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

Ladies and gentlemen, thank you for standing by. I am Gaily, 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 6 months ended 30 June, 2022. [Operator Instructions] 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; Mr. Demetris Demetriou, Chief Risk Officer. Mr. Nicolaou, you may now proceed.

Thank you. Good morning, everyone. Thank you for joining our first half of 2022 financial results conference call. I'm joined by Eliza Livadiotou, Executive Director of Finance and Legacy; Demetris Demetriou, Chief Risk Officer; and Annita Pavlou, Manager, IR and ESG. Before commencing my introductory remarks on the financial performance of the group for the first half of 2022, I would like to comment on the announcement that was published on the 19th of August 2022. Bank of Cyprus has received 3 unsolicited, conditional, non-binding proposals from Lone Star over the past 3 months, which the Board has unequivocally rejected. The potential of Fed is governed by the Irish Takeover Rules and the Takeover Bids Laws administered by the Cyprus Securities Exchange Commission. Under the Irish Takeover Rules, Bank of Cyprus management is prohibited from discussing any material or information, or significant new opinion, which has not been publicly announced. And we are also subject to restrictions regarding statements, which may constitute a profit forecast, asset valuation or quantified financial benefit statement. We may, therefore, be limited in responses that we may provide to some of your questions during the call. Any person interested in shares in Bank of Cyprus is encouraged to consult his or her professional advisor. In accordance with the requirements of the Irish Takeover Rules, the presentation, including any [ current date ] is being recorded, and the recording and presentation slides will be made available on the Investor Relations section of Bank of Cyprus' website. So, I will start now by highlighting some of the key messages of the first half on Slide 6. First, we see healthy loan growth momentum and extended record EUR 1.2 billion of new loans. Our net performing book grew by 4% during the first 6 months of 2022 and reached EUR 9.7 billion, up 8% from EUR 9 billion 18 months ago. Second, we delivered a healthy profit after tax before non-recurring items of EUR 59 million with an underlying return on tangible equity of 7.3%, converging to our medium-term target of over 10%. An important driver of this performance is our non-interest income that amounted to EUR 154 million in the first half, representing over 51% of total income, driven by higher fees and commissions and higher insurance-related income. Our insurance business recorded a 6% increase year-on-year and is a key contributor to income growth. Equally important, we are seeing that net interest income has now bottomed and we expect a steady improvement from here. Third, in July, we successfully completed a voluntary exit plan through which around 550 applicants were approved to leave at a total one-off cost of around EUR 99 million to be recorded in the third quarter. The estimated annual saving of EUR 37 million represents 19% of total staff costs. Simultaneously, we have reduced the number of branches 20 year-to-date to 60, a reduction of 25%. Fourth, our capital position remains robust and comfortably in excess of our regulatory requirements, after absorbing in full the cost of the voluntary exit plan. As at 30th of June, 2022, our capital ratio on a transitional basis were 19.3% for total capital and 14.2% for CET1. Both pro forma for HFS and VEP has remained well above our target of maintaining a capital at a range of 13.5% to 14.5% for the period 2022 to 2025. The process of balance sheet de-risking is now largely complete. During the first 6 months of 2022, we reduced our pro forma NPE ratio to 5.7% and to 2.4% on a net basis. We remain well on track to achieve our target of NPE ratio of 5% by the end of this year and to less than 3% by 2025. Our cost of risk at 43 basis points in the first 6 months of 2022 remain well within our normalized target range. Our transformation plan is already in progress and aims to enable the shift to a modern banking organization. Our digital users continue to increase. Since the beginning of the year, active digital users have increased 8% to almost 400,000, while our active mobile banking users have increased by 8% to 344,000. Moving now to Slide 7, which provides further details for our performance in the first 6 months of 2022. I will briefly go over this. Despite concerns regarding the outlook for global and European economic growth, the Cypriot economy continued to grow strongly in the second quarter with GDP increasing by 6.1%, significantly outperforming the Euro area. The strong touring season is expected to support growth this year, with GDP in Cyprus projected to exceed 5% in real terms in 2022, according to the Ministry of Finance. During the first 6 months of the year, profit after tax before non-recurring items reached by EUR 59 million, up 20% year-on-year, driven mainly by 12% year-on-year increase in net fee and commission income and lower impairments. The reported result for the 6 month period was a net profit of EUR 50 million compared to EUR 1 million a year earlier. The cost to income ratio stood at 58% for the first half 2022, broadly flat year-on-year. Deposits increased in the second quarter by 4% to EUR 18.5 billion, and we continue to operate with a significant liquidity surplus that now totals to EUR 6.7 billion. We are well positioned to benefit from further interest rate increases. Turning now to Slide 8, which states the drivers of our upgraded near-term guidance. We operate in an environment of increased geopolitical risks, resulting high macro uncertainty with high inflation and central banks embarking on a constrained interest rate tightening cycle. We now expect a faster normalization in interest rates, as this has provided a big boost to the banking sector. We are one of the most geared banks forward driving rate and we are, therefore, upgrading our near-term performance to reflect a strong recovery in net interest income and group profitability. Group NII has bottomed and we expect for full-year 2022 NII to reach roughly EUR 320 million, an increase of 8% compared to prior year. NII is expected to increase further in 2023 by between EUR 100 million to EUR 120 million on a yearly basis, an increase of 30% to 35% from the expected 2022 level. These improvements in NII demonstrate faster repricing of loans and liquids than funding costs. Net fee and commission income for the first half of 2022 remained strong. However, it is likely to be under pressure in the near term, mainly due to the phasing out of liquidity fees in 2023. We have made considerable progress in delivering a lean operating model through the efficiency plans that were completed in July 2022 ahead of schedule. The reduction in the number of employees and branch network unlocks meaningful savings from 2023, allowing us to absorb inflationary pressures on total operating cost. All efficiency actions and improved revenue outlook lead us to review our cost to income guidance. We now expect cost to income ratio for full year at around current levels compared to mid-60s previously expected. And now our cost to income to converge to roughly 50% already in 2023, confirming the near-term guidance of 50% cost to income ratio. The cost of risk remains under control, mainly reflecting the strong and resilient loan portfolio performance in the first half and we expect cost of risk to reach 50 basis points in 2022. The cost of risk is expected to range between 50 and 80 basis points in 2023, a wider range than normal, reflecting considerable overlays for the prevailing uncertainty of the macroeconomic outlook. We expect to maintain healthy capital buffers, and we remind you that the implementation of IFRS 17 on 1st of January 2023 is expected to have a positive impact of around EUR 50 million on the group's tangible equity, enhancing group's CET1 ratio by around 50 basis points. As a result of these updates, we now expect to reach double-digit ROTE a year earlier already in 2023, laying the foundation for a meaningful capital and dividend distributions, which we expect to resume in 2023, subject, of course, to regulatory approvals and market conditions. Slide 9 and 10 provides an overview of macroeconomic conditions. [ The challenging ] geopolitical risk following the Russian-Ukrainian war and the sanctions imposed on Russia have profoundly changed the global macroeconomic outlook and increased uncertainty. GDP in Cyprus grew by 6.1% in the second quarter of 2022, facilitated mainly by the faster-than-expected recovery of tourism and the continued expansion of export of other services. Economic growth is further supported by the [ increased ] employment rate in the second quarter of 2022, increased wages and continued deposit inflows. The strong tourist season is expected to support the growth this year with GDP in Cyprus projected to exceed 5% in real terms in 2022, outperforming the Euro area. Tourist arrivals in the first 7 months of 2022 reached 77% on the corresponding 2019 levels. Likewise, tourist revenue in the first half of 2022 reached EUR 836 million, representing 83% of the corresponding 2019 levels despite sizable loss of tourists from Russia. Cyprus has no energy dependence on Russia as it imports all of its oil from Greece, Italy and Netherlands. However, it is indirectly affected by the pricing pressures in the international energy market. It is important to note that Cyprus does not use gas for its energy needs. It has a milder winter compared to other European countries and here energy consumption typically peaks in the summer. As in many other countries, consumer inflation in Cyprus has accelerated significantly as a result of supply chain disruptions and higher energy and other commodity prices. In July 2022, inflation accelerated to 10.6%. Currently, households and corporates are able to absorb these higher costs, supported in part by government's fiscal measures of EUR 350 million. Moving now to Slide 11 of new lending. As mentioned earlier, new lending grant in Cyprus reached a record of EUR 1.2 billion for the first half, up by 30% year-on-year, reaching higher levels than the equivalent period pre-pandemic. The 6 month increase was driven by increased activity in all sectors. New lending continues to be carefully considered against a robust assessment criteria and 99% of new exposures in Cyprus since 2018 are performing. We have high-quality originations, supported by prudent underwriting standards that will make meticulous assessment of the repayment capability of our customers. As of the 30th of June 2022, the outstanding performing loan book grew by a further 4% in the 6 months to EUR 9.72 billion. Only 11% of this loan book is restructured. I will now hand over to Eliza to take you through our financial results for the year.

Thank you, Panicos, and good morning from me too. So starting on my part from Slide 13 on the income statement. NII was up 4% Q-on-Q, driven by growth in the performing loan book, loan yield improvement in line with rising interest rate environment and the effect of 2 additional calendar days in the second quarter. NII for the first half was down 4% year-on-year, reflecting the foregone NII on the Helix 2 portfolio around EUR 15 million in the first half of 2021. Non-interest income was up 6% Q-on-Q, driven mainly by higher net fee and commission income. Non-interest income for the first half of the year was up by 13% year-on-year, mainly due to higher net fee and commission income, following the introduction of a revised price list and extension of liquidity fees to a wider customer group in the first quarter of '22. Loan credit losses and impairment were up 14% Q-on-Q, mainly due to higher impairment on net legacy overseas exposures. Loan credit losses and impairments were down 27% year-on-year due to higher COVID-19 related charges in the equivalent period of 2021. Profit after tax and before non-recurring items amounted to EUR 32 million for the second quarter with an underlying ROTE of 7.8%. And profit after tax and before non-recurring items for the first half of the year amounted to EUR 59 million, with an underlying return on tangible equity of 7.3%. The overall result was a profit after tax of EUR 29 million for the second quarter and EUR 50 million for the first half of the year. Moving to Slide 14. The quarterly NII bottomed in Q1 2022 and is now reverting to growth, reflecting increased lending and faster repricing of loans and liquid assets compared to funding costs. The quality of NII is also significantly improved with low contribution from legacy interest income. Net interest margin for the second quarter remained flat Q-on-Q at 1.33%. The increase of 4% in deposits had a diluting effect on the yields of liquid assets as they were placed in cash balances with ECB. This yield is expected to improve in the event of further ECB rate hikes. We are encouraged by income evolution within our performing loans, which is increasing with yields of 301 basis points, improving over the past 2 quarters and volumes growing over recent quarters. Our TLTRO III borrowing stands at EUR 3 billion as at 30th June and participation is expected to be maintained to maturity, subject to no change in terms and conditions. The NII benefit of EUR 15 million was recognized in the income statement over the period June 2021 to June 2022. Let's now turn to Slide 15, where we will discuss in more detail our liquid balance sheet composition. As at 30th June, cash balances with ECB amounted to EUR 9.9 billion, including TLTRO of EUR 3 billion and Exempt Tier of EUR 1 billion. Following the uplift of 50 basis points of ECB deposit rates in July 2022, the group will have an immediate NII benefit of around EUR 12 million in the second half of this year. Securities, including debt securities, treasury bills and equity investments amounted to EUR 2.1 billion as at 30th June. We expect conducive conditions going forward to expand the fixed income portfolio. Net loans amounted to EUR 10.1 billion as of June, of which EUR 9.7 million is the performing book. Around 50% of the loan book is repriced on Euribor since repricing on the reference rate will gradually benefit the interest income on loans. Customer deposits amounted to EUR 18.5 billion as of June and liquidity fees charged from March 2021 contributed around EUR 8 million to net fee and commission income in the first half of this year. These are expected to phase out as interest rates pickup. Wholesale funding of EUR 0.6 billion as of June is expected to increase gradually in order to comply with MREL requirements. Now turning to Slide 16, where we will discuss in more detail our gearing to higher interest rates. As shown on the graph, forward curves have moved more steeply in the short term since May '22. Using this latest curve, we now expect full-year 2022 NII to reach to EUR 320 million. NII is expected to increase further in 2023 by between EUR 100 million to EUR 120 million on a yearly basis. These projections incorporate assumptions on partial pass-through to deposits, gradual change in deposit mix and higher wholesale funding costs from 2023. Slide 17 provides an update on the group sensitivity to rising interest rates. We estimate that a further 50 basis points and 100 basis points parallel increase in rates versus the current forward curves would add EUR 56 million and EUR 103 million to annualized NII, respectively, assuming no other changes. On Slide 18, we highlight the strong liquidity surplus in our bank, which makes us one of the most highly geared EU banks to ECB rising rates. Cyprus banking system has one of the lowest net loan to deposit ratios among EU countries at below 55%. Turning now to the bond portfolio on Slide 19. As of 30th June, the bond portfolio of the group amounted to EUR 1.9 billion, representing 7% of total assets. The portfolio comprises of highly-rated holdings with low average duration, providing flexibility and enabling the bank to benefit from the rising interest rate environment. Going forward, there is an appetite to expand this portfolio in order to take advantage of increased yields. These proportion is lower than where we believe it should be and is lower than many peers and we expect to increase it gradually going forward. Slide 20 now provides a summary of non-interest income. Net fee and commission income for the second quarter was up 14% Q-on-Q due to higher volume of transaction fees, higher credit card commissions due to seasonality, as well as the full impact of the introduction of the revised price list and extension of liquidity fees. Net insurance income and net FX and other income were broadly flat Q-on-Q. Now moving to our insurance business on Slides 21 and 22. The underlying operating performance of our insurance companies continued growing into the second quarter. Net insurance income for our life insurance company EuroLife, amounted to EUR 19.6 million for the first half of 2022, up 7% year-on-year. For our general insurance business, net insurance income amounted to EUR 13.2 million for the first half, up 4% year-on-year. Both increases were driven by higher gross written premiums, partially offset by increased costs and claims. Overall, the insurance business is a valuable and growing revenue stream for the group as net insurance income contributes more than 20% of the group's non-NII. The profitability of the insurance businesses contributes 27% to the group's profit before tax. However, we believe it can deliver more and we have set ambitious medium-term target for both EuroLife and GIC. We are aiming to enhance their value by growing the businesses even further supported by digitization and our lean operating model. Based on current estimations, the IFRS 17 implementation on the 1st of January 2023 is expected to have a positive impact of around EUR 50 million on the group's tangible equity, enhancing the group's CET1 ratio by around 50 basis points. Slide 23 is an introduction to our subsidiary, JCC. The group's net fee and commission income is also enhanced by transaction fees from this subsidiary JCC Payment Systems Limited, a [ limited ] [sic] [leading] player in the card processing business, which is 75% owned by the bank. JCC's net fee and commission income contributed 9% of non-interest income and amounted to EUR 12 million in the first half of the year, up 26% year-on-year, backed by strong transaction volume. Moving now to expenses on Slide 24. Total operating expenses for 2Q were at EUR 87 million, up 2% Q-on-Q. The cost to income ratio, excluding special levy on deposits and other levies and contributions for the quarter was at 57%, down 2 percentage points, driven by the Q-on-Q increase in total income. As discussed earlier, in July, the group completed the voluntary staff exit plan. Following the completion of the plan, the overall number of employees is reduced by around 16%, with an estimated annual savings of around EUR 37 million or 19% of staff costs. Branch footprint rationalization continues facilitated by the ongoing digital transformation of the bank, with 15 branches closed down in July, resulting in a 38% reduction of branch network since June 2019. Our efficiency actions and improved revenue outlook lead us to review our cost to income ratio guidance. We now expect cost to income -- the cost to income ratio for the full year 2022 at around current levels compared to mid-60s previously expected. Our cost to income ratio is expected to convert to around 50% already in 2023, confirming the medium-term 2025 guidance of 50% cost to income ratio. Now turning to capital on Slide 27. Our CET1 and total capital ratios as at 30th June stood at 14.2% and the 19.3%, respectively, both pro forma for held for sale assets and the charge arising from our VEP, the cost of which will be included in Q3. During the second quarter, we generated around 60 basis points of organic capital through operating profit, which was largely offset by expected loan credit losses and impairments of around 30 basis points and other movements [ with further ] 20 points, including the payment of AT1 interest and the movement in the fair value through OCI reserve. Our CET1 ratio on a fully loaded basis was at 13.9% as of June and 13.4% pro forma for held for sale and the VEP. The completion of our NPE sales is expected to be capital accretive by further 60 basis points, whereas the VEP is expected to reduce capital by 95 basis points in the third quarter. The group continues to monitor opportunities for the optimization of its capital position, including AT1 capital. Now moving to asset quality on Slide 29. The NPE ratio was reduced to 5.7% pro forma for held for sale and 2.4% on a net basis, and is on track to reach around 5% by the end of the year. The bank's NPE coverage ratio was stable at 59% pro forma for Helix 3. The coverage of reperforming NPEs is relatively low at 32%, reflecting the lower risk associated with this stock of NPEs where our coverage of core NPEs stands at 66%. On Slide 30, we see very strong organic NPE trends in the first half of the year, a very modest increase in gross inflows and relatively sustained outflows of cash in the second quarter being translated into EUR 74 million net organic NPE reduction. Moving on Slide 31. We observe steadily declining Stage 3 exposures, relatively stable Stage 2 exposure and a steady increase in Stage 1 exposures. On Slide 32, we share more details on our Stage 2 loans. These are well collateralized, show very modest migration and around EUR 520 million of these reflect post-moratorium restructuring, expected to be eligible for exit to Stage 1 in 2023. Let's now turn to Slide 33, cost of risk. Cost of risk for half one was at 43 basis points compared to a cost of risk of 61 basis points in the first half of 2021, down by 18 basis points compared to the first half of 2021 cost of risk, which included 21 basis points loan impairments related to COVID-19. Cost of risk for 2Q amounted to 41 basis points, virtually flat Q-o-Q and includes 18 basis points or around EUR 5 million, reflecting management overlays on sectors that may be impacted by the ongoing geopolitical uncertainty and soaring energy prices resulting to pressure on the domestic economy and the release of 5 basis points due to improved macroeconomic outlook in 2022 for the Cyprus economy as compared to our projections in the previous quarter. While half one cost of risk levels have been better than expected, we guide for a conservative increase in 2022 cost of risk to around 50 basis points as we allow for management overlays for the volatile macro environment. And, with that, I hand back to Panicos for his closing remarks.

Thank you, Eliza. Let's now turn to Slide 36, where our progress on our priorities set in 2020 is summarized. In November 2020, the group, after a considerable period of change introduced medium-term targets and set the group priorities to achieving sustainable profitability. These included completion on balance sheet de-risking, delivery of sustainable profitability, enhancement on operating efficiency, modernization of the BoC franchise, including IT and digital investment, and addressing challenges from low rates and surplus liquidity, initiation of MREL issuance and Tier 2 refinancing and optimization of capital management. Since then, the group's progress has been remarkable, delivering on all fronts. In summary, the key achievements have been an 81% NPE reduction through organic and inorganic actions; NPE ratio is approaching to 5% and is on track with our 2022 target; the completion of several Voluntary Staff Exit plans and branch footprint rationalization; a 26% increase in active digital users, net interest income that has now bottomed out and is growing again; and inaugural MREL issuance and Tier 2 refinancing, regaining market access. The original medium-term recurring ROTE target of 7% set in November 2020 was achieved in the first half of 2022, 2 years ahead of schedule. And the group is on a clear path to achieve a double-digit ROTE in 2023. The CET1 ratio since September 2020 has remained broadly flat, absorbing in full the complete restructurings and is now positioned for dividend resumptions. Moving now to Slide 37. As a result, medium-term strategic targets have evolved, reflecting a dynamic strategy, capitalizing on the changed macroeconomic outlook and the group's strong performance. We are today updating and raising our profitability target to over 10% ROTE in 2023, while expected to be sustained for the following years 2024 and 2025. This is underpinned by a cost to income ratio, excluding special levy and other contributions, of roughly 50% and a normalized cost of risk of 40 basis points to 50 basis points by 2025, reflecting a less than 3% NPE ratio. Over the period of the plan, we expect to maintain a CET1 ratio of between 13.5% and 14.5%. These increases our confidence in assuming meaningful dividends from 2023 onwards, subject, of course, to regulatory approvals and market conditions. This concludes our presentation. And we'll now open the floor for your questions. Thank you.

[Operator Instructions] The first question is from the line of Boulougouris Alexandros with Wood & Co.

Congratulations on the results and the updated guidance. A few questions on my end regarding the liquidity fees that you mentioned. On a full-year basis, the amount is about EUR 15 million and we should assume that this would basically -- on the fee line, this would be excluded and will be phased out in 2023, correct? That is the first, a bit technical question. The second is regarding MREL issuance. What are the expectations for MREL issuance until the end of the year and maybe 2023, 2024? And one also on the TLTRO phase-out of the EUR 3 billion, if you could tell us a bit the maturities, what is the planned phase out? And then the third and last question is on -- question on my end, regarding the security book of about EUR 2 billion at the moment. You mentioned in the presentation that you're looking to expand these. At what levels do you think we should be seeing do you think? Because the security book is quite -- as the percent of assets is well below the peer group and should we assume getting closer to peer averages in a 2-year, 3-year period? Is that your assumption in the medium-term target?

Thank you, Alex. I will start with the last one, the security book and then I'll ask Eliza to answer the technical on the liquidity fees and the MREL issuance. So in the past, the risk return was not conducive for significant [ investments ability ] is how we see things. We saw things at that time and as a result of considerable portfolio expansion, the market is now well positioned given the recent market volatility and increase in interest rate. At that time, preservation of capital was important to facilitate the execution of our restructuring plans, NPE rates and exit plan. So going forward, portfolio is reasonable to be expanded, taking advantage of the increased yields, then we have available room in terms risk appetite limits for an increased exposure maybe in the short term, short to medium term. So, you should expect an expansion of the book, but it is important to flag out that our business plan assumes a conservative increase in the bond portfolio. So the improvement in net interest income is expected to mainly come from rate increases and the loan book rather than the increase in the bond portfolio. So Eliza, on the MREL and the liquidity fees?

Yes. So on liquidity fees and the amount included in fee and commission income in the first half of this year was at EUR 8 million, so you can do the math on the annualization of these number. And we expect to phase them out as rate hikes start to happen, but no decisions has been taken yet as regards timing, amount and so on. On MREL, so we are currently compliant with the only interim binding milestone for MREL, which was a January 2022 milestone. There is a slide in the deck that shows the gap to full compliant and, of course, you have to project that in line with capital and risk-weighted asset evolution. We are currently not under pressure to issue in the current market conditions, which are obviously not conducive to issuance. We will continue monitoring the market and proceed with issuance when market conditions are -- I don't dare say favorable, but at least are more conducive to issuance -- for issuance of our rating and our credit profile. On the EUR 3 billion of TLTRO, EUR 1 billion of that mature contractually in June 2023 and most of the rest matures in March 2024.