Bank of Cyprus Holdings Public Limited Company (BOCH) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. I'm Merto, your Chorus Call operator. Welcome, and thank you for joining the Bank of Cyprus conference call to present and discuss the group financial results for the 9 months ended 30th September 2021. [Operator Instructions] And the conference is being recorded. [Operator Instructions] At this time, I would like to turn the conference over to Mr. Panicos Nicolaou, Chief Executive Officer; Ms. Eliza Livadiotou, Executive Director of Finance; and Mr. Demetris Demetriou, Chief Risk Officer. Mr. Nicolaou, you may now proceed.

Thank you. Good morning, everyone. Thank you for joining our 9 months financial results conference call. I'm joined by Eliza Livadiotou, Executive Director of Finance; Demetris Demetriou, Chief Risk Officer; and Annita Pavlou, Manager, Investor Relations. After my introductory remarks, Eliza will go into more detail on our financial performance and then we will turn to Q&A. Slide 4 summarizes the key highlights of the third quarter. I will briefly go over this. I will start with the macro. The strong recovery in economic activity continues and GDP has recovered to pre-pandemic levels. GDP grew by 5.3% in the third quarter and is expected to grow by around 5.5% for the full year 2021. We continue to support the domestic economy and extended EUR 1.3 billion of new loans in the first 9 months of the year, an increase of 35% compared to the same period last year. We continue to execute on our strategic priorities, demonstrated by the improvement in our performance. During the first 9 months of the year, we recorded a profit after tax of EUR 20 million, impacted by NPE sales and restructuring expenses. Recurring profit, a more indicative measure of our performance, totaled EUR 64 million year-to-date, of which EUR 13 million in the third quarter. More specifically, in the third quarter, we generated total income of EUR 139 million, down 8% quarter-on-quarter, impacted mainly by Helix 2 completion in June 2021. Net fees and commissions remained strong in the quarter and amounted to EUR 44 million, representing 32% of our total income. Following the quarterly decrease in our total income, assets-to-income ratio increased to 64% for the quarter while operating expenses remained flat at EUR 89 million in the quarter. Our capital position remains strong and comfortably in excess of our regulatory requirements. As at 30th September 2021, our capital ratios on a transitional basis were 20.4% for the total capital ratio and 15.3% for CET1 ratio, both pro forma for Helix 3. Deposits increased in the quarter by 2% to EUR 17.1 billion. And we continue to operate with a significant liquidity surplus of almost EUR 6 billion and an LCR of 294%. The third quarter 2021 is an important milestone for Bank of Cyprus. Following the agreement for the sale of around EUR 600 million NPEs in Project Helix 3, we achieved a single-digit NPE ratio for the first time since the financial crisis of 2013, achieving it a year early compared to our 2022 target. Pro forma for Helix 3, our cost of NPEs are now less than EUR 900 million and EUR 400 million on a net basis. Overall, pro forma for Helix 3, our NPE ratios are now reduced to 8.6% and 3.6% on a net basis. The performance of the loans under expired moratorium remained solid. 96% of performing loans whose payment deferrals have expired presented no arrears. This is a better performance than expected now nearly 11 months after deferral expiry and bodes well for future trends. Overall, we are pleased with the progress we have achieved to date. And we are well on track with achieving our medium-term targets. Reflecting on how we manage the bank over this very challenging pandemic period, we are pleased about the progress achieved in delivering against our strategic goals but also acknowledge where the challenge has been. I'm now on Slide 5. Firstly, asset quality has been much better than some half year. We have reduced the NPE ratio to single digit from just over 30% 2 years ago. We saw the cost of risk normalize in line with our medium-term expectations. Capital ratios have been preserved and modestly increased. Activity has bounced back from the pandemic lows with new lending this year at over 18% of pre-COVID levels. And we are confident about the continued momentum in volume growth. We have taken pricing actions, which alongside the recovery in activities, have seen strong growth in fees, now 15% higher than in 2019. We must, however, acknowledge the challenges. Our net interest income has declined mostly due to the NPE reduction but also reflecting the interest rate environment. We have managed costs tightly. While expenses were 10% lower in absolute terms, net efficiency ratio has been negatively impacted by revenue pressures. Slide 6 provides an overview of the macroeconomic conditions. As I mentioned in my opening remarks, the economy continued to grow in the third quarter by 5.3% facilitated by rebound in tourism, trade and manufacturing sectors. GDP is expected to grow by 5.5% this year, recovering to pre-pandemic levels by the end of the year. And this strong growth is expected to continue in 2022. Leading economic indicators show continued upward trend, giving confidence about healthy consumption and business activity into the next year. With the additional implementation of the Cyprus Recovery and Resilience Plan, growth is expected to be sustained at pre-pandemic levels. 2021 tourist activity has recovered significantly year-on-year and the tourist season was extended until late October. Tourist arrivals saw steady monthly recovery. And October arrivals reached 90% of October '19 levels. We remain cautiously optimistic for next year. Slide 7, new lending. Loan demand remained strong across all business lines with EUR 1.3 billion of new lending in the first 9 months of the year, up 35% year-on-year. New lending continues to be carefully considered against robust assessment [indiscernible]. We have high-quality originations via prudent underwriting standards. And we make meticulous assessment of the repayment capability of our customers. Slide 8 to then present a short summary of Helix 3 and the [indiscernible] on our derisking strategy to date. Earlier this month, we reached an agreement for the sale of a portfolio of NPEs with gross value of EUR 568 million as well as real estate properties with book value of EUR 120 million. This is a profitable and capital-accretive transaction, allowing us to reduce the NPE stock by 40% and the REMU sold by 10%. Overall, by completion, Helix 3 is expected to add 67 basis points of capital and EUR 21 million on the group's income statement. We are reaching the end of a long journey that started in 2014. Our track record is excellent. Overall, since that peak, we have now reduced the stock of NPEs by EUR 14.1 billion or 94% to less than EUR 1 billion and the NPE ratio by 54 percentage points from 63% to less than 9% but with net organic reductions of over EUR 9 billion. We remain on track to deliver an NPE ratio of 5% in the medium term by continuing to deliver current organic NPE reduction and managing the post-pandemic NPE inflow. Turning now to Slide 11, where we provide an update on the performance of loans that were under expired payment deferrals. The performance of the moratorium portfolio remains strong and [ historically ] better than expected nearly 11 months after the deferral expiry and bodes well for the future trends. As shown on the slide, EUR 4.7 billion loans on the performing loans under expired moratorium have installment due by 22nd of November. 96% of these performing loans present no arrears and roughly EUR 590 million have been restructured. Our arrears remained low at EUR 186 million or 4%, out of which EUR 178 million of this early arrears were less than 30 days. The trends remained strong for both the portfolio of loans under expired payment deferrals, private individuals and businesses. We, of course, acknowledge that the uncertainty in the market remains, particularly following the emergence of a new variant. And we continue to closely monitor the sectors vulnerable to pandemic. And we [indiscernible]. I will now hand over to Eliza to take you through our financial performance in the third quarter before turning to Q&A. Eliza?

Thank you, Panicos. So good morning from me, too. I'll start with Slide 13 on the income statement. Net interest income was at EUR 71 million for the third quarter, down 6% Q-on-Q reflecting the completion of Helix 2 in June. The net interest margin for the quarter fell to 134 basis points, impacted by the reduction in NII following Helix 2 completion and the 3 percentage point increase in the average interest earning assets that is [indiscernible] in liquid asset form. Noninterest income for the third quarter amounted to EUR 68 million compared to EUR 76 million in the previous quarter. The Q-on-Q decrease is mainly due to lower insurance income. We shall discuss this further on Slide 17. Total operating expenses remained flat at EUR 89 million for Q3. And total loan credit losses, provisions and impairments were EUR 26 million for the third quarter compared to EUR 24 million in Q2. Other cost of risk stood at 78 basis points. Profit after tax and before nonrecurring items amounted to EUR 13 million in Q3 and EUR 64 million for the 9 months. We achieved a return on tangible equity before nonrecurring items of 3.3% for Q3 and 5.2% for the 9 months of 2021. The overall result was a profit after tax of EUR 19 million for the quarter and EUR 20 million for the 9 months of the year. Moving now on Slide 14, the drivers of NIM. As I previously mentioned, our NIM in the quarter decreased to 134 basis points and was negatively impacted by the reduction in NII following the derecognition of NPEs as well as the increase in liquid assets. Our NII reduced by EUR 5 million or 6 percentage -- or 6% Q-on-Q, reflecting the EUR 8 million NII loss on the deconsolidation of Helix 2. We are encouraged by the non-legacy loans [indiscernible], which was up EUR 2 million, reflecting stable yields of 287 basis points. Our interest expense decreased due to higher wholesale funding costs following the issuance of [ EUR 300 million ] senior notes in June 2021. Our TLTRO III borrowing stands at EUR 3 billion. We have already reported an NII benefit of EUR 7 million for the 12 months to June 2021. And the potential NII benefit was for the 12 months from June '21 to June '22 is currently estimated at around EUR 15 million, provided that the bank meets the net lending thresholds and this accrues to NII over the respective period. While as you can see, individual capital spreads were relatively stable, the largest driver of the overall decline in the net interest margin was the change mix of our balance sheet towards liquid assets. On Slide 15, you can see that over 1/3 of our balance sheet is balances with central banks and over half of our average interest earning assets are in liquid form. The increase in liquid assets reflects the continuing derisking, which replaces NPEs with liquid assets, our participation in the TLTRO program and the strong deposit trends. On Slide 16, you can see our deposit balances rose again in the quarter and now represent almost 76% of our total liabilities. Our loan-to-deposit ratio is down to 57%. While these welcomed trends from a country's perspective, they did have a dilutive impact on our reported margin. Now moving to Slide 17 on noninterest income. In the third quarter, noninterest income amounted to EUR 68 million, down 10% Q-on-Q, mostly impacted by lower net insurance income. Net fee and commission income remained strong at EUR 44 million in the third quarter. Net fees and commissions for the 9 months increased to EUR 128 million, above pre-pandemic levels, supported by the introduction of liquidity fees to a wider customer group and the introduction of a revised price list in February '21. Net insurance income stood at EUR 12 million, down by 36% on the previous quarter, impacted by seasonality and higher claims as well as the discount rate volatility. Net FX and other income increased to EUR 10 million, up 15% Q-on-Q mainly due to the increase in dividend income. Moving now to insurance on Slide 18. The underlying operating performance of our insurance companies continued flowing into Q3. Net insurance income for our life insurance, EuroLife, amounted to EUR 23.6 million for the first 9 months of the year, roughly flat year-on-year, as it was positively impacted by higher profit and premiums offset by a discount rate volatility. Net insurance income for EuroLife contributed 12% to total noninterest income. For our general insurance business, net insurance income amounted to EUR 19 million for the first 9 months of the year and remained broadly flat year-on-year, contributing 9% to total noninterest income. Looking now at expenses on Slide 19. Total operating costs for the third quarter were EUR 89 million. And despite the fact that operating expenses remained flat Q-on-Q, our cost-to-income ratio for the quarter increased to 64%, reflecting lower total income nearly impacted by Helix 2 completion. Beyond this year, we expect our cost-to-income ratio to decline through specific initiatives, including exit solution to release FTEs and further branch rationalization. And over the medium term, this is expected to increase to mid-50s. The medium-term guidance of total operating expenses below EUR 350 million remains unchanged. Now let's turn to capital on Slide 22. CET1 ratio and total capital ratio as at 30th of September stood at 15.3% and 20.4%, respectively. During the third quarter, we generated around 40 basis points of organic capital through operating profit; 10 basis points from the reduction in RWAs; and around 10 basis points from Helix 3. These were partially offset by expected loan credit losses and impairments of around 30 basis points. Our CET1 ratio on a fully loaded basis was at 13.3% as at December and 13.9% pro forma for Helix 3. I'll now give you an update regarding the changes in our capital requirements. Minimum capital requirements for 2022 for CET1 and total capital ratio is expected to increase to 10.09% and 15.02%, respectively, following a 27 basis point add-on in P2R due to ECB's prudential provisioning expectations and 25 basis point phasing-in of the O-SII buffer. Taking it in turn, the P2R add-on is dynamic and can be reduced during 2022 on the basis of in-scope NPEs and the level of provisioning. It is important to also note that the P2G reduction more than offsets the increase in P2R for the CET1 ratio. The second component is the total O-SII buffer, which is the Other Systemically Important Institutions buffer, which is now reduced by 50 basis points to 1.5%. And here, hence, there will be a 25 basis point phasing-in, in each January 2021 -- sorry, 2022 and 2023 instead of 50 basis points after the previous level. Now moving to asset quality on Slide 24. During the first 9 months of 2021, gross NPEs were reduced by EUR 2.2 billion to less than EUR 1 billion and to EUR 0.4 billion on a net basis pro forma for Helix 3. The reduction comprised of Helix 2 relating to EUR 1.3 billion gross loans; Helix 3 covering EUR 0.6 billion of gross loans; and organic reductions of around EUR 300 million. Pro forma for Helix 3, the gross NPE key ratio is reduced to 8.6% and 3.6% on a net basis. The balance to NPE coverage ratio was maintained at 60% pro forma for Helix. And then taking into account tangible collateral fair value, NPEs are fully covered. The coverage of reperforming NPEs is relatively lower at 22%, reflecting the lower risk associated with these type of NPEs whereas coverage of the core NPEs increased to 69%. Moving to Slide 26. As shown on the left graph, 71% of our loan book is classified in Stage 1, 20% in Stage 2. The coverage of these two stages amounted to 1.2% and 2.9%, respectively, whilst the coverage of Stage 3 loans stood at 43.1% pro forma for Helix 3. We are pleased with the performance of the moratorium book as only EUR 8 million of loans have migrated to Stage 3 during the quarter. In addition, during Q3, there was an overall net transfer of around EUR 150 million of loans from Stage 2 to Stage 1, reflecting the improved macro assumptions. Now moving to cost of risk on Slide 27. The cost of risk for the 9 months was at 66 basis points. And for the third quarter, cost of risk was up 78 basis points of gross loans. The stronger-than-expected economic performance allowed us to reverse part of our COVID-19 overlays amounting to 62 basis points. This reversal partly offsets the impact of model recalibration expected in the third quarter to address modeling improvements relating to the new default definition and updated curing and default experience. Overall, we currently expect the cost of risk for the full year to be in line with cost of risk for the first 9 months of the year. And we will, of course, continue to closely monitor the sectors that are vulnerable to COVID-19. Now let's have a quick look at our asset disposal engine, REMU, on Slide 28. For the first time since the beginning of 2017, the value of REMU sales have exceeded the value of properties onboarded. Pro forma for Helix 3, we completed disposals of EUR 212 million for the 9 months, up 280% year-on-year, reducing the REMU stock by 14%. And with that, I hand back to Panicos for his closing remarks.

Thank you, Eliza. Moving to Slide 31 and 32. Slide 31 provides a summary of our journeys and our priorities going forward. I will not spend too much time on this since these targets, of course, haven't changed in the previously discussed [indiscernible]. I am encouraged that we are delivering on this commitment this year and are well positioned to deliver them over the medium term. Slide 32 shows the medium-term strategic targets we set this time last year. I would like to remind you that the previous medium-term guidance was communicated in November 2020, when there was a great effect [indiscernible] pandemic. Since then, a lot has been achieved. We are currently working [indiscernible] on our business plan. And we expect to be in a position to update you on our targets after the application of our full year financial results. This concludes our presentation. I will now open the floor for your questions. Thank you.

[Operator Instructions] The first question comes from the line of Boulougouris, Alexandros of Wood & Company.

My first question is regarding NII. Could you please explain a bit better to understand the effective yield of liquids, which you mentioned increased by 13 bps on to EUR 2.7 million. You mean that in your NII in Q3, it includes EUR 2.7 million from Helix 2 still, which will be gone in Q4, I would assume. That's my first question. My second question is regarding costs, which excluding the Deposit Guarantee Fund, stable Q-on-Q, but including, they're higher. So could you please explain why is that? I mean, it was a higher deposit cost -- cost for the deposit contribution fund in Q3 compared to the second quarter and maybe understand a bit how this works because I thought it was more stable on a quarterly basis. That's my question on cost. And maybe on the cost side, if you could -- I know you will update us on the business plan on -- after the full year results. But if there is any clarity or if you plan to proceed with any new voluntary retirement plan that would help reduce costs, any color on that would be helpful as well. And also maybe a final question on -- given that you are now on an NPE ratio post completion of Helix 3 below 10% and your capital is above 20%, when do you think would be the time to start the conversation with regulators regarding dividends?

Okay. Thank you, Alexandros. I will start with the last question and then I hand over Eliza to answer -- to provide some clarifications on the NII and the cost. We know, and we -- I would say we very, very well know that the [ share return ] important for our [ shareholders ] and is extremely important for us as well. And this is why all of our efforts have been to speed up the [indiscernible] of the bank achieving this a year earlier than we have previously guided the market. So having entered into this single-digit ratio and having the capital ratio that you previously mentioned, we are currently finalizing our 3-year plan. And we plan to go and initiate a supervisory dialogue immediately after the application of our full year results. So this is our plan of action, complete our 3-year plan, announce our full year results and immediately initiate the supervisory dialogue for this subject. So Eliza, back to you on the...

Okay. So on NII, Alex, if I understand correctly, your question is on the Helix 2 component of NII. As we had said in previous quarters, as you might remember, we -- Helix 2 had a deferred payments component of the consideration. And that DPP is interest-bearing. So the EUR 2.7 million that we indicated on the slide for the third quarter is the NII coming from this deferred consideration effectively. And there will be similar numbers in the following quarters that amortizes. And you might remember, they expire, let's say, the final amortization is in 2025. So that's the NII point. On the DGF, it is -- the way the mechanics work in the law to create some volatility on a Q-on-Q P&L basis, it's a technicality. I think it's too much detail for this call. But the average for the year remains at the level that we've previously been guiding. It's just that the way the mechanics work because the government handles our contribution to the Single Resolution Fund, the European fund, meaning that Q-on-Q, there is some volatility, which should be neutralized for kind of -- on an annualized basis, let's call it. And on staff costs, our previous commentary -- I mean, previous quarter commentary, I think it's fair to say still remains. We haven't updated the EUR 350 million -- sub-EUR 50 million guidance that we have from November 2020, when we issued the guidance. We do look to update our guidance on the back of full year numbers. Having said that, we are currently running a new [indiscernible], a new staff exit plan, as we did in Q4 2020. And then the rest, we will provide more color together with our guidance next year.

The next question comes from the line of Cunningham, Corinne with Autonomous Research.

A couple of quick ones for me, please. Can you just elaborate why the Pillar II R went up, given that your nonperforming loans are coming down? I'm a bit surprised to see that, so perhaps a bit more color there. And the other one, the Ministry of Finance in Cyprus did a presentation on their debt issuance plans. And they talked about an asset management company plan to produce EUR 1 billion to EUR 1.5 billion capacity to remove nonperforming assets from the balance sheets in the whole of Cyprus, obviously. Do you have any information as to the timeline on that and your expectations as to whether you might participate in it?

Okay. Thank you, Corinne. I will again start with the last question. I know that the government, through the Ministry of Finance, are working on a plan. I wouldn't call it asset management company, I will call it -- from what we know in the market, I would call it an effort to support the vulnerable sectors that are vulnerable to retain their PPR residence. And in that respect, they have -- they are thinking of a [indiscernible] that is the -- that handles along the previous NPEs of cooperative banks. And in that respect, they are planning to use this as a tool that they offer to the banks to buy their, let's say, NPEs that are related with PPRs of less than [ EUR 350,000 ] value. I don't know the exact timeline, other than they are planning within 2022. But it's not a holistic AMC. It's just an effort to facilitate the, let's say, vulnerable borrowers with PPRs. So this is what I know from my information. And of course, this is an extra tool for us as a bank to speed up the resolution of our remaining retail NPEs. On the P2R?

On P2R, this is a formulaic calculation by the regulator, which you understand, is why we don't have a decision, let's say, for all the [indiscernible]. Relating to what [indiscernible] that formulates the calculation of the provision requirements by the regulator which is formulaic, it is expected [indiscernible]. Now the level with 27 basis points was set by the regulator and is a mixture of a 2020 December opening position and some element of dynamic evolution in the 9 months. It doesn't fully reflect our derisking up to 9 months. And we do look to more reduction -- look forward to more reductions into next year. We understand that regulators remind us to allow the flexibility, this dynamic component, let's say, in P2R. And we are fairly confident in our deleveraging or reduction in NPEs quarter-on-quarter for many, many years now that we can achieve adoption in this going forward. Just as a reminder, our P2R guidance has come down to more than [indiscernible] And this Other Systemically Important Institutions buffer has also been reduced. There was a decision yesterday by the Central Bank on this, which also the right direction [indiscernible].

The next question comes from the line of Quinn, Daragh with Keefe, Bruyette.

A few questions from me, please. First, just on the cost/income ratio guidance kind of medium-term target of mid-50s, given that you're effectively running at your cost targets to see that level of improvement in the cost-to-income ratio, you would effectively have to come from fairly decent growth in revenues. Maybe if you could provide just a little bit of color about how you plan to achieve that revenue growth, the mix between NII and fees? A second question on MREL. I mean, I know you're ahead of your short-term target. But just looking at the targets a bit further, the 23% requirements, just what are your -- what is the planning in terms of debt issuance to meet that target? And then final question on the organic NPE reduction, continues to remain strong. But obviously, the stock of NPEs is also falling. So just maybe if you could provide some outlook for what kind of pace of organic reduction you expect to be able to deliver over the coming quarters.

Okay. Thank you, Daragh. I will start again with the last question on the organic NPE reduction. Yes, there was a strong 9 months reduction of roughly EUR 100 million of cost there. And of course, as the NPE stock [indiscernible], then this number is expected to be repeated as well. So we do expect to have -- to continue to have significant organic NPE reduction next year as well. We have a machine that is about happen in [indiscernible] results. But the numbers will not be -- will be lower, I will roughly say EUR 50 million to EUR 60 million per quarter. But this is a rough estimation, having in mind that the stock has been [indiscernible] as well. That's on organic NPE reduction. On the cost-to-income, it's a combination of both increasing the income and, of course, decreasing the cost. On the cost side, we run -- I would say on the cost side, we run a significant, I would say, cost program, which is for the third year now. It, of course, is a priority for us. We do expect to have -- deliver in the next 2, 3 years based on the [indiscernible] program [indiscernible] for our branches, centralization, automation and of course, because of this, optimization of the number of our employees. So that means a new exit plan for our staff. So it takes some time to see the effects because, at the same time, you deleverage and you are losing the income. On the income side, you know that we have previously mentioned that we do have a kind of different focus of revenue increase. The obvious one is new lending. We have been growing this year for the first time because of net new lendings. And having in mind that our diversification initiative for EUR 1 billion new lending outside Cyprus and the guidance of 10% increase in the new [ term ], we do believe that this is actually very feasible. On the net interest income, our initiative actually [indiscernible] results, and we see the growth on the fees and commissions even since 2019. So if you combine them together, you can see the trend is not pretty obvious. That's why we plan to -- for early, let's say, to guide on these with more explanations after the full year results of 2021. So that's on the cost-to-income.

On the MREL question, so first of all, let me say that, as you might remember, our only binding target, interim target is for January 2022. And we have more than met that with issuance in the summer. Yes, we are aware and cognizant of the fact that there is a substantial amount of issuance to go. We are monitoring the market. And this is something that we'll look to do into 2022 or 2023, depending on the evolution of our balance sheet but also market conditions.

[Operator Instructions] Ladies and gentlemen, there are no further questions at this time. I will now turn the conference over to Mr. Nicolaou for any closing comments. Thank you.

Thank you all for your participation. As always, we'll be glad to take offline any questions or any further [indiscernible] you may have. Thank you very much.

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for calling. Have a pleasant day.