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

Ladies and gentlemen, thank you for standing by. I am Yota, your Chorus Call operator. Welcome and thank you for joining the Bank of Cyprus conference call to present and discuss the first quarter 2023 financial results conference call. [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. Mr. Nicolaou, you may now proceed.

Good morning, everyone. Thank you for joining our financial results conference call for the first quarter of 2023. I'm joined by Eliza Livadiotou, Executive Director of Finance; Demetris Demetriou, Chief Risk Officer; and Annita Pavlou, Manager, IR and ESG. After my introductory remarks, Eliza will go into more detail on our financial performance and then we'll turn to Q&A. We would also like to invite you to the investor update event that will take place in London on the 8th of June 2023, where we will present and discuss an update of the group's outlook. Of course, we remain available for questions both during this call and afterwards. I will start by highlighting some of the key messages for the quarter on Slide #4. We started the year strongly with the performance in the quarter being ahead of our 2023 targets. Overall, we recorded a profit after tax of EUR 95 million versus EUR 17 million on prior year, corresponding to a ROTE of 21.3%, driven mainly by the growth in net interest income, which has more than doubled on prior year, benefiting from rates higher than expected and anticipated increases in deposit costs not yet developing. We continue to focus on cost discipline, delivering a reduction in our cost base of 3% year-on-year despite inflationary pressures. Our cost-to-income ratio, excluding special levies and other contributions stood at 34% in the first quarter compared to 60% in the prior year. Our cost of risk remained broadly flat at 44 basis points, evidenced by the resilience in our credit portfolio quality. Asset quality is in line with our target, reflected in an NPE ratio of 3.8% and an improved level of coverage of 73% as of quarter end. The vast capital position remains robust and comfortably in excess of our regulatory requirements. As of the end of the quarter, our total capital ratio was 20.3% and our CET1 ratio is 15.2%, unlocking 90 basis points of capital generation. Our liquidity position remains robust, stemming from our growing retail fund deposit-based highly liquid balance sheet. As of the end of the March, our cash balances amounted to EUR 9.2 billion, while our deposit remains flat at the December level, but increased by 7% on the prior year to EUR 19 billion. And finally, we are pleased to note that we have restated our dividend, as I will discuss on Slide 5. This year, we have achieved a significant milestone with the delivery of our long-standing intention to resume dividend payments after 12 years. This represents an important step in the group's journey of delivering sustainable profitability and shareholder returns. In April 2023, we proposed a dividend of EUR 0.05 per share irrespective of 2022 earnings equivalent to 14% payout ratio on adjusted recurring profitability as reported in the 2022 annual report. The dividend is evidence that the group's period of restructuring is complete. And a further transformation to a strong diversified well-capitalized organization successfully exceeded on all of our financial '22 targets that have been set in prior year. We continue to work hard on our business model in order to create value to our shareholders. Going forward, dividends are expected to be prudently and progressively towards a payout ratio in the range of 30% to 50% of our net profit before any nonrecurring items adjusted for the AT1 coupon. We note that for CRR compliance purposes, we have accrued a 30% dividend payout ratio in our capital in the first quarter, in line with our dividend policy. The final dividend decision will be taken by the Board around the year-end results. And of course, as a reminder, dividends are subject to regulatory approval. Moving now to Slide #6. I am pleased with the group performance in the first quarter, surpassing its key milestones. In summary, we've turned tangible equity of over 20%, cost-to-income ratio at mid-30s and an NPE ratio of sub-4%. Our positive set of financial results this quarter provides the foundation to help us deliver against our targets. Slide #7 provides an overview of macroeconomic conditions. In spite of macroeconomic headwinds in the global and European economies, Cyprus continues to demonstrate its strength and its ability to expand external shocks. The economy is at a different stage of the economic cycle, with GDP growing by 5.6% in 2022. Economic momentum is expected to continue in 2023 with recent projections by the Minister of Finance pointing to growth rate of around 2.8% in 2023, but ahead of the Eurozone average. Tourist was strong in the first quarter despite the fact that this off season, with arrivals 10% higher than the corresponding arrivals in 2019, itself a record year for Cyprus. The unemployment rate decreased to 6.8% in 2022 and is expected to decrease further to 6.5% in 2023. As in many other countries, consumer inflation accelerated significantly impacted by supply chain disruptions, higher energy and other commodity prices. In Cyprus, inflation peaked in July 2022, has been decelerating since, falling to 3.8% in April 2023, while Eurozone inflation has proved stickier. For 2023, inflation in Cyprus is expected roughly at approximately 3% according to the Ministry of Finance. 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 on Slide 8, as you look at the financial performance for Q1, I will not go through every line, but highlight a few important figures in the first quarter. Total income for the quarter ended 31st March continued to improve to EUR 234 million, of which EUR 162 million relates to net interest income. This quarter saw an increase of 19% on a quarterly basis and 127% on a yearly basis in net interest income, benefiting from the current interest rate dynamics and the continued low deposit pass-through. Our non-NII remains an important contributor to revenue generation. Noninterest income recorded an increase of 8% on the prior year. And on a quarterly basis, noninterest income reduced by 11%, reflecting mainly the termination of liquidity fees and NPE sale-related service increase in December '22 and February '23, respectively, as previously communicated. The cost base reflects the benefits of the efficiency actions we undertook last year, offsetting higher inflation. Total operating expenses of EUR 80 million were down by 5% in the previous quarter and down 3% on the previous year. Cost of risk remained flat at 44 basis points, tracking below the level we guided in February 2023, reflecting the Brazilian credit portfolio quality. The overall result was a profit after tax of EUR 95 million for Q1 '23, equivalent to return on tangible equity of 21.3%. Now moving to Slide 9. Let's now deep dive into the main drivers of NII. NII continued to expand in the first quarter, totaling EUR 162 million, with our margin improving to 2.91%. The margin is a multidimensional metrics affected by the dynamics in its position in parts. This includes, firstly, the immediate repricing of liquid assets. During Q1, we have benefited from an increase in effective yield on liquid by 125 basis points to 280 basis points. Secondly, the gradual repricing of the loan portfolio. As a reminder, over 95% of our loan book is variable rate with around half of it linked to Euribor. The effective yield on the performing book grew by 65 basis points to 4.55% in Q1. And thirdly, a better than expected deposit behavior and a well-managed deposit pass-through facilitated by the very high liquid -- the very liquid supervising sector. This is evidenced by the evolution of our cost of deposits, which remained low at 10 basis points, corresponding to a 10% term deposit pass-through. As a reminder, in February, we have guided for a pass-through rate on term deposits of around 50% by year-end, with term deposits making up around 45% of our total deposits as compared to 30% at the end of Q1. Our deposit trends are currently tracking better than expected compared to our assumptions set in February. Now turning to Slide 11. Given recent banking turmoil and focus on liquidity, it's important to note that the group has a robust liquidity position stemming from a predominantly retail funded deposit base and a highly liquid balance sheet. Deposits remained stable at EUR 19 billion, flat on the prior quarter and up 7% on the prior year. Close to 60% of our deposits are protected by deposit insurance scheme. Our deposit base is granular with the average retail ticket size at EUR 27,000. There are no particular deposit concentrations. As of 31st March, 78% of total liquid assets were in cash, of which EUR 9.2 billion were in cash and balances with central banks. The remaining 22% of liquid relates to our fixed income portfolio comprising mainly of highly-rated fixed income assets with low average duration, giving the group the flexibility to take advantage of rising rates. The group's liquidity ratios have historically been significantly above minimum requirements and that remains the case today. As of 31st March, the group LCR ratio stood at just over 300%, resulting in a significant LCR surplus of EUR 7.4 billion. When disregarding the effect of the TLTRO, the group's liquidity position remains very strong with an LCR of 248% and a liquidity surplus of EUR 5.4 billion. On Slide 12 now we show a further breakdown of our EUR 19 billion deposit base. And as you can see on the bottom left, almost 90% of our deposits are from Cyprus residents and only 1% is from Russian or Belarusian residents. Slide 13 on new lending now. And the group extended EUR 624 million new loans in Q1, which is usually a strong quarter, representing an increase of 41% on the prior quarter and is similar to prior year levels, whilst maintaining strict lending criteria. As a result, the gross performing book, the gross performing loan book grew by 1%, both Q-on-Q and year-on-year at EUR 9.9 billion. We have high-quality loan originations, supported by student underwriting standards and meticulous assessment of the repayment capability of our customers, evidenced by the fact that 99% of new loans extended in Cyprus since 2016 are performing. Turning now to Slide 14 on the fixed income portfolio. As of 31st March, the fixed income portfolio amounted to EUR 2.7 billion, up by 48% year-on-year and 10% on the prior quarter, representing 11% of total assets. We have been cautious in building our securities book in recent years, seeing an attractive risk return. More recently, improved market opportunities and the group's comfortable liquidity position facilitated a prudent expansion of the fixed income portfolio, subject of course to market conditions. The majority of the fixed income portfolio is measured at amortized costs and is held at to maturity. Hence, no fair value gains or losses are recognized in the group's income statement or equity. The mark-to-market impact of the amortized cost portfolio amounted to EUR 87 million as of 31st March, equivalent to around 85 basis points of CET1 ratio. Slide 15 provides a summary of noninterest income. As a reminder, liquidity fees and NPE sale-related service increase were terminated in December '22 and February '23, respectively. Net fee and commission income reflecting those factors for Q1 was up 16% year-on-year, but down 3% on the prior quarter due to seasonally lower transactional fees. Net foreign exchange gains and net gains on financial instruments decreased by 3% Q-on-Q, reflecting lower FX income through FX swaps partly offset by higher valuation gains in financial instruments. On this note, I would like to remind you that this source of income is volatile, is a volatile contributor to revenue generation. Overall, noninterest income in the first quarter of the year increased by 8% on the prior year to EUR 72 million, mainly driven by higher net fee and commission income on a like-for-like basis and higher net FX gains and the net gains on financial instruments. The year-on-year increase in net fee and commission income reflects the introduction of price adjustments in February, the higher non-transactional fees and higher credit card commissions. Now on Slide 16, on a slightly different topic, as the new accounting standard that impacts our insurance business. On the 1st of January this year, the group adopted a new accounting standard for insurance contracts, IFRS 17, which replaced the previous IFRS 4. Given the retrospective application of the new standard, we would like to spend some time on Slide 16 to provide an overview of IFRS 17 and take you through the main changes that impact the group's results. In substance, IFRS 17 impacts the phasing of profit recognition for insurance contracts, as the profit is spread over the lifetime of the contract rather than substantially at inception, as was the case under IFRS 4. Therefore, this new accounting standard does not change the lifetime economics of the insurance contract, but it does decrease the volatility of earnings. With the adoption of IFRS 17, the present value of in-force life insurance contract assets was eliminated, insurance assets and liabilities were re-measured and the contractual service margin was recognized. The overall result was a reduction in the group's total equity by EUR 52 million and an increase in the group's tangible equity by EUR 64 million. With the restatement, the group's 2022 profit after tax was reduced by EUR 14 million, mainly reflecting the deferral of new business profit and the assumption changes on the valuation of insurance contract assets and liabilities. Now on Slide 17 and 18, we focus on the performance of our insurance business in Q1 of this year. The group's insurance companies are leading players in the life and general insurance business in Cyprus and have been providing a recurring and improving income further diversifying the group's income streams. The net insurance result for Q1 amounted to EUR 10 million, down 15% year-on-year, impacted mainly by higher claims and higher reinsurance expenses as well as higher attributable expenses driven by higher new business in Q1. Overall, the insurance business remains a valuable revenue stream for the group as net insurance results contribute 13% of the group's non-NII. Moving to operating expenses on Slide 20. Total OpEx amounted to EUR 80 million in Q1, down 3% year-on-year as efficiency actions partially offset wage and inflationary pressure. Staff costs for Q1 were down by 4% year-on-year as a result of staff reductions that took place in July 2022, partially offset by inflationary pressures. On a quarterly basis, staff costs were up by 9%, driven by total leading adjustments linked to inflation, salary increments and accrued staff cost rewards of around EUR 2 million following the introduction of a short-term incentive plan. The plan involves variable remuneration to selected employees and will be driven by both delivery of the group strategy as well as individual performance. Other operating expenses were flat year-on-year and down 19% on the quarter to EUR 34 million, mainly as a result of seasonally higher professional and marketing expenses in Q4 last year. Overall, our Q1 cost-to-income ratio, excluding the special levy on deposits and other such levies, was at 34%, down 5 percentage points in the prior quarter, mainly driven by higher total income. Now turning to Slide 23 on capital. As of 31st March, our CET1 ratio stood at 15.2% and our total capital ratio at 20.3% after an approval of dividend, representing a 30% payout ratio on adjusted recurring profitability within the range of the group's approved dividend policy, demonstrating our commitment to deliver sustainable shareholder returns. We note that this accrual does not constitute an approval by regulators for a dividend payment. The final dividend decision will be taken by the Board at the year-end in accordance with the regulatory process. Our organic capital generation of around 90 basis points, together with a 50 basis point dividend received from our insurance business relating to the day 1 implementation of IFRS 17 have supported our capital base. The final phase in IFRS 9 impacted capital by around 70 basis points. Note also that our capital ratios at 31st December have been restated in order to reflect the depletion of dividend out of 2022 earnings following the declaration, apologies, the declaration of dividend out of 2022 earnings. Following ECB approval, the Board has reversed proposed a final dividend of EUR 0.05 per share in respect of full year '22 earnings, subject to approval at the AGM. This proposed dividend amounts to EUR 22.3 million and has reduced the year-end capital ratio by around 20 basis points. Moving now to Slide 25, which provides an overview of asset quality. Our NPE ratio was reduced by 20 basis points in the quarter to 3.8% or 1.1% on a net basis, reflecting low organic formation. The bank's NPE coverage ratio further improved to 73% and when including tangible collateral and fees are fully covered. With the legacy asset quality issues firmly behind us, our focus remains on monitoring and limiting NPE inflows. Despite macroeconomic uncertainties, there are no signs of asset quality deterioration to date as evidenced by the modest working flows during 2023. Now continuing to cost of risk on Slide 26. In Q1, the cost of risk remains broadly flat at 44 basis points on a quarterly and yearly basis. The cost of risk included the release of management overlay for the performing loan book on the back of strong loan performance in specific sectors and expected improved sector performance as well as charges on Page 2 and Page 3 exposure following post-model adjustments to capture conservative assumptions and uncertain macroeconomic conditions. Now let me hand back to Panicos for his closing remarks.

Thank you, Eliza. Let's now turn to Slide 31. We are a well-capitalized, sustainably profitable organization with a diversified business model across banking, insurance payments, with focus on technology. The resumption of dividend payments after 12 years is a significant milestone and represents a new chapter for the group, capable of delivering sustainable shareholder returns. The dividend decision was supported by a strong start of the year with the performance in the quarter ahead of our 2022 targets. On the end of June, we will host an investor update event in London, where we will present and discuss an update of the group's outlook. We look forward to seeing you all there. This concludes our presentation. And we're now available for questions.

[Operator Instructions] The first question comes from the line of Alevizos Alevizakos with Axia Ventures.

Congratulations on the set of results, really amazing, more than 20% return tangible equity. A couple of questions from my side. The first one is regarding the investment securities. The book still looks quite small. So I wanted to know, like, what are the plans going forward, are you planning to continue to grow it? And then looking compared to other banks in Europe, you seem to be having like one of the lowest modified duration. So you're actually having the exact opposite problem compared to everybody else. So are you thinking about taking more risk and perhaps reducing the LCR ratio, which is still the leading in Europe? That's question number one. And then question number 2 is regarding the payout. I wanted to know whether you -- how you are thinking about it on dividend versus buyback. What are the options perhaps of doing some targeted buybacks, especially for some shareholders that may be dormant? And then I think that 30% sounds a bit conservative. So I was wondering, what do you think that the SSM could actually use in order not to allow you to do more?

Okay. Thank you, Al. The first question on the fixed income. You all know that historically we had a conservative approach, because we felt that it didn't make too much sense in terms of recent trend dynamics. As rate start going up, we could see more attractive recent trend dynamics. And that is why we increased the portfolio of 10% quarter-on-quarter and 48% year-on-year. So other things being equal, we expect to carefully expand -- the capital expansion to continue on the portfolio. This is very important to mention. And of course, we still will still be prudent. You already mentioned that of the short duration of our portfolio and the limited mark-to-market sheet. So in a nutshell, you should expect a careful expansion of the fixed income portfolio in the future. In terms of dividend question and about the buybacks, I have to remind us all that we have just resumed payment of dividends after 12 years. So the Board of Directors took the decision that the appropriate way to start coming out [indiscernible] is paying dividends. However, and it's very important to mention that we don't rule out anything, including buybacks, everything is on the table and are under constant review. Regarding the payout ratio, as we already mentioned now our announcement for payment of dividends, dividends are expected to build prudently and progressively over time towards a payout ratio which you already know is between 30% and 50%. And it's important to mention that the 30%, the accrual was set to be in line with our requirements for CRR and we choose to be at the lower end of the calibration. Final dividend decision, as Eliza mentioned in her early remarks, will be taken by the Board at the year-end results and by no means that this 30% accrual is not a signaling of any dividend payment.

The next question comes from the line of Hamilton James with Numis Securities.

A couple of if I may. Firstly, looking at guidance. You've obviously mentioned -- and that's very strong quarter for new lending in Q1. I appreciate the seasonal bias towards it. But if you could provide some sort of outlook as to how, has that momentum been continued into Q2 that would be helpful? Also on guidance, looking on provisions, I mean, just a little bit of clarity around your thinking, because on the one hand, you're saying there's no signs of deterioration and then I noticed that Stage 3 loans are declining, declining quite rapidly suggesting that the book quality is improving. Yet the provisions against those continues to go up. And I believe you cite some of the macro there. So a little bit of clarity about what you're actually thinking there? And finally, on the sort of digital strategy, if you could comment on how you're seeing the new sort of products like quick loans evolve, are customers using it? What's the sort of penetration there? And what are you hoping for?

Okay. Thank you, James. Starting with the first question on the new loan. I mean, you've all seen that we have a seasonally good quarter and 1% quarter-on-quarter, numbers are good. But given macro uncertainty, we are more cautious on new lending growth. So in the near term, we expect the growth on NII to be mostly coming from yields and rate rather than growth. Of course, in the immediate term prospects remain good for the secured economy. And we expect to have growth on the loan book. Where we are seeing demand? We are seeing demand across all the sectors of the economy. Priority segments for portfolio growth are in line with the RRF for Cyprus. I remind you that RRF for Cyprus is all in, it's EUR 4.4 billion. And it's mostly focused on green transition and digital transition, which is very important. I will add to these sectors the health and education. And of course, tourism residential-wise a sector of growth in Cyprus. Regarding the cost of risk, I will ask Demetris, our Chief Risk Officer, to answer the question.

Yes. Now as far as cost of risk in Q1, it's important to point out an agreement by cost more than I asked as already explained by Eliza because we see that can capture fully continuing volatility in the economic environment. Now it's important to say that we budget the higher legislative delay the risk portfolio also until now we have seen no evidence of that. Now we charted the adjustment to do [indiscernible] take into account information, for example, we introduced a new order relate to decrease in our Stage 2 and Stage 3 portfolio in anticipation of delays in high interest rates in our credit portfolio. And we have introduced higher haircuts to more sensitive exposure on primary businesses. On the other hand, we have done reversals as well on part of the portfolio that was in Stage 2, for example, the tourist portfolio that we feel is performing well, continue to be performing well.

On digital, if I take that question and progress is continue. Our digital road map is very busy. In fact, earlier this month, this is a Q2 development actually, we did launch what we call quick loan, which I think you referred to, James, earlier. These are the first fully digitalized lending product in the island. It's around secured personal loan, consumer loans. It was launched on the 5th of May. And we actually got about 11,000 of applications to date, which was a big achievement because it was a totally new introduction, new type of service into the island. EUR 31 million worth of these loans are already on the balance sheet as we speak today. And there are many other examples. We launched the other day what we call quick app, which is a mobile portal for new products, both deposit and loan products and the road map is continuing. We aim to give a bit more color on this and bring it to life a bit more on the 8th of June in our investor update event.

The next question comes from the line of Bergoe Kim with Numis Securities.

Sorry. Just a follow-up from James' question. And well, maybe it's an entirely additional question. But you mentioned that the average size of retail deposits is EUR 27,000. And that's -- so obviously, a very strong number. Could you give us a little bit of additional information around that? What's sort of the trend and the distribution around that? And also, if you could touch a little bit upon how we should see that in terms of households having that as liquidity versus savings and what the evolution could be there? I appreciate maybe that's more one for the investor event in June. But if you could touch a little bit upon how we should see that going forward.

Thank you, Kim. So first of all, on the 27,000 average balance, it has been broadly similar over the last few years, actually, the trend has been the same. And the same on the 60%, I also mentioned on the transcript, the 60% deposit guarantee -- deposit below that is for the current in the threshold of EUR 100,000. So these trends have been similar. We haven't seen any changes in the recent years. And we haven't also noticed any change since the March turmoil in the market internationally. The same on the distribution, 60%, as I said, is distributed below the EUR 100,000 threshold. Obviously, there are higher amounts of depositors out there. But we don't have any noticeable concentrations of depositors or depositor group. Now on your savings question, there is a slide which shows that our term deposits, which I guess, you see the only proxy we can have, the term deposit mix is currently at 30% with a term and the notice and time deposits. And this is the one that, again, we haven't seen a change. But we are aiming to move it to 45% by year-end and also at kind of full invested liability management through the deposit beta, which as I also mentioned, we are building in for our guidance, the 50% time deposits beta by year-end.

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

And again, congratulate you on a great set of results. Turning to capital maybe. With the capital position as it is, could you actually consider redeeming outright the Tier 1? Or would you like to maintain that for capital efficiency? And then maybe I couldn't quite hear the question or the reply on the asset quality. I'm just wondering what type of macro deterioration would you need to see to get up to that 80 bps cost of risk?