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 9 months ended 30th September 2022. [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.

Good morning, everyone. Thank you for joining our financial results conference call for the 9 months of 2022. I'm joined by Eliza Livadiotou, Executive Director of Finance and Legacy; Demetris Demetriou, Chief Risk Officer; and Annita Pavlou, Manager, IR and ESG. I will start by highlighting some of the key messages for the first 9 months of 2022 on Slide #4. Despite concerns regarding the outlook for global and European economic growth, the Cyprus economy is proving resilient to extend ourselves and continue to grow strongly in the third quarter with GDP increasing by 5.4%. GDP is forecast to grow by 6% in real terms in 2022, supported by stronger-than-expected tourists, and then grow by 3% in 2023, outperforming Eurozone average in both years. During the first 9 months of 2022, we delivered a profit after tax before nonrecurring items of EUR 109 million, of which EUR 50 million in the third quarter, with underlying return on tangible equity of 8.8% converted to our mid-term target of over 10%. An important driver of this performance is our net interest income. That was EUR 234 million in the first 9 months of 2022, up by 5% year-on-year. The improved momentum in net interest income is clear from the 19% increase in the third quarter net interest income compared to the prior quarter. Other loan and liquid yields continue to improve. In the third quarter, we have managed to contain operating expenses on the back of the efficiency accounts despite the inflationary environment. Specifically in July, we completed a voluntary staff exit plan, for which 16% of the group's full-time employees were approved to leave for a total staff cost of EUR 101 million recorded in this quarter. The gross annual savings is estimated at EUR 37 million or 19% of total staff cost with a payback period of 2.7 years, supported by lease plus accommodation for the 9 months stood at 5.54%, 7 percentage points down on a yearly basis. As a result of the one-off cost of debt and other restructuring expenses, the group reported a net loss of EUR 9 million for the 9 months. The bank's capital ratio remains robust and capable in excess of our regulatory requirements after absorbing in full the cost of the debt. As of end of September, our total capital ratio was 19.8%, and our CET1 ratio was 14.7% on both traditional and pro forma basis. Our liquidity position also remains strong. And as such, our cash balances with ECB, excluding TLTRO of EUR 3 billion, amounted to EUR 6.9 billion, leaving the bank well positioned to benefit from further interest rate increases. Deposits on our balance sheet increased by 2% in the quarter and 7% year-to-date to EUR 18.8 billion. The third quarter was marked by value achievement of our sub-5% NPE ratio target for 2022 with a pro forma iteration decreasing to 4.5%. Also, we have just announced the condition of Helix 3, our last NPE trade. So now the 4.5% is not pro forma, is factual. Our cost of risk was 44 basis points for the 9 months of 2022 remain well within our normalized target range. They're performing more strong fundamentals, reflecting good underwriting and high loan origination standards in recent years and is well positioned to face external shocks. Moving now to Slide #5. I am pleased that group achieved 3 key milestones this quarter: return on tangible equity of over 10%, plus 50% cost to income ratio and sub 5% NPE ratio, these being key factors for the group. Turning now to Slide #6, which sets the drivers of our upgraded guidance for 2022, capitalizing on the group's strong performance in a rising interest rate environment. Firstly, interest rates have increased faster than we expected in August, with immediate benefits from our liquid assets and viable rate loans. Faster in higher rates, we are upgrading our net interest income guidance for 2022 to over EUR 350 million, reflecting the group's positive higher and faster interest rate rises. In terms of the efficiency, the cost to income ratio excluding special levy on deposits and other contributions for 2022 is revised downwards to low 50s from the premium guidance of 55% to 60%, driven both by the improving inflationary environment but also management's ongoing efforts to contain costs. The efficiency actions undertaken that have resulted in the reduction of employees and branches unlocked meaningful sales from 2023, allowing us to more than absorb inflationary pressures and total operating costs. The cost of risk remains under control, as reflected by strong and resilient loan portfolio performance in the first 9 months of 2022. Hence, we now expect cost of risk to be around mid-40s in 2022. As a result of these updates, we now expect to generate a recurring ROTE of around 10% in 2022, supporting the ability to make meaningful dividend distributions from 2023, subject to regulatory approvals and market conditions. For transparency reasons, we have included a reminder for our current 2023 guidance. While we are continuing our budgets in light of the benefit of factoring current trade movements, I would like to affirm our confidence in continuing to deliver on key milestones: double-digit ROTE, 50% cost to income ratio and strong asset quality. We released our financial targets plus full year results. Moving now to Slide 7. The prolonged geopolitical crisis in Ukraine has changed the economic landscape, reflecting a potential slowdown in economic growth and escalating inflationary pressures with a resulting rise in the interest rate outlook. As a result, the global macroeconomic outlook is uncertain. Against this backdrop, the group is delivering on the levers that are under our control in order to face external shocks from a strong provision. The group's diversified business model significantly improved efficiency in asset quality as well as our ability to maintain healthy capital and liquidity buffers all play a valuable role as we head towards with uncertain times. Slide 8 and 9 provide an overview of macroeconomic conditions. The effects from the war in Ukraine, the energy crisis, high inflation and global monetary tightening are weighing on the global economy. The Cypriot economy is at a different stage of the economic cycle with GDP continuing to grow by 5.4% in the third quarter. Recent projections by the Minister of Finance pointed a growth of around 6% in 2022 and then 3% in 2023, outperforming Eurozone average in both years. The recent sovereign upgrade by Standard & Poor's to BBB demonstrates the resilience of the Cypriot economy to extend our stocks. As a reminder, Cyprus may change in investment grade. If we have public debt levels compared well to other EU countries are steadily on a downward path and expected to reach approximately 90% of GDP by the end of the year. Economic growth in Cyprus, supported by stronger-than-expected tourists despite the high level loss of tourists from Russia, lower employment rates and improved real estate prices, although it is important to note that these prices remain well below the previous peak levels in 2010. As a reminder, Cyprus has no energy dependence on Russia as it imports all of its oil from Greece, Italy and Netherlands. However, it is entirely affected by pricing pressures in the international energy markets. Cyprus does not use gas for these energy needs. It has milder winter compared to other European countries. It has 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 and inflation is expected to average to 8% for 2022. Turning now to Slide 10 of lending. Lending was lower at EUR 497 million for the third quarter, reflecting the seasonal patterns and totaled EUR 1.7 billion for the 9 months of 2022, up 25% year-on-year, recovering to pre-pandemic levels. At the end of September, the net performing book has grown by 4% in the first 9 months to EUR 9.7 billion, spread across all sectors, although it remains flat on a quarterly basis due to higher payments. We have high quality loan originations supported by prudent underwriting standards and meticulous assessment of the repayment ability of our customers as 99% of new loans extended in Cyprus until 2016 are performing. Currently, our near-term interest income is expected to be supported primarily by asset in pricing and higher securities investments. I will now hand over to Eliza to take you through our financial results for the period.

Thank you, Panicos, and good morning from me too. So starting from Slide 12 on the income statement, I will highlight a few important figures in the quarter. Net interest income was up 19% on the previous quarter, positively impacted by higher loan and liquid asset yields. Total operating expenses were reduced by 7% in the quarter due to lower staff costs, following the completion of the VEP. Cost of risk was broadly flat in the prior quarter at 35 basis points. And profit after tax and before nonrecurring items was at EUR 50 million for Q3 and EUR 109 million for the 9 months of 2022. During the third quarter, we could recognize a one-off cost of EUR 101 million from the completion of the voluntary exit plan. The overall result was a loss after tax of EUR 59 million for the third quarter and EUR 9 million for the 9 months of the year. Now moving to Slide 13. Quarterly NII is now on a growth trajectory on the back of the effective pricing of loans and liquid assets compared to funding costs. The quality of NII is also significantly improved with reduced contribution from legacy interest income. The net interest margin for Q3 was up by 20 basis points to 1.53%. Excluding the TLTRO of EUR 3 billion, the net interest margin stood at 1.69%. We're encouraged by income evolution within our performing loans, reflecting the increase in volumes over recent quarters as well as improved yields currently at 319 basis points. Our TLTRO borrowing stands at EUR 3 billion as of September. The bank expects an additional net NII benefit from TLTRO for the period from June to November 2022 of a total of EUR 8 million, EUR 3 million of which was recognized in the Q3 income statement. Following the changes in the TLTRO terms announced by ECB in October and given the bank's strong liquidity position, the bank is concentrating earlier repayment of this funding. Let's now turn to Slide 14, where I will discuss in more detail on our liquid balance sheet composition. As of 30th September, cash balances relatedly amounted to EUR 9.8 billion, including EUR 3 billion of TLTRO, on which the group benefits immediately from the ECB deposit rate increases. Securities, including debt securities, treasury bills, elected investments amounted to EUR 2.5 billion. And 92% of our securities represent the fixed income portfolio, which increased by 18% Q-on-Q. A further meaningful increase is expected in 2023, subject, of course, to market conditions. Net loans amount to EUR 10.1 billion, of which EUR 9.7 billion is performing. Around 50% of the loan book is priced on EURIBOR, which will benefit from the reference rate pricing over time. Customer deposits amount to EUR 18.8 billion, and the liquidity fees charged since March 2021 and -- which contributed EUR 13 million to net fee and commission income year-to-date will be paid out as from the 1st of December '22. Also, a funding of EUR 0.6 billion as of 30th September is expected to gradually increase in order to comply with MREL requirements. Moving to Slide 15 now. As shown on the graph on the slide, forward curves have moved more steeply in the short term since August '22 with immediate benefits from liquid assets and variable rate loans. The bank has cash balances placed with ECB of EUR 6.9 billion excluding the TLTRO, and over 90% of it's loan portfolio is based on variable rates. Using this latest curve, we now expect full year 2022 NII to exceed EUR 350 million from previously guided levels of EUR 320 million. NII for 2023 is expected to be significantly higher compared to 2022. These projections incorporate assumptions for 2023 on the following points: the partial pass-through of deposits -- to deposits of rates starting in 2023, the gradual change in deposit mix towards term deposits gradually increasing to 50% of the product, higher wholesale funding costs and some pressures on the loan book back book spreads. On Slide 17, we highlight the strong liquidity we had in our bank, which makes us one of the most highly geared EU bank rising ECB rate with the repricing taking place immediately. The group operates comfortably above its regulatory requirements with excess liquidity of EUR 6.8 billion. The Cyprus banking system has a very low net loan-to-deposit ratio amongst the EU countries, below 55%, which should support moderate pricing pressures on deposits. Now turning to Slide 18 on the fixed income portfolio. As of 1st of September, the bond portfolio of the group amounted to EUR 2.3 billion, up by 18% in the quarter and now representing 10% of total assets. The completion of the balance sheet derisking and the group's comfortable liquidity position allow us to further grow the bond portfolio into 2023, subject to market conditions. The portfolio comprised of highly rated fixed income assets with low average ratio, giving the group flexibility to take advantage of rising rates. Now moving to Slide 19 with a summary of noninterest income. Net fee and commission income for Q3 was down 3% due to lower nontransactional fees but was partly offset by seasonally higher transactional fees and credit card commissions. Net insurance income was 9% down in the quarter, mainly impacted by the changes in valuation assumptions and higher insurance claims. Net effects and other income increased by 57% in the previous quarter, reflecting higher FX gains through FX swaps and the one-off gain of EUR 5.5 million on financial instruments. And total noninterest income for the 9 months represents 50% of our total income, supporting the group's diversified business model. Noninterest income for the 9 months increased by 16% year-on-year, driven by higher net fee and commission income, higher net FX gains and net gains on financial instruments and higher insurance income, net of claims and commissions. Now moving to Slide 20 and 21 on our insurance subsidiaries. Net insurance income for our life insurance company, EuroLife, amounted to EUR 28.6 million for the 9 months, up 21% year-on-year. For our general insurance business, net insurance income amounted to EUR 19.4 million for the 9 months, up 2% year-on-year. Both increases were driven by higher growth rates and 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 contributed 20% of the group's noninterest income and 21% of profit before tax and nonrecurring items. 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 CET1 ratio by 50 basis points. Now moving to Slide 22 on JCC. The group's net fee and commission income is further enhanced by transaction fees from the group's JCC Payment Systems Limited, a leading player in the card processing and card -- and payment solutions business. JCC has an 85% market share in Cyprus and is 75% owned by the bank. JCC's total income contributed 10% of noninterest income and amounted to EUR 24 million for the 9 months, up 33% year-on-year, but a strong transaction volume growth. Now looking at expenses on Slide 23. Total operating expenses for the third quarter amounted to EUR 81 million, down 7% on the previous quarter. The cost-to-income ratio, excluding the special levy on deposits and other levies on contribution for Q3, was at 47%, down 10 percentage points. The significant reduction in the cost-to-income ratio was achieved following the disciplined cost management actions of the group. Following the VEP in July, a one-off cost of EUR 101 million was recognized in the third quarter income statement with an estimated payback period of 2.7 years. Subsequent to the completion of the VEP, the overall number of employees has been reduced by 16% with an estimated cost annual saving of around EUR 37 million or 19% of staff costs. Our branch footprint rationalization continues facilitated by the ongoing digital transformation of the bank. 20 branches were closed for the first 9 months, resulting in a 38% reduction of the branch network since June 2019. For the full year '22, we expect cost to income ratio to improve towards the low 50% compared to a 54% level for the 9 months of the year, reflecting some cost seasonality in the last quarter and higher revenues. Now moving to capital on Slide 26. Our CET1 and total capital ratio as of September stood at 14.7% and 19.8%, respectively, both pro forma for Helix 3, which is expected, which is now completed as of a couple of -- as of an hour ago. Our CET1 ratio on a fully loaded basis was at 13.9% pro forma for Helix. As regards to our capital requirements, we just set decision received in October provides for a decrease by 25 basis points of the P2R requirement as from January 2023, excluding the ECB's prudential provisioning. Moving now to Slide 28 on asset quality. The pro forma NPE ratio was reduced to 4.5% or 1.7% on a net basis, achieving early the 2022 NPE target of around 5%. The bank's NPE coverage ratio improved to 63% pro forma, and when including tangible collateral, NPEs are fully covered. And as already mentioned, we have just completed Helix 3, the sale of EUR 0.6 billion of NPEs to entities controlled by SME, Corp. We have seen very strong organic NPE trends in the first 9 months with modest drop inflows, indicating that there are no signs of asset quality deterioration. On Slide 29, we set out the staging rate down, and where you can see that we have already discussed the reduction in Stage 3 to now 4.5%. So let me move to Slide 30 to give you more detail on Stage 2 loans. These are well collateralized and show very modest migration into Stage 3. Overall, 19% of gross loans are classified as Stage 2. This can be broken down to 10% that was classified of Stage 2 due to COVID-19 forbearances, of which 51% is expected to be eligible for transfer to Stage 1 in 2023. 3% of gross loans was classified as Stage 2 due to overlay. These loans are reviewed on an ongoing basis and are expected to be eligible for transfer to Stage 1 in 2023. Now moving to cost of risk on Slide 31. The cost of risk for the 9 months was up 44 basis points compared to 66 basis points for the 9 months of 2021, down by 22 basis points reflecting strong asset quality this year, but also impacted by one-off prior year charges. The cost of risk for the third quarter amounted to 45 basis points, roughly flat on the prior quarter. We are improving our guidance for cost of risk for the full year to mid-40s given the strong performance in the loan portfolio to date. The cost of risk target of 50 to 80 basis points for 2023 remains unchanged, reflecting the prevailing uncertainty on macroeconomic outlook. I'll now hand back to Panicos for his closing remarks.

Thank you, Eliza. Let's now turn to Slide 33. The third quarter was marked by solid performance, exceptionally on our core strategic targets and delivering tangible results. Specifically, we have delivered our inflation target of sub-5% early. We have achieved sub-50% cost to income ratio in the third quarter, well below our previous 2022 guidance. We achieved a recurring return on tangible equity of 11.7%, underpinned by strong NII and efficiency improvements, giving us confidence of achieving 10% recurring ROTE in 2022 and laying the foundations of reviewing meaningful dividends from 2023 onward subject to regulatory approval and market conditions. We will aim to update our financial targets post the full year results. This concludes our presentation. I will now open the floor for your questions.

[Operator Instructions] The first question is from the line of Quinn Daragh with KBW.

I wonder if we could just go into a little bit more detail on your guidance for NII for next year and particularly around the deposit beta assumptions just given the amount of liquidity that you have, market share, et cetera. I just want to try and gauge kind of how conservative you're being with those deposit pieces. Or in practice, will you be -- will deposit prices move up more slowly maybe than what you're assuming in your guidance? And a second question, maybe just on the bond portfolio as well. If you could give any indication of what kind of size you would like it to move to. You've already made an increase this quarter, I think, to 10% of assets, but maybe if you could give an indication of what your target for that portfolio. That will be great.

Thank you, Daragh. I will start with the last question on the bond portfolio. As we said, we aim to meaningfully expand this portfolio going forward, taking advantage of the increased yields. We have now available limits and risk appetite to do this. You have already seen 18% increase during the third quarter. We gradually see this portfolio increasing meaningfully, but please allow me not to be too specific on 2022 -- 2023 targets. As I already have mentioned to you that we'll come back to update the market post full year '22 results. . On the NII, okay, I will ask Eliza to comment on this.

Okay. So on the deposit pass-through assumptions, as we've mentioned, the assumptions are that as from 2023 we will start to build -- to pass through 50% of the rate rises and also to increase our mix from -- between installments and term deposits to gradually a 50% level from the current level of roughly 30%. Now on your question on whether this is feasible, if that's the right way I understood it. I think it is. And the best answer to that is that we're still charging today liquidity fees on depositors. We will remove that as from the 1st of December, and the rates have gone to 0, back in July, if I'm not mistaken. So the pass-through -- the current pass-through level with positive rate on deposits is negligible. We are still charging negative rates on the book where the liquidity, where we were charging before. So we believe that these assumptions are prudent and feasible. As I mentioned earlier also, not just us, but the whole banking sector is incredibly liquid with the ratios of the banking sector at 55%. So there is -- we believe that the pressure on deposit rates will be manageable.

I mean, we are market leaders in a very liquid market. So...

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

Maybe a couple of questions. First one on capital. Specifically, what was driving the Pillar 2R lower this time around? What would be needed to get the Pillar 2G? I know you don't say exactly what that is. But what would it take to see you Pillar 2G requirement reduced? And then maybe something on asset quality. It looks very good from everything in the slides. But now that the serious season is kind of coming to an end, are you seeing any signs of deterioration in any pockets given that you have kept your cost of risk guidance at other more innovative levels for 2023?

Okay. Thank you, Corinne. On asset quality, as we earlier mentioned, we have surpassed the sudden NPE ratio, we then -- inflows for the year is very low, very limited and much better than what we initially expected. As of now, we don't have any expectations of significant deterioration on asset quality for next year. But being prudent under an economy that will probably slow down, you see that we have guided with the cost basically between 50 and 80 basis points. So it's not driven by -- this is not driven by any signs of deterioration from our portfolio. It's mostly delivered by, let's say, lower growth, which 3% is still on the high side as the rest of Europe. And so we prefer to be prudent and use some what -- or relates to capture any potential deterioration. On capital, okay, I'm not sure if I get your question right. Our NPE is EUR 12 billion for certain decisions. So this was a driver of the reduction, if trust it to be, the decision given by SREP tests, which are due for next year.

If I may just start P2G, we disclosed it last year. We had a reduction in 2022, although it's not public. We did disclose that we had a reduction in the P2G level last year already in effect. On P2R, the -- obviously, there are 4 pillars that the ECB looks at when they review banks and capital, liquidity, asset quality, governance, so a business model liability. So this is the result of the work that the EBITDA for the SREP every year. And it's the first time we've seen a P2R reduction. We've been at the 3% level since the beginning of P2R. So it's a welcome positive for us.

But irrespective of the capital, it's good to know that we have CET1 14.7% after completing Helix 3 and after taking the heat from the exit plan. And just a reminder, we have another 50 basis points coming in, in January 2023 from the IFRS 17. And of course, sustainable profitability and current generation is more than obvious given the ROTE expectations of the bank from 2022 onwards.

That's actually helpful. Can I just ask a quick follow-up on MREL and what your plans are there?

Okay. I think we have a very comfortable position. We are not under pressure to issue this year. Of course, otherwise, we will value the opportunities to advance MREL availability even when market conditions are low.

The next question is from the line of Giannoulis Dimitris with ResearchGreece.

Just following up on MREL. So is it safe to say that no issuance for 2022 but most likely for 2023? And secondly, about the dividend, are you willing to see any kind of payout rates you have in mind with regards to the dividend? And also in terms of timing, when should we expect to have more details about the decision to pay a dividend? And a clarification on that as well, will it be out of 2022 earnings and profits or 2023 to be paid in 2024?

And so starting on the MREL, we have what -- what Panicos said is that we are not under pressure to issue this year. That doesn't mean -- I mean, you can never say never in these markets. So if we do find an opportunity to issue in the next few quarters, we may consider it. So I don't think it's an absolute no. We say depending on market conditions, we may issue. We have a couple of issuances to go between now and 2025 in order to be compliant with the end target. And we are not under pressure. We will do it in an austerely way, hopefully in the markets that can accommodate what we believe to be good pricing.

Despite of the dividend question, Dimitris, you know that we are in constant dialogue with ECB. We also hope to come back to you with the full year results with more information. In your question, yes, therefore, we'll be to pay dividends in 2023, of the '22 year results, clearly. And the combination of improving ROTE and high CET1 ratio that is above our target rate provides current conditions for an exceptional dividend. But ultimately, we need to wait for the regulatory approval. Regarding the payout ratio, I think payment, if approved, will be gradually so that payout ratio will gradually be tough. Priority is to get the approval for dividend. And this is something that we come back to you post the application of our full year results.

[Operator Instructions] The next question is a follow-up question from Quinn Daragh with KBW.

I thought I'd just ask a follow-up question on the outlook for the NPEs. I mean, obviously, it's an amazing achievement to get to 4.5% from over 25% just a few years ago. But just wondering now from this level of NPEs, will it just be a case of organic reduction from here? Or are you still looking at further portfolio sales?

Daragh, I think the level of the current NPE portfolio actually guide us to focus on the current reduction rather than on another outright sale. So plan A for the time being, with no plan B for the time being is current reduction, which we have been constantly delivering all these years.

If I may just add, the currency variable with years are up EUR 360 million growth, and there are 63% -- or 72% covered. So this is what Panicos is referring to in terms of volume of NPEs left.

Actually, the legacy book is not so much of a concern because we believe we can write down reasonably soon. So the focus is on the portfolio quality of the existing performing book to keep it under control. So far, the very limited new NPE flows, even in Stage 2, the migration to NPE is very low and well collateralized. And even Stage 2 expect to see reduction next year.

Mr. Quinn, are you finished with your questions?

Yes, thank you very much.

[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. Thank you all for the questions. And as always, myself and the team are available for one-to-one calls upon your request. Have a nice weekend, everyone, and thank you very much.

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