and if you like, you could follow me on the Page 43 where we do not have new numbers in. But on the other hand, there are some remarks under others, under the -- and some comments under others, which are very, very important. And I just want to highlight those because, clearly, we are subject to churn. We are reviewing our internal models with respect to upcoming EBA requirements. And hence, the regulatory push into the models is not over yet. It's still ongoing. And one clearly could imagine and should expect that we will see significant a RWA increase with respect to our internal models. You know that we are now working on a density of 21%, if you look into the other slides. And I would expect that, that density will go up significantly, be it via TRIM, be it via EBA requirements. Unfortunately, there is no real time line behind that. So it could be sooner or very soon or later, so nothing that we could really deliver yet. But you should calculate that into in your model. As you know, we are running the bank anyhow against Basel IV and my comment is still a more political one, if you like. I would be surprised if we could end up into higher RWAs from heavy Basel IV. Could I exclude that? Not really, because we are still working on both issues.Funding positions, 17. Comfortable funding, well mixed now, I think more or less, picture-wise, 1/3, 1/3, 1/3, which is a good starting point in turmoil times. I think very stable deposit funding, very stable covered bond funding. And as you may have noticed, we are now in Germany in the position to do a preferred senior as well and we are clearly looking into those markets as well. And we started with a little first touch into this market, which was quite, if I may so, promising. And we clearly will follow this route and there are some benchmarks, not from our end, but from the major banks, to be expected very soon, as far as I know [ to ] the market's movement.Page 19, portfolio delivery and spreads. Nothing really to comment on that.Page 20. As I said in the figure others, there's our exposure to be included. Including the NPLs, we are on net EUR 110 million, gross EUR 130 million.U.K., more or less same or pretty much unchanged picture, 21. On 22, Italy, 1 or 2 comments on that. NPLs, we are really managing that end of our portfolio as well. And as you may have noticed, a nice pickup on the yield on debt now with 7.8%. So yes, we've done some new business with very, very high yield on debt in Southern Europe or Italy as well. Russia, 23. So far unchanged. So we'll see how the development will go on here.24, our NPL portfolio. As I mentioned, it's further down now with 3.8% NPL ratio according -- or similar to those ratios which we presented on that slide in the past. So nice and good development here as well as I already mentioned.Overall outlook is on Page 20 -- sorry 27. So we are sticking to our full year guidance. Clearly, we have to see whether the derecognition results will catch up. And as I already mentioned in 2017, there has been a similar picture. First half was very much down on that and all of a sudden, transaction volumes and repayments in the right bucket hiked up in the second half. And we will see how that goes, whether we will see a reversal on that as well. So the overall conclusion, operating performance in H1 was very robust. The transformation of our group is well underway, so we are investing heavily in projects, and so far, they are pretty much in line content-wise. And so I'm quite sure that we will be on a good way in the second half of our transformation process as well. As a full summary, I think that we are tracking against our 2018 outlook. And so far, I do not see a reason to revise that, to not to be very explicit on the -- that. I see no reason to revise that. So thank you very much for your attention, and I'm happy to take your questions. Maybe [ there'll be one or other ] left for Jürgen as well.

[Operator]

[Operator Instructions] The first question is from the line of Britta Schmidt of Autonomous Research.

[Britta Schmidt, Partner, Spanish and German Banks]

I've got 3 questions, please. The first one would be on the lower new business margin in this quarter. You also seem to have written some lower risk new business. Can you maybe talk us a little bit through the considerations of the risk-adjusted return on that business and whether that is a change in strategy or just where you saw opportunities in this quarter? The second question I would have is on the RWA decline of the Basel IV RWAs. Maybe you can shed some light into what has occurred there to see a decline under Basel IV. I understand that the risk density decline under Basel III will be largely evaporated under Basel IV, but what has driven the adjustment there? And then lastly, there's some revisions for CRR and CRD IV currently being discussed between the European Parliament, the European Commission and the council. Is there anything that you could see in there that could impact your capital position?

[Hermann Josef Merkens, Chairman of the Management Board & CFO]

If I may start with the last question, could you give me a hint what you have in your mind precisely with the CRR and CRD IV because there's so much under discussions, so many topics.

[Britta Schmidt, Partner, Spanish and German Banks]

Exactly. I mean, there are some changes to deductions. Most of them will probably not impact Aareal Bank, but there's some ideas about changing software, intangible deductions, about DTA deductions, about treatments of material holdings, et cetera. I was just wondering whether there's anything that you've spotted in there that could impact the bank?

[Hermann Josef Merkens, Chairman of the Management Board & CFO]

No, not yet, so to speak. Clearly, one has to look into the details. But as far as I have a view on that, there should be no material impact on all those items. And with respect to the lower margins, the question here is -- or your question was whether there's a change in strategy. No, because we are clearly following our new business approach doing business in the U.S. and in Europe. And hence, there is no change in strategy. But as I've said, we do have simply different [ strats ] in the new business, which is half-and-half U.S. and European business. And hence, I think that, that is -- and I am aware that is at least reflected in the Q2 margins. And as I said and stated, we are clearly targeting our full year business margins as explained. And therefore, I would think that we will be able to fulfill the business targets on that in 2018. The more interesting question is, so to speak, how that will move on in 2019, but little bit too early to look into that. But here, it's really the question whether one should follow this margin decline in Europe heavily or whether one should pause, so to speak, a little bit, because I pretty much think it's not the time to increase the risk appetite and to look after higher LTV business. The other option clearly is to look into whether one do AB structures with a reasonable LTV value. But at least I think we will do that or review that during our planning process. So more on that maybe in Q3. But clearly, the overall margin development in Europe is still, so to speak, deteriorating. So with respect to your question in Basel -- with respect to Basel IV it's -- the Basel IV, to a certain extent, is a tricky calculation to some extent because simply portfolio shifts. If we do more new business in portfolios which are in hard test eligible countries, that could change the RWAs. If we do have repayments with higher LTVs, that could change the bulk -- sorry, the RWA density as well. So -- and as we had both elements, new business compared to the first quarter, new business in countries with hard test, the overall new business RWA might be, even under Basel IV, lower compared to the first quarter if I do EUR 1 billion in U.S. and do not have a hard test privilege. And if I now do again EUR 1 billion in the U.S. but accompanied roughly with EUR 1 billion in Europe, France, especially France and U.K., the RWA density in the new business is better. And secondly, if I'm repaid on business which is above 60% LTV, there's a threshold in this Basel IV calculation, then for all of a sudden, the overall Basel IV density is benefiting from that as well. And you may remember that I said that even under Basel IV, one has to have a kind of management buffer to deal with overall volatilities. And so that's the kind of first example in the right direction, to be honest -- in the right direction that even Basel IV is, to a certain extent, volatile.

[Operator]

The next question is from the line of Benjamin Goy of Deutsche Bank.

[Benjamin Goy, Research Analyst]

Also 3 questions from my side, please. Yes, you highlighted your underlying net interest income run rate came out better than you originally expected and also seems like you raised this range a bit at the upper end. Just wondering, is it all driven by the U.S. dollar, which is clearly helping or also a bit more positive view on underlying opportunities? Secondly, excess capital is still unchanged wording, so further review in 2018. Over the last 6 months, since you first gave this guidance, has the probability increased or that you rather would return capital? Or anything on the M&A front, which you will be more positive on? And then lastly, more of a midterm strategic question, now with the rise of WeWork and your ultimately short-term renting, just wondering how do you think about office or -- yes, lending towards offices? And yes, which -- as officially is to the [ OLEG ], sorry -- yes, can perceived to be lower risk in -- within CRE lending? So just wondering what are your thoughts here?

[Hermann Josef Merkens, Chairman of the Management Board & CFO]

Yes. Thank you very much for your questions. So if I may start with the probability questions or question. So unfortunately, for that event, we do not have a kind of -- and that came into my mind as you raised the question with the probability, evaluate-first model with the probability forecast, so to speak, just a little bit joking. But on the other hand, we clearly said, yes, we will take some time looking into business opportunities on Aareon and maybe on other ends. So if a business opportunity is there, then we clearly will do that instead of doing some excess capital [ dispersion ] to the stakeholders. We are still working on that, and hence, the probability clearly increased because the time that is now -- the remaining time, is shrinking towards the end. So by nature, one should expect further guidance on that. On the other hand, we are working on M&A thoughts as well at the same time. And not to forget, the overall market volatility increase, I would say, more or less dramatically across Europe in the last couple of weeks. So -- and that was my very end comment. Always with respect to those questions that clearly one has to have an environment where when one really is able, willing, and on the other hand, one should distribute capital at that moment to shareholders. With respect to net interest income, clearly, a nice uptake, which is driven and supported, clearly, by the U.S. dollar. But on the other hand, you've seen that we are portfolio volume-wise on EUR 26.5 billion now. We started with EUR 25.9 billion, if I have that correctly, in Q1. So both ends are clearly supporting and supportive higher portfolio, and to a certain and lower extent or smaller extent, the U.S. dollar. With respect to WeWork, generally in Germany, we do have, so to speak, or have in the past, the privilege, those which are engaged in the property market, that the overall lease term is somewhat 5 to 10 years. If you look into other markets, the lease term has been by far not in this area. So sometimes you see 3 -- 7 years or even shorter terms. So hence, I would not rule out that certain markets will switch to very short term or more managed by WeWork, so to speak, properties. On the other hand, it will be interesting to see whether WeWork will win the race or whether the property owners themselves are looking much more how to generate a profit out of IT tools, et cetera, et cetera, because some of the business margin they are losing, so to speak, to WeWork. And there are other IT tools, if I may so, around which would allow property owners to do the WeWork game by themselves. So we will see how that will work out. Although it is a really interesting development which would lead to the fact that we do have hotels where you have to rent out every room, every day, 365 days a year, where we have shopping centers, where you have to manage the turnover every day, every year, 365 days. And last but not least, even maybe office buildings, following more or less the same attitude. And if I may have an analogy, so to speak, to the hotels. Yes, in private times, hotel revenues are coming down very fast. On the other hand, they pick up very fast as well. So at least that would lead to higher amplitude and cycles. On the other hand, it should not necessarily be a bad thing to have quicker reversion of lease terms. And I think it's more with the companies because they have to pay the WeWork as well on a daily basis. And the play to rent large volume or do large-volume leases in the downturn for 15 years, that is over for companies as well. So there's always, so to speak, the flip side on the argument. But as you, I think, pointed out, I would expect a much more managed intense play with offices, which we see with shopping centers and hotels anyhow.

[Operator]

[Operator Instructions] The next question is from the line of Tobias Lukesch of Kepler Cheuvreux.

[Tobias Lukesch, Equity Research Analyst]

Two to three questions from my side as well. First, I have to follow up on the net interest margin expectation or your guidance you gave for the full year. You just said that, yes, a proportion is probably gaining in importance for the full year. So if we look at the margin guidance, is that fair to say that we can expect the kind of 190 to 200 bps range, including ForEx? Attached to that question is, let's assume that after this very strong EUR 2.7 billion in new business, EUR 2.4 billion net, you are not as aggressive in H2 than you were probably in H1. And you end up with a EUR 7 billion in new business in 2018, expecting more or less unchanged U.S. dollar at 1.13 to 1.16, where would your total portfolio size and real estate end up by year-end? And finally, on costs, you said, okay, you're not expecting reversals in Q3, Q4, so we would expect this is done. So you have this EUR 25 billion transforming costs planned for 2018. Now you spent EUR 8 million, if I'm not mistaken. Is that something which is more or less set in stone for 2018? And is there eventually something that will be postponed or to be maintained in 2019?

[Hermann Josef Merkens, Chairman of the Management Board & CFO]

Yes, thank you for your questions. I would never say with project that something is set in stone, it could be go up or down. On the other hand, all the projects are started and running. And so to speak, simply shift into 2019 would clearly somewhat affect the admin expenses in 2019. So hence, I would say and I would expect that we would end up around the EUR 24 million number. And your calculation in that respect is, so to speak, right, that there is EUR 24 million minus EUR 8 million, so to speak, volume left, which one should expect in Q3 and Q4. With respect to the margin, full year target, it is still intact with the 190 to 200 basis points. All what we see in our deal pipeline is the directing into that corridor, little bit above at that point in time. But I would say, we will see how the second half will develop on that end. And from the portfolio size, I do expect the portfolio pretty much in line with our full year target of EUR 26.5 billion. So clearly, if Turkey or something other will blow up, we will see how that affect overall market situation. But that is our general rule on that.

[Operator]

The next question is from the line of Philipp Häßler of equinet Bank.

[Philipp Häßler, Director of Research]

I'm Philipp Häßler, equinet. I have 2 quick questions, please. Firstly, on the margin development again. Quarter-on-quarter new business margin was down, was it only due to the lower proportion of North American business? Or were there any other regions where you had lower new business margins? And secondly, you just mentioned Turkey again. So I'm just curious to know whether you are now, I mean, happy is probably the wrong expression but whether you feel comfortable with the EUR 110 million net exposure or whether we can expect a further reduction in the coming months or quarters?

[Hermann Josef Merkens, Chairman of the Management Board & CFO]

Yes, thank you. If I may start with the last question and you express that quite right. I'm happy that we've been able to manage that down from [ EUR 700 million ] to EUR 110 million. Whether I'm really happy with the remaining portfolio, to a certain extent, yes, because I pretty much think that we are, in general, good provisioned on the NPL. And on the other hand, that our outstanding performing loan, is just one, is working like -- as planned. On the other hand, would we really pitch aggressively for a repayment? Not really, and so far, we are "happy" with the portfolio. And on the other hand, if there's an opportunity to be repaid, then we really will grab this opportunity as we've done in the last couple of months. And just want to remind everybody that we've seen end of Q1 was EUR 250 million somewhat, and we are now down to EUR 110 million net. And we've done that during the Q2, simply indicating, yes, we're working on that. We are not paying for that. But on the other hand, if we have the opportunity to be repaid, then we will follow that. If we don't have the opportunity to be repaid, then we will stay with the portfolio. And EUR 110 million, I think, at least, is a size, which is manageable. Could you remind me on your first question, please?

[Philipp Häßler, Director of Research]

It was on the new business margin, the decline quarter-on-quarter?

[Hermann Josef Merkens, Chairman of the Management Board & CFO]

Yes. It's simply the mix, so to speak. We've done business, as I said, in France, U.K., some Netherlands and the peak was like this. And the indication in our R&D pipeline is still that we are able to fulfill the full year business target on margins. It's this, to a certain extent, challenging environment as it is. But I pretty much think that we are able to manage -- to meet the full year business target.

[Operator]

There are no further questions at this time. I hand back to Jürgen Junginger for closing comments.

[Hermann Josef Merkens, Chairman of the Management Board & CFO]

So no, it's a question to you, as I indicated. So I think Q2 again was very robust. And as you see, all items that are in our hands, we have managed quite well. All items which are somewhat not in our hands, we will have to see. And as I said, especially with derecognition income, we will see how that will charge the second half. And hence, I think this will be an interesting Q3 call in many aspects. And I think even in the last -- next couple of months, we will see that our new business volume will go up, and I do not expect further irritations, if I may so, around the [ RM ] business. So we are well in line to meet our outlook. Thank you very much.

[Operator]

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