Deutsche Pfandbriefbank AG

XETRA:PBB

Earnings Call Transcript 2024-Q1

[Kay Wolf, executive]

Good morning, ladies and gentlemen, and a warm welcome to our analyst call today. Thank you for taking the time to join us today. First, my colleague, Marcus Schulte and I will give you a brief overview of our financial figures. And afterwards, we will be happy to answer your questions for which we will have sufficient time.

Allow me to start with a few messages that I consider especially relevant before we dive deeper into facts and figures.

Ladies and gentlemen, despite turbulent markets, we have made a solid start into 2024, as you can see on Slide #3. With a pretax profit of EUR 34 million, based on unaudited consolidated figures in accordance with IFRS, we have achieved the results slightly above last year's quarter. This puts us within the range of our full year guidance.

Our pre-provision profit of EUR 81 million benefited from a strong NII and realization income. As expected, our risk provisioning remains at an elevated level, albeit significantly lower than in the fourth quarter of 2023.

This brings me to a topic that I will discuss in more detail later: the active management of our balance sheet, both on the asset and liability side. It has been a priority in the first quarter, and it will be a priority going forward. We work on improving our return on equity and on creating more capacity for profitable growth.

Our existing portfolio remains resilient. The average loan-to-value ratio of 54% underlines the solidity of our book as a pure senior lender. Roughly 88% of our real estate finance loan volumes are collateralized with properties at LTVs below 50%. We have been able to further increase our margins in the portfolio and in new business as well.

In my first conference call 2 months ago, I emphasized that the market environment would remain challenging for the foreseeable future. That's why it is so important for the bank to have a comfortable liquidity and capital position. We were able to further improve our liquidity. And Marcus will come to that later, so I will keep this topic short here and directly hand over to him to walk you through the first quarter in more detail.

[Marcus Schulte, executive]

Thanks, Kay. Good morning, and a warm welcome also from my side.

Before going into more detail, let me walk you through highlights of our Q1 financial performance on Page 5. You may remember that I stress our strong operating performance when presenting our full year results. This continues to be a key driver.

Our solid Q1 pretax profit of EUR 34 million is the result of a still strong operating income of EUR 146 million which, in turn, is mainly driven by robust net interest income of EUR 125 million. Actually, we again benefited from slight portfolio growth and strongly improved new business margins.

So we continue to demonstrate operating resilience that allows us to stem the still elevated risk provision. At the same time, we fortified our already strong liquidity position and capital remains strong as well. Kay and I will come back to that in more detail in the respective sections.

Turning to Slide 6, you see the, again, supportive underlying development of our key balance sheet KPI. In line with our full year guidance, we were selective on new business and focused on strong risk-return profiles. Nonetheless, our rev portfolio continued to grow, albeit moderately. In combination with our rising margins, this continued to support our NII.

Also, the development of our cost-effective deposit funding remains encouraging. In the first quarter alone, deposits were increased by EUR 0.5 billion to EUR 7.1 billion. At the same time, we were making very good progress in reducing our noncore portfolio, helping our realization income. We have gained further momentum in reducing assets at attractive prices.

The overview on Slide 7 then shows on a year-on-year basis how we are able to stem increased risk provisioning of EUR 47 million with increased operating income. On stable cost, we were, in effect, actually even able to moderately increase profit before tax to EUR 34 million compared to a year ago.

As said, general and administrative expenses remained stable year-on-year as we managed to mitigate the ongoing inflationary cost pressures. However, let me reiterate the strategic objective remains crystal clear: cost has to come down from next year onwards.

Turning to Slide 8, we look into our operating income in more detail. As mentioned, NII benefited from our strategic portfolio growth and improved gross margins and was increasing on a year-on-year basis. However, NII is slightly down on a quarter-on-quarter basis due to a reduction of the noncore portfolio and increased refinancing costs.

Also realization income increased from EUR 14 million a year ago to EUR 23 million. Driver for realization income were, again, sales from the noncore portfolio and the buyback of corresponding liabilities. That said, robust realization income was slightly lower than in the exceptionally strong fourth quarter where operating income in general has been benefiting from some special effects that we discussed in great detail on the last call.

Taking stable costs into consideration, also our pre-provision profit remains very strong. Strongly increased on a year-on-year basis, it admittedly also benefited from the fact that there were no expenses for the European bank levy in the first quarter of this year, which saved us EUR 22 million compared to last year.

Turning to risk costs on Slide 9. At EUR 47 million, risk provisioning remained higher on a year-on-year basis, as expected, but was already significantly below the levels of the previous 2 quarters. Stages 1 and 2 of risk provisioning with a net increase of EUR 10 million continued to be dominated by the U.S. market. Changes in credit risk and the impact from interest rate increases in the U.S. were partially offset by a EUR 9 million release of the U.S.-only management overlay.

Turning to Stage 3, we also observed a continuation of previous trends, as expected. Just over half of the increase in Stage 3 of EUR 37 million is attributable to office properties in the U.S. The remaining Stage 3 are related to Project Development segment in Germany. We will take a few details on both of these topics in a minute.

Slide 10 shows how we further build up the stock of loan loss allowance on balance sheet. REF coverage increased by 10 basis points to 199 basis points. In Stage 1 and 2, we saw a net increase of EUR 6 million, all of which went to the U.S. Growth Stage 1 and 2 formation of EUR 10 million was partly reduced by Stage 3 migration. Stage 3 increased by a net of EUR 28 million. Growth formation that I mentioned of EUR 37 million was partly compensated by Stage 3 write-offs in the context of successful NPL management. I will come back to that as well.

Turning to our REF portfolio then on Slide 12. Our portfolio quality has continued to prove solid due to our focus on pure senior lending. We always stress that point. In addition to our general focus on prime properties in core locations, the portfolio also benefits from strong diversification. We've reviewed and, where necessary, revalued 100% of our portfolio in the last 12 months.

On the part which had to be revalued, the average value change on the overall performing REF portfolio is minus 10%. This is reflected in the average LTV of the performing portfolio which only increased slightly from 53% to 54%. The exposure at risk on the bottom right increased accordingly to around EUR 380 million as has the counterbalancing stock of Stage 1 and 2 loan loss provisions.

Turning to the nonperforming portfolio, we are on Slide 13. The nonperforming portfolio increased only slightly to EUR 1.65 billion. We have significantly reduced the dynamic through active NPL management. The 3 new additions in the first quarter were offset by 2 restructured or worked out loans in the U.S. To be specific, we restructured 1 U.S. loan, another 1 was repaid and both, again, at internal valuation marks.

The additions were driven by 2 U.S. office loans with Stage 3 formation and 1 German development without Stage 3 formation. We reviewed and, where necessary, revalued 100% of the portfolio in the last 12 months with an average value change of minus 32% on the part which has to be revalued.

Let's then take a look at the U.S. portfolio. At the full year press conference, we emphasized that we are fully focused on risk mitigation in the existing portfolio. As expected, the pressure on valuation continues. We reviewed and, where necessary, revalued 100% of the portfolio in the last 12 months with an average value change of minus 17%, 1-7, on the part which had to be revalued.

The average LTV increased from 64% at year-end to 68%. Accordingly, also here, the exposure at risk increased from EUR 100 million to EUR 163 million at the end of the first quarter. However, again, this was partially compensated by model-based risk provisioning in the magnitude of EUR 128 million, as mentioned.

The NPL portfolio in the U.S. increased by approximately EUR 50 million on a currency adjusted basis. Two U.S. NPL loans were added and 2 were successfully worked out. I already mentioned this, so I will keep it short here, again, we reviewed and, when necessary, we also revalued 100% of the portfolio in the last 12 months, here, with the revaluation change of an average minus 35% on the part which has to be revalued.

Turning to Slide 16, we further reduced our project development portfolio in the first quarter. As a senior lender, we benefit from our focus on experience developments. At the same time, we have decent granularity. We have 60 projects from 40 developers on our book. 2/3 of the projects are either in the so-called land phase, these are undeveloped plots of land, or in the completion phase.

Our risk mitigation focus remains on the remaining 1/3, which is the construction phase. We have seen 1 addition in Germany to NPL in the land phase with no Stage 3 assigned to it. I mentioned that. However, on 1 nonperforming German development loan in the construction phase, Stage 3 had to be increased, as mentioned.

Let me mention in addition, around 75% of the projects in construction and completion phase has been completed or are expected to be completed in the course of the year, which implies further derisking over time.

Finally, we have a new deep dive on our German book on Slide 17. The portfolio, which is focused on the big 5, is highly diversified across regions and types of use and is characterized by a continued low LTV of 52%. It is important to stress that NPL and Stage 3 formation in the German book has so far been entirely limited to the development space.

Let me then finally turn to the bank's liquidity and funding. Absolute liquidity stands at well above EUR 6 billion and has been further increased using the full range of instruments. Regulatory ratios remain well above requirements, namely the growth of retail deposits to EUR 8.1 billion at the end of April is well above the bank's funding needs, so we are now strongly reducing the interest rates we offer to our retail clients.

Also on the secured side, markets are resilient and open. We were able to tap our successful and oversubscribed January Pfandbrief benchmark by EUR 100 million at almost unchanged and, therefore, manageable costs. Our funding needs for 2024 are, therefore, largely covered. No further senior unsecured issues are planned for the remainder of the year. There's also limited need for fund given prefunding, a reduced balance sheet and our broad-based secured funding toolbox.

On Page 20, a deep dive on deposits. We see the impressive resilience of our retail deposits, which have grown EUR 1.5 billion since the beginning of the year, more of EUR 1 billion since we increased interest rates in March. Focus clearly remains on term deposits, which are now above 90%, so that the weighted average life has been increasing further to now 3.6 years. The generated volume was exceeding expectations and needs. So rates will be lowered in two steps by 100 basis points and volume is to be lower by year-end.

On Page 22, you finally see the openness and resilience of our core funding markets, both shown versus swaps, and they show that funding markets are ensuring manageable costs again for our liability side.

Thank you very much. And with that, I hand over to Kay Wolf.

[Kay Wolf, executive]

Thank you, Marcus.

Let's look at capital on Page 24. When looking at capital, I can keep it rather short. pbb remains well capitalized. CET1 ratio at 15.2% remains well above regulatory requirements with a comfortable MDA buffer of 550 basis points or roughly EUR 1 billion.

The European Parliament has now passed the Basel IV legislation, which is scheduled to come into force by January 2025. This puts us on a firm transition path to Foundation IRBA, which we intend to apply following ECB approval. Therefore, we begin to show you our pro forma ratios for this new world, which is a CET1 ratio of 16.3%.

Let us come to the active management of our balance sheet, Page 25. We have started in Q1 and intend to be much more proactive and dynamic across our entire balance sheet going forward. Overarching objective here is to significantly improve our return on equity.

We have picked up speed in the management of our noncore portfolio. In the first quarter alone, we sold assets with a volume of EUR 400 million compared to EUR 600 million for the full year 2023. Further transactions are in the pipeline.

Our proactive liability management has also been a priority. In addition to a balanced mix of secured and unsecured funding, this also includes the buyback of securities where this provides opportunities for the bank. In the first quarter alone, we bought back a volume of EUR 300 million, half of the full year 2023 volume.

In addition to that, we have also started in Q1 to look into proactive portfolio measures in our real estate finance portfolio. In May, we expect to sell a portfolio with risk positions in the U.K. and the U.S. It comprises financings for office, residential and hotel properties with a total volume of around EUR 900 million and would reduce our risk-weighted assets by a significant EUR 700 million.

I am convinced that transactions of this kind are an integral part of the bank's business model to be considered if they make economic sense and strengthen our return on equity.

In addition, we will, of course, continue to focus on new business as such transactions allow for more profitable growth in the future. Just last week, we announced the financing of a pan-European logistics portfolio. Other deals are also in the pipeline.

Let's have a quick look at the economic outlook on Page 27. Key interest rates have stabilized in recent months. This should support the real estate market going forward. The current market expectation is that ECB will cut interest rates somewhat earlier and somewhat more sharply than the U.S. Federal Reserve.

Turning now to our guidance for the full year on Slide 28. We see us on track to meet our expectations for new business, earnings and capital.

Ladies and gentlemen, let me summarize our presentation.

First, the bank has made a profitable start into 2024 and generated a solid pretax profit in the first quarter.

Second, risk provisioning, as expected, remains at elevated levels but significantly lower than in the fourth quarter of 2023.

And thirdly, we have started to manage our balance sheet much more actively in the first quarter and will continue to do so in the coming quarters. The focus will also be on our real estate finance portfolio, both performing and nonperforming.

Thank you for your attention. Marcus Schulte and I now look forward to your questions.

[Operator]

[Operator Instructions] And the first question comes from Johannes Thormann, HSBC.

[Johannes Thormann, analyst]

Johannes Thormann, HSBC. Some questions from my side. First of all, could you give us a bit more details on the German development NPLs? Why was no additional LLP is needed for the land development, whereas the additional LLP for the construction was done? So explain this.

Secondly, in terms of your portfolio sales of EUR 900 million, it's fair to assume that this business is showing also above-average margin, so you will probably lose a mid-double-digit amount of NII in the next year. Is it fair to assume? So I don't know, you lose 5% of your of NII or more.

And last, but not least, you only said costs to come down from next year. I thought costs should come down this year, alluding to the opportunity with this low regulatory costs and so on. And in this perspective, first of all, personnel expenses continue to increase. When does this trend revert? And when are they going down? And secondly, from your rising retail deposits, any implications for your regulatory costs?

[Kay Wolf, executive]

Thank you, Mr. Thormann. I think I noted 4 questions down and will probably share the one or the other answer with Marcus here as well. Let me start on the German development portfolio. And I think, in general, what Marcus also has stressed when presenting, we are consistently reviewing and revaluing our financings, and that holds also true for our NPL portfolio. And the addition that we have put on NPL as a land loan, with regard to the valuation, we feel comfortable that it doesn't require a loan loss provision at this stage, yes. So from that perspective, consistent revaluation is happening as it does for existing NPLs. And there, you see that we had to book an additional CLP to an existing development financing which, when you look into the individual transaction, it's very idiosyncratic and relates to the respective project. We are monitoring that very closely and have taken according action in the first quarter.

[Marcus Schulte, executive]

Perhaps one addition, Kay, from me. I think it reflects quite nicely what we've been saying, which is that in the land phase, we tend to have a plot of land in the big locations in Germany, which we don't see a lot of valuation risk or other risks in the construction phase, which is the focus of our risk mitigation that we do. And therefore, it ties into the overall discussion that we had last time and this time and, of course, Kay's comments.

[Kay Wolf, executive]

Then I would come to your second question around the sale of the EUR 900 million portfolio. And of course, yes, if we sell the portfolio, we are going to lose NII, that's part. Our NII is consistently driven by the overall volume of our portfolio. However, as you can see from our guidance, we do continue to expect EUR 30 billion to EUR 31 billion in terms of volume by the year-end. And our current real estate finance book stands at EUR 31.2 billion. So from that perspective, we remain comfortably within our forecast.

Nevertheless, we do this transaction because we see this portfolio as not generating enough return on equity that it is requiring. And this is why we do the transaction which, on the other hand side, allows us going forward to put on our books more attractive, more higher-yielding new business that will, going forward, allow for more profitable growth.

With regard to costs as well as the retail deposits, I would hand over, Marcus, to you.

[Marcus Schulte, executive]

Yes. Thank you, Kay. To cost, we start to deep dive this time, Johannes Thormann, because we had acquired it this time last time around. Essentially, what I was explaining last time around applies, which is that we have two very strategic projects in the bank, one of which is a very defining IT transformation project where we are essentially moving from a monolithic legacy structure to a multi-provider structure. This transition will be completed this year. The same applies to the streamlining of our credit decision engine where we also invested to save costs, also personnel cost. This will be finished soon as well, certainly this year.

And therefore, you see two effects from next year. First of all, the investment costs fall away, number one. And number two, the savings that these investments were meant to generate will kick in. And that's why the cost saving will be predominantly visible from next year onwards.

On the retail deposits, if you could repeat the question, I was acoustically not fully understanding. You were asking about regulation?

[Johannes Thormann, analyst]

Normally, if the retail deposit base continues to increase, you should also have a certain amount you have to pay to the German deposit insurance in terms of basis points. Will this lead to increasing cost or, as you said, your retail deposits will not grow but rather shrink now from your rate decision or interest rate decision that this will be an offsetting effect? What should we put into our models in the next year's regulatory costs?

[Marcus Schulte, executive]

I understand. So essentially, I think you see that quite nicely. On Page 22, we plotted, for the example of 3-year deposits, the pure external rate that we quote to our customers versus the swap rate. And you see, of course, that the cost that we effect are a function of two things, obviously: first, the movement of the swap curve; and secondly, our increases or decreases of external rates. And you see very nicely that increases generate a very strong reaction in Q4, March and April this year. And that, of course, also growth subsides when we lower. You see that we lowered already by 50 basis points and we'll lower by another 50 basis points.

Now the cost of the deposit insurance and protection scheme comes on top of that and is a linear function on the unit of deposits. So it's basically a linear transformation of that curve, meaning that we have to come back with that figure, 10 basis points or so were added to this curve on a linear basis, but we will have to come back to the precise figure.

[Operator]

Next question comes from Tobias Lukesch, Kepler Cheuvreux.

[Tobias Lukesch, analyst]

Also four questions from my side, if I may, as well. One on asset sales, the other one on capital, quickly on expenses, and lastly, on the NPL.

So starting with the asset sales, you guided for this EUR 0.9 billion in asset sales in Q2 and you also said that you target more sales in '24. Could you please share a ballpark number in terms of the total portfolio sales you're targeting? And attached to that, you're implicitly guiding basically for EUR 50 million in realization gains in '24 with strongly benefiting basically asset sales. Should we expect this number to be considerably higher, for example, closer to the EUR 85 million that we reported in '23? And what would be the kind of loss you expect basically from that portfolio, say, in terms of operating income?

Secondly, on the capital, what is the current CET1 ratio level that you're steering at for the next 3 months, 6 months, 9 months to come?

Thirdly, on the admin expense, a quick one on the noncore segment. There, the admin expenses decreased from EUR 7 million basically in Q1 and Q4 last year to only EUR 3 million. I was wondering if there are some extraordinary effects or if this is the new run rate we should expect for that? And then what you just mentioned in the earlier question in terms of cost savings for next year, could you please remind me what kind of number you expect, absolute number or delta you expect basically, next year to benefit from compared to '24 cost base?

And very lastly, we have seen a lot of Cigna Group entities now also filing for insolvency. Would you please quantify your direct/indirect exposure to the bankrupt Cigna entities, maybe also a provisioning ratio?

[Kay Wolf, executive]

Thanks, Mr. Lukesch. I noted down a couple of more than 4, so we will make sure that we get through everything. I would start with your last question. And I think I said it at the 7th of March presentation as well, reiterating we are not going to comment on any client relationship. And therefore, please understand that we will not be able to answer your questions on that. And also, I would reiterate that we'll keep that stance with regard to every client relationship also going forward. I think that is, for a bank, the appropriate way of handling relationships.

With regard to the other questions, I would hand over to Marcus on the other topics.

[Marcus Schulte, executive]

Yes. So you were addressing the question around general and administrative expenses. I think in the strategic update, we gave a general guidance on how we expect that to develop. And you see that our target is to be below the '21 or '22 level, which was roughly EUR 224 million G&AE, number one. Number two, we were also saying that our write-downs on nonfinancial assets, which are also increasing with the investments that I mentioned, would also come down. So it will not only be a G&AE in the magnitude that I mentioned but also the write-down on assets that we have, on nonfinancial assets.

Then you had a question, I think, on where we expect realization income to go. I think we also gave a guidance to that end. And I think we also said that Q4, with the EUR 85 million, was an extremely strong quarter. We also, I think, explained last time around that not only the realization income has been strong but also the other operating income has been very strong. You remember that also money saved for litigation was released because the litigation cases were basically not relevant anymore. In sum, we had a very strong and, I think, extraordinarily strong Q4 effect that you cannot extrapolate to the remainder of the year.

I think in the composition, what we expect is that for this year, the driving forces will continue to be noncore asset sales and the buyback of respective liabilities. But over time, I think what you will also see is, as the interest cycle and the REF cycle normalizes, that the normal prepayments out of our REF business will increase again. Historically, we were observing a realization income in the magnitude of EUR 30 million, EUR 35 million, so clearly lower than what we had it in 2023, but I would expect it to be in the ballpark this year.

Then there was one last question, Kay, noncore administration expenses. I think, of course, we have reduced our staff on the public investment finance business quite a while ago. So there are no further effects from that. But with a lower volume and also lower capital bound to it, there is less cost allocated to it. So it's more a cost allocation matter than it is an absolute reduction of costs, which are already reduced to close to nothing because we don't do that business anymore.

[Tobias Lukesch, analyst]

Understood. If I may follow up on the asset sales, so I'd get that correctly. So there might be additional, a couple of hundred billion sales for the 9 months basically or for the second half, basically because you announced the EUR 0.9 billion for Q2. So that might be something still coming. And then we might see a considerable or a similar impact on the operating income that you expect basically with the EUR 0.9 billion sale, right? And if you look at the portfolios, I think is it then fair to assume that the RWA relief would be lower than that EUR 0.7 billion versus EUR 0.9 billion of total that we see with the U.K. and U.S. portfolio, which might be a bit more higher-risk asset?

[Kay Wolf, executive]

Yes, that was the one, Mr. Lukesch, that I think was still left open where I tried to kick in. First of all, to the asset sales, we remain comfortable in our real estate finance portfolio to be at year-end between EUR 30 billion to EUR 31 billion. I think that's important when you consider that transaction at the moment, it is not intended to get our volume lower. So from that perspective, looking forward, the free up of the risk-weighted assets here, we intend to reinvest, and we do that with a very focused new business on a higher return basis. So that's what your model, when you look into that going forward, should assume. So don't please assume a rundown of NII out of that when we look towards the year-end. It's not the intention to get smaller. It's the intention to grow more profitable.

With regard to the noncore side of things, yes, we are going to accelerate our rundown of the portfolio. However, we have done this reduction over the last years already, so please continue to assume maybe with an accelerated path and we are looking into opportunities. And we do that not only from an asset side perspective, this is why we do that step by step, but also then, at the same time, considering the liability side of that business. So it's really a reduction on assets and liabilities, and we continue to do that.

And I think your last question that you had was on capital steering. I don't want to miss out on that because it's a very important question. We remain, as we have always been saying, committed to an ambition level of 14% on our CET1. That is and will remain our key ambition level. And you see when you look forward on the foundation approach, which we are showing as of Q1 with 16.3%, that I would call that leaves us with a solid capitalization going forward to further develop the business.

[Tobias Lukesch, analyst]

Exactly. And then does that projection going forward already include the asset sale? Or should we take the 16.3%? I think that's a pro forma as of today, right? So we take the 16.3% and add on another 60 bps from the Q2 sales, so we get close to 17%, correct?

[Kay Wolf, executive]

If you just take the sale, that's right. Yes, please don't forget, we also want to do and do new business, as I communicated. But you are totally right, on isolation, yes, the portfolio sale was the EUR 700 million is, of course, supporting CET1 and own funds ratio substantially.

[Operator]

[Operator Instructions] There are no further questions from the audience. I hand back to the company for closing remarks.

[Kay Wolf, executive]

Thank you very much. And honestly speaking, a bit surprised to say that, yes, but I take that, that we obviously have addressed all the questions in the presentation. And thanks very much for joining.

We will remain committed to be transparent and understandable in the way we develop the bank going forward and, therefore, appreciate very much your participation and looking forward to the next one. Have a good day.