Aareal Bank AG

XETRA:ARL

Earnings Call Transcript 2019-Q2

[Jürgen Junginger, Managing Director Investor Relations]

Thank you, and good morning ladies and gentlemen. My name is Jürgen Junginger. I'm heading IR with Aareal Bank and I'd like to thank you for joining our Q2 conference call. Our CFO, Marc Hess, will present you the figures. And later, we will be happy to take your questions. Marc, please.

[Marc Oliver Hess, CFO & Member of the Management Board]

Yes. Thank you, Jürgen. Good morning from my side, too. Thank you for joining. I'm happy to present our Q2 figures to you today in detail. Let me just start with the overview on Page 3. As you can see there, certainly, we showed a solid development in the second quarter and in the first half, too, in line with our plan. We showed a robust Q2 result of EUR 61 million, so absolutely in line with the first quarter and on the same level as in the second quarter. The new business was really good. We are absolutely in line with our target, both regarding new business for the full year and regarding the portfolio size that we want to keep stable, as you know. We continue to focus on attractive risk returns, so you will see in a second that we are above our planned margins for 2019, and we generated that business at really good LTVs. When it comes to the integration of the DHB, we can say that it was successfully completed both in time and budget, or, to be more precise, even a little bit below budget, so cheaper than originally expected. Aareon, on the other side, continued its strong development. Here, we see a really positive trend in the sales revenues, especially in the digital solutions. And of course, as you would expect, this is all done on a solid capital base. So we are above 17% in Basel III and above 13% in Basel IV figures. All that said, and on the basis of this good development in H1, we are confirming our outlook for 2019.So let's go into the details. I would like to start as usual with Structured Property Financing segment. Here, you can see the details on Page 5. Regarding new business, we generated EUR 2.4 billion of new business in a market where transaction volumes really came down significantly, especially in Europe. Here, the transaction volumes on stabilized loans were roughly 20% below what we saw last year in the second quarter. And in North America, the development a little bit better with minus 6%. On that basis, nevertheless, we generated that volume and kept the high margin level. We are at 205 basis points in the second quarter and 225 in the first half, so still well above the 180, 190 target range for this year. And I could say that I'm confident that we will be at the upper end of this level at the end of the year. Regarding the LTVs, we even improved our LTV slightly compared to last year. So LTVs were at 59% in the first half versus 60%, so we can say that this margin level was not generated at the expense of higher risk. When it comes to the portfolio size, at the end of the second quarter, we were at EUR 26.6 billion, so in line with our target range. But I can also say that with the new business came many commitments that were just paid out in July. So at the end of July, at the 31st, we were already at EUR 27.4 billion, so at exactly the same level as at the end of last year. And therefore, we made a tick on keeping portfolio stable here.When it comes to the Consulting/Services segment, the operating profit was unchanged. Here, you know this segment comprises 2 business lines. One is our transaction and deposit business where the deposit business, of course, has high strategic value for us as a funding source. Nevertheless, it is certainly burdened in this negative interest rate environment and therefore, not generating a positive NII contribution. Second, very important part certainly is Aareon, and here, you can see that the positive trend continued. Aareon increased its sales revenues from EUR 57 million to EUR 63 million quarter-over-quarter. So a nice increase of 11%, even above our target. And here, again, driven by the digital solutions with an increase of 22%. So here, we are exactly performing as we planned and very confident that we will reach our midterm target, at least on the basis of this good development in the second quarter and the first half of this year. The operating profit of Aareon in the first half increased from EUR 14 million to EUR 17 million. So you can also see that it is not only a top line growth, it's also materializing in the bottom line. Going into the P&L in more detail, but first, starting with the overview on Page 8. NII was stable here in the second quarter. The derecognition result is in line with our expectation this quarter, purely from CRE repayments. LLPs are also in line with our expectation. Here, you know the volatility throughout the year. You are aware of that. Net commission income, as just said, nicely increased, driven by Aareon; and admin expenses are basically flat. Here, we'll come to the development in a second. Of course, you know that Q1 is always distorted somehow. So operating profit at EUR 61 million as I already mentioned.On Page 9, deeper look into NII and derecognition result. So as just said, the core NII was stabilized or is stabilizing on the back of the good margin development that we see. When it comes to the derecognition result, we talked about that Q1 was somehow affected by positive one-off from the adjustment of our treasury portfolio. In the second quarter, we can see a different picture. So here, the EUR 11 million are purely from commercial real estate repayments. Certainly also, the lower interest rate level also contributed somehow on that side. When it comes to the LLPs, on the next slide, as just mentioned, we are in line with our full year guidance. However, volatile throughout the year. So typically, Q1 shows very low LLPs. In Q2, we were rising a little bit above even the second quarter last year. The effect here comes from some new NPLs in U.K. I will come to that in a second on the respective slide, but we also had some releases of provision, so these new NPLs were well covered by that releases.Net commission income, also just commented on that; a nice increase here. It's consistently rising, and I think the beauty of that business is really that it comes from Aareon, which is independent from capital market volatility. So I think we really have a differentiating factor here compared to other banks. And of course, we are strongly focusing on realizing the potential that we have here midterm, as we explained to you in the Aareon's investor seminar.On admin expenses, well, first of all, we are coming back to the normalized level. Q1 always distorted by the monetary protection scheme and banking level, and this year, in particular, by the integration costs of DHB with EUR 9 million in Q1. Here, we promised to you that this integration will be completed by the end of the second quarter, and we are delivering on that. The second quarter was only burdened by another EUR 2 million of costs, so even below our own internal expectations. And here, we can say this is now done, and DHB is fully integrated into the group. We even gave back the banking license. We also had some EUR 4 million of transformation costs and EUR 5 million reversal of provisions. So all in all, we can say that we are in line with the second quarter last year. And I would like to point out what's written here in the first bullet because this is also, let's say, reflecting Aareon's growth. You know that here, we are on different cost/income ratio levels. It's an industry type of business certainly. So the cost/income ratio is higher, around 80%, and that means that the growth that we show in the top line in commission income had some effects on admin expenses, too. So all in all, we have seen EUR 3 million of costs related to the growth of Aareon with a EUR 5 million revenue increase. And as I also said, bottom line, of course, it is a positive contribution.I would like to draw your attention now to capital funding and balance sheet, starting with the regulatory ratios on Page 14. All in all, we can say we kept the levels of the end of last year. So the Basel IV ratio is at 13.1% compared to 13.2% at the end of last year. The Basel III ratio is a little bit up at 13.3%. We recognize the interim result of the first half now, so that removed the deductions of the gross LLPs that we had to take into account in the Basel III ratio only in the first quarter. This is why we have seen an uptick here from Q1 level. Why have we done that? Because on the other hand, we have also fully recognized the prudential provisioning. That means that we have taken the linear approach here as an option, meaning that we have already provisioned 30% of the stock fully with the H1 results. You know that we should come to a 60% level until 2020, and we also took the risk -- or the prudential provisioning in the capital for the new NPLs that was EUR 17 million. Here, we also explained to you in our full year call that we would build a linear path here, EUR 35 million per year. So EUR 17 million have been recognized already now in the first half. We find that this is a much more prudent approach than waiting until the end and then taking it all at once. On top, as we have also explained to you already, the TRIM results are already fully recognized in these figures, meaning that they stand on a solid basis, and we are certainly confirming our 12.5% target for the Basel IV core Tier 1 ratio even if we grow the portfolio by the end of this year in line with our expectations.When it comes to funding, we can say that our funding plan for 2019 is mostly fulfilled. This is reflecting our good business pipeline. You can see the slight pickup here at the end of June, so this is where we funded the payout that we expected in July. You can also see that on the next slide then. Staying on Page 15, regarding the issuances, we issued 3 major papers, 2 Pfandbriefe, 1 in U.S. dollar, and also a senior benchmark, EUR 500 million over 5 years. So as said, we are well funded and basically through with our funding plan for this year.So turning on the next slide. Here, you can see that money market position increased by EUR 2 billion. This is, as just mentioned, mirroring the payout that we expected for July. So this is already diminishing now and coming back to normalized levels as we have already increased the portfolio by roughly EUR 1 billion. On the other hand, when it comes to the treasury portfolio, here, we are down again by EUR 300 million. You remember certainly that with DHB, it increased by EUR 1.4 billion. We said we want to readjust that to the original level. We have already decreased it by EUR 1.1 billion, so here, we are absolutely in line with our plan.Let's move to asset quality and the portfolio composition on Page 18. Here, you cannot see any bigger changes. I think the only thing that is worth commenting on is the increase in North America. You have seen that in the slide before, 50% of our new business came from that market. Here, we benefited from our global footprint, and were able to generate that business there, where the transaction volume didn't come down at the same speed as in Europe. So we are increasing our share to 31%, and therefore, well in line with our target to get to 1/3 of the portfolio. So absolutely in line with our strategy. That is also reflected on the next slide. Here, we have the LTVs and the volumes per country. In the U.S., you can see the slight increase of EUR 150 million. On the other hand, in U.K., it went down by roughly EUR 360 million, half of that from repayments and the other half from the low pound, so a pure FX effect. The other countries remained basically unchanged. Germany went back a little bit. And also worth mentioning, I also commented already on the LTV for the new business, that is also reflected here on the overall LTV of the portfolio that remained at 58%. So even a little bit better than in Q1 where we were at 59%, at the same level then at the end of last year.When it comes to the defaulted exposure on Page 20, we saw an increase. But as I already said in the Q1 call, we are confident that our NPLs will be significantly below the 2018 volumes by the end of this year. The increase came from the U.K. Here, we had 3 on-watch loans, all the 3 were shopping centers. In total, we had 4. So 3 of those 4 now defaulted, and they deteriorated so into NPL. That is the increase that you can see here. We started at 0 in U.K. So 0 NPL at the end of Q1, and this EUR 229 million purely relate to these 3 shopping centers. However, as I just said, we fully digested that in our risk provision, that is one aspect. And secondly, the NPL ratio in the U.K. is now basically at the same level like in France and other countries. Nevertheless, we continued with our adjusted NPL strategy. So taking a little bit more active stance, and we wait some first, but I can say little progress. You can say that -- see that in Italy. Here, we reduced our NPLs by EUR 50 million, but, and this is not reflected in that figure, we already signed another reduction of EUR 70 million. That is now due in the second -- in the third quarter, sorry. However, the LLPs are fully already booked in the second quarter. So this is why, as I just mentioned, we are confirming that our nonperforming loan exposure at the end of this year should be significantly below of where we started at the beginning of the year, and this is also already included in our LLP guideline. On top, certainly, we are not ruling out that if we see additional reduction opportunities, that we would also take them into assessment and also execute if they are attractive.Coming to the spotlights. The Italian portfolio, as just said, we saw some first reduction here. Apart from that, no bigger changes, so nothing I would comment on at this stage.That is different when it comes to the U.K. So here, apart from the defaults that I just mentioned, we have revaluated the entire portfolio with new external appraisals. So taking into account the more so huge economic outlook that is just materializing, that you can see here that most asset classes were more or less insensitive regarding their LTVs, if you compare that to the figures that we presented in the second -- in the first quarter. However, the retail cap rates went up remarkably. So the LTV on retail increased by, on the average, nearly 10%. You cannot see that directly here in the table because the 3 NPLs moved out of the sample. So that was a relief on that side. On this basis, we have recalculated our stress scenario, and we have again, calculated an additional stress of a property value decrease of 20%, leading to an LTV of 74%. So even a slight improvement compared to the first quarter. That means that overall, the new economic outlook that is now figured in shows a stable portfolio here. And therefore, apart from these 4 shopping centers that were on-watch, with now 3 defaulted, we feel comfortable with the portfolio from what we can anticipate today.When it comes to the treasury portfolio, also just hinted on that. We continued our portfolio reduction by EUR 300 million in the first quarter, mainly in the BBB bucket. As you can see here, the share decreased from 19% to 17%, so here, we feel very comfortable with that portfolio. And this already takes me to the outlook on Page 25. As mentioned initially, the outlook remains unchanged. So on the basis of this robust business development in the first quarter, we are confirming our targets for this year, as you can see them on this slide.So let me summarize. We showed a solid performance in the second quarter in a difficult and competitive environment. That means that we are clearly able to benefit from our USP as a specialized commercial real estate lender with a global footprint. We can confirm our targets on that basis, and we continue to deliver on our strategy both in the CRE business as well in the Consulting/Services, where we continue to develop Aareon according to the strategy that we explained to you in its investor seminar in May. So thank you for listening, and I'm now happy to take your questions.

[Operator]

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

[Britta Schmidt, Non]

I've got a few questions actually. On the asset quality issues, you said you saw some releases in the portfolio. Can you specify where you've seen them? And should we expect that the loan loss provisions are now more likely to be at the upper end of the target range with a more aggressive strategy? And then maybe just a bit of a nerdy question. Do you have any exposure to U.K. care homes as well? I also have a question on the CET1. Maybe you can just give us a number as to what amount you've reflected for the deduction for the stock of NPLs and confirm that you've accrued profits with an 80% dividend payout ratio. And then my third question will be, there has been some press comments regarding a potential safe disposal of Aareon. I would welcome if you could make any sort of comments on this.

[Marc Oliver Hess, CFO & Member of the Management Board]

Yes. Thank you very much for your questions. It was really a challenge to write them down in that speed that you asked them, so I hope I covered them all. If not, please remind me then. When it comes to risk provision, first, yes, we had some relief here. That was, well, regarding some NPLs that we had on the book for quite a while. They're still on the books, so you cannot see the LLP reduction yet, but at least one of these exposures is going to be reduced in the third quarter. We will certainly specify that in the call then. They are related to Continental Europe and to -- yes, to Continental Europe, both. Well, basically, Continental Europe or Scandinavia, let's say. I'm not quite sure where we should allocate that country to. So this regarding the LLPs. U.K. care homes, no, we do not have any exposure there. Your question regarding the regulatory ratios, the prudential provisioning, here, we deducted, as just said, EUR 17.5 million for the new NPLs. So that's 50% of the EUR 35 million that we calculated. And for the stock, it was 5 million or 6 million -- yes, 5 or 6, even in that range. When it comes to Aareon...

[Britta Schmidt, Non]

Can I just ask on this one, just quickly to follow up? So on the stock of NPLs, you have -- because the coverage ratio was around 30%, you have not allocated anything? So should we expect that a larger number is going to therefore see in 2020?

[Marc Oliver Hess, CFO & Member of the Management Board]

No, no.. We always said that for the stock, and you're fully right, we can take in against that the loan loss provisions that we booked. We expected roughly EUR 10 million. This is what we also saw last year already. Remember the stock was already covered last year. For the new NPL, it started with the year 0. So no provision last year; starting then this year. We said around EUR 10 million then. We said around EUR 10 million this year, and then we should already be in a balanced state. So we don't expect much on the stock going forward. Then you also asked on the dividend payout that we took here with the recognition of the result. Well, basically, here we have no choice, let's say, according to the form that we have to deliver to the ECB. That means we have to stick exactly to the dividend policy that we communicated. And therefore, we deducted 80% of the first year's result as a dividend. When it comes to Aareon, and the rumors around Aareon that you have suddenly read in the press recently, well, first of all, let me say that Aareon certainly is an integral part of the group. We've just presented our midterm growth strategy in the investment seminar. And as you can certainly also see here, we believe we have great opportunities that we want to realize for the group, and this is our first priority. So regarding your question, I have to ask for your understanding that we don't comment on those rumors or speculations.

[Operator]

[Operator Instructions] The next question comes from Benjamin Goy from Deutsche Bank.

[Benjamin Goy, Research Analyst]

Two questions from my side, please, both on treasury and the net interest income. So you mentioned you reduced the share of BBB rated exposures in your treasury portfolio. So just wondering now you're left basically with high-quality AAA, AA exposures, which is very likely a burden on your profitability, and that gets even bigger probably every day, so wondering what's the strategy here. And related to that, typically, say, your liquidity coverage ratios should be above 150%. Just wondering where we stand specifically at the moment. And was there any optimization potential, yes, is possible here?

[Marc Oliver Hess, CFO & Member of the Management Board]

Benjamin, thank you for your questions. Regarding the adjustment of the treasury portfolio, as I just mentioned, we inherited, so to say, some additional treasury volume with the integration of DHB that was EUR 1.4 billion. And we said that we want to bring that down to the original level. We have already reduced EUR 1.1 billion. That included some BBB exposures that we inherited from DHB. So for example, some Catalan bonds. They were already off in the first quarter. And we also adjusted, let's say, from a risk perspective our BBB exposure. You're certainly right. That is somehow a burden then on NII regarding the loss spread that we have, but we took that into account. As said, it was, let's say, a trade-off between risk and return. So we felt that we should be on the conservative side here. Nevertheless, we also see some, let's say, smaller adjustment possibilities in the treasury portfolio, in the overall management, for example, also in our cover pool, yes, the speed of where we -- of how we get the collateral into that. So it's really working on different bits and pieces to optimize our portfolio to cope with the lower interest rate environment. And as you can see, we are confident that we have some triggers for this year. And therefore, we confirmed our NII target. Regarding the LCR, we are not publishing the current level, but let me say, it's around 200 percentage points. So we feel comfortable on that level, and we wouldn't really reduce that for an optimization. There are other triggers, as I just gave some examples, which we are currently looking at.

[Operator]

[Operator Instructions] Next question is from Philipp Häßler from Pareto Securities.

[Philipp Häßler, Analyst]

Philipp Häßler from Pareto. I have 3 questions, please. Firstly, on the commission income, growth was very strong with 12% year-on-year. Was it purely normal business? Or were there any one-offs included? Maybe what do you expect for the next quarters, whether we will continue seeing such high growth rates? Then secondly, on the U.S. business, which was once again very strong and contributed positively to the new business margin. You are saying you're targeting this 1/3 of the portfolio coming from the U.S. So I would assume that contribution to new business and to new business margins would decline in the coming quarters from the U.S. once you've reached your target. Maybe you could comment on this, whether this is true or whether there will be some offsetting factors. And lastly, a number of questions, could you remind us again of your Italian government bond exposure?

[Marc Oliver Hess, CFO & Member of the Management Board]

Yes. Thank you very much for the questions. Regarding commission income, yes, we had one small extraordinary effect that was the first time consolidation of plusForta, the company that we acquired here. That contributed EUR 1 million -- I'm not quite sure now, I think in the first half, not in the first quarter, first half, okay? In the first half. Some smaller effects on the cost side here to, but I think nothing to comment on. The underlying growth itself is purely operational. So we expect that to continue. We know that, let's say, to keeping the pace, especially on Aareon, we need further investments, yes? This is what we presented to you in the investor seminar. So targeting the 7% to 9% CAGR of the whole Aareon business. This is starting. So these investments are starting as planned in the second half of this year. But so far, as said, even without, we are holding that pace. So apart from the volatility you're certainly aware of that we always see, according to the seasonality in the fourth quarter, as said, that's the trend and it's purely operational. The new business contribution from the U.S., certainly, 50% are a little bit above average, but please also taking account the portfolio in the U.S. is maturing on that level, so we also see some paybacks. And you can see that in the development of North America that I presented to you here, the increase of the portfolio was "only" EUR 150 million despite of the 50% share in the new business. So don't expect that the new business share will come down dramatically. We have to have a certain level here to keep the portfolio stable and grow it slightly towards the 33-some percent that we target. Regarding the Italian bond portfolio, yes, this is part of the reduction that is reflected in that BBB figure. We started at the beginning of the year with a portfolio of close to EUR 1.1 billion, and we are now down to roughly EUR 750 billion -- EUR 750 million, sorry, yes. Million, certainly. So this is part of the reduction that is reflected in that figure.

[Operator]

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

[Jürgen Junginger, Managing Director Investor Relations]

All right. Thank you for joining our conference call. I would like to thank you, Marc, for doing the call. And if you've further questions, I'll be at the phone to answer.

[Marc Oliver Hess, CFO & Member of the Management Board]

Yes. Thank you very much from my side, too, and have a good day.

[Jürgen Junginger, Managing Director Investor Relations]

Thanks.

[Marc Oliver Hess, CFO & Member of the Management Board]

Bye.

[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.