BAWAG Group AG (BG) Earnings Call Transcript & Summary

Good day, and thank you for standing by. Welcome to the BAWAG Group Preliminary Full Year 2022 Results Call. [Operator Instructions] Please be advised that today's conference is being recorded. A transcript, thereof, will be publicized on the website. I would now like to hand the conference over to your speaker today, Anas Abuzaakouk, CEO. Please go ahead.

Thank you, operator. Good morning, everyone. I hope everyone is keeping well. As usual, I'm joined this morning by Enver, our CFO. Let's start with a summary of full year 2022 results on Slide 3. For the full year 2022, and on an adjusted basis, which excludes the City of Linz write-off, we delivered net profit of EUR 509 million, earnings per share of EUR 5.81 and a return on tangible common equity of 18.6%. The underlying operating performance of our business was very strong with pre-provision profits of EUR 849 million, up 14% versus prior year and a cost income ratio of 35.9%. Total risk costs were EUR 122 million, of which EUR 39 million were related to continuing to build up our management overlay provision. The fourth quarter was strong with a net profit of EUR 132 million and a return on tangible common equity of 19.6%, despite accounting for the unwind of the TLTRO hedge resulting in a net negative impact in other income of EUR 14 million and booking an incremental EUR 18 million to our management overlay provision. We delivered on all our 2022 targets with profit before tax over EUR 675 million, return on tangible common equity greater than 17% and a cost income ratio under 38%. We also distributed EUR 592 million of capital in the form of a EUR 267 million dividend and completed the EUR 325 million share buyback during 2022, reducing our share capital by 7%, which now stands at 82.5 million shares. In terms of customer loan growth and capital, average customer loans were down 1% quarter-over-quarter and up 4% versus prior year. We generated 250 basis points of gross capital for the year. We ended the year with a CET1 ratio of 13.5% net of the 2022 dividend accrual, an excess capital of EUR 261 million versus our CET1 target of 12.25% with an additional management overlay provision of EUR 100 million equal to almost 1 year of annualized risk costs. We will be proposing a dividend of EUR 3.70 per share or EUR 305 million to the AGM on March 31. We are purposely maintaining dry powder for organic opportunities and potential M&A in the coming quarters while staying conservative given the overall uncertain macroeconomic environment. If specific opportunities do not materialize, any potential buyback in 2023 will be under 100 basis points of CET1 as we remain prudent and conservative. Above all else, we aim to be good stewards of capital, making sure we are prudent in our capital distribution plans, maintain our fortress balance sheet and be ready to capitalize on unique opportunities to grow our franchise. With the strong momentum on the back of a record year in 2022, we are setting the following targets for 2023: A profit before tax greater than EUR 825 million, a return on tangible common equity greater than 20% and a cost-income ratio under 34%. We are also targeting earnings per share of greater than EUR 7.50 per share and a dividend per share of greater than EUR 4.10, which excludes any potential buybacks. Therefore, we are accelerating and upgrading our 2025 financial targets, which we set during our Investor Day in 2021 to this year 2023. Despite our strong record of performance over the past decade with an average return on tangible common equity of approximately 15%, we have under-earned over this period defined by negative interest rates. We have an opportunity to deliver more normalized returns in the years ahead. Going forward, we are targeting a return on tangible common equity greater than 20% in a cost-income ratio under 34%. However, we should never confuse the benefits from a normalized interest rate environment with the daily execution of our strategy. Our focus on managing costs and maintaining a conservative and disciplined risk appetite are more important than ever. The resilience of our franchise lies in our ability to consistently deliver results for our stakeholders across all cycles. Moving to Slide 4, a recap of our full year results. We delivered a full year adjusted net profit of EUR 509 million and an EPS of EUR 5.81 per share, up 6% and 8% versus prior year, with a return on tangible common equity of 18.6%. Overall, strong operating performance across the board with operating income up 8% and operating expenses down 2% versus prior year. Risk costs were EUR 122 million, up 28% versus prior year as we decided to book EUR 39 million of additional management overlay provisions. Tangible book value per share was EUR 32.78, down 6% versus prior year and up 4% versus prior quarter. This considers the full year 2022 dividend accrual of EUR 305 million. On Slide 5, our capital development and distribution plans. At year-end 2022, our CET1 ratio was 13.5%, we generated 250 basis points of gross capital as we continue to consistently generate significant amounts of capital despite negative impacts to OCI from both credit spread widening in FX movements. As of year-end 2022 and after deducting the full year dividend accrual of EUR 305 million or EUR 3.70 per share, we have excess capital of EUR 261 million versus our CET1 target ratio of 12.25%. The acquisition of Peak Bancorp or Idaho First Bank in the United States, which has received shareholder approval but is still pending regulatory approval, will consume 25 to 30 basis points of CET1 capital. We are purposely maintaining dry powder for organic opportunities and potential M&A in the coming quarters while staying conservative given the uncertain macro environment, any potential headwinds. If specific opportunities do not materialize, any potential buyback in 2023 will be under 100 basis points of CET1 capital as we remain prudent and conservative. Moving to Slide 6. Our retail and SME business delivered full year net profit of EUR 442 million, up 22% versus the prior year and generating a very strong return on tangible common equity, up 34% and a cost income ratio of 33%. Average assets for the quarter were EUR 22.5 billion, up 7% versus prior year and flat versus prior quarter. Average customer deposits were EUR 27.8 billion, flat versus prior year and versus prior quarter. Full year pre-provision profits were EUR 689 million, up 22% compared to the prior year with operating income up 12% and operating expenses down 3% versus prior year, resulting from several operational initiatives and the continued focus on driving synergies across the franchise. Risk costs were EUR 81 million, up 34% versus prior year, of which EUR 8 million was tied to the proactive buildup of our management overlay provision despite solid credit performance and a reduction in our NPL ratio to 1.6%, down 30 basis points versus prior year driven by the proactive sale of the NPL portfolio. We executed on various operational and strategic initiatives last year and will continue to do so in 2023. We expect continued earnings growth across the retail and SME franchise in 2023, driven by strong operating performance despite an expectation for subdued loan growth throughout the year. On Slide 7, our Corporates, Real Estate & Public Sector business delivered full year net profit of EUR 146 million, down 5% versus prior year, but still generating a solid return on tangible common equity of 17.8% and a cost income ratio of approximately 23%. Average assets for the quarter were EUR 15.1 billion, flat versus prior year and down 3% versus prior quarter from proactive portfolio management and deleveraging from customers that are taking a more cautious approach. Pre-provision profits were EUR 242 million, flat compared to the prior year. Risk costs were EUR 36 million, up 25% compared to prior year, of which EUR 33 million was tied to the proactive buildup of our management overlay provision despite solid credit performance and a reduction in our NPL ratio of 10 basis points, landing at 70 basis points for the full year. We continue to see solid and diversified lending opportunities with a good pipeline of commitments in the first half of 2023. We will continue to maintain our disciplined underwriting, focus on risk-adjusted returns and avoid blindly chasing volume growth. Moving to Slide 8. Our cash position, including money held with central banks, was EUR 13.2 billion at year-end 2022. Of this, TLTRO III funds accounted for EUR 5.4 billion. We paid down EUR 1 billion during the fourth quarter, another EUR 2 billion in January of this year, and we will pay off the remaining EUR 3.4 billion by June later this year. Excluding TLTRO funds, our LCR at year-end would be 130%, more than ample liquidity buffers. Our investment book or securities portfolio was EUR 5 billion at year-end, up 6% versus prior quarter as we saw more opportunities to deploy capital at higher spreads. The investment book is 100% investment grade, of which 71% is single A or higher and has a weighted average life under 4 years with solid diversification across both geography and issuers. With that, I'll hand over to Enver to go through the financials and outlook in more detail.

Thank you, Anas. I'll continue on Slide 10. We had a solid fourth quarter, core revenues up 3% versus third quarter with continued growing net interest income up 4% and stable net commission income. Compared to prior year, core revenues were up 9%. Other income was minus EUR 14 million for the quarter, mainly resulting from the accounting for the unwind of the TLTRO hedge, resulting in a net negative impact. Operating expenses remained stable at EUR 118 million, reflecting our ongoing disciplined cost control. Total risk costs were EUR 36 million, of which half came from an increase in our ECL management overlay, bringing it to EUR 100 million, which equals a full year of normal risk cost. On Slide 11, key developments of our balance sheet. Average interest-bearing assets and risk-weighted assets were down in the quarter, 2% and 3%, respectively, mainly from proactive portfolio management and deleveraging from customers that are taking a more cautious approach. Customer deposits remained relatively stable, while we increased our own issues by more than EUR 1 billion or 16% through issuing covered bonds and senior preferred notes. CET1 ratio improved by 50 basis points net of dividend accrual while we completed our EUR 325 million share buyback. Moving to Slide 12, core revenues. Stronger net interest income, up 4% versus prior quarter despite low interest-bearing assets. Adjusting for the TLTRO benefit in Q3, NII would actually be up 6% quarter-over-quarter. Net interest margin improved to 243 basis points, driven by higher interest rates. Our interest rate sensitivity remains unchanged with approximately EUR 100 million for every 100 basis points. Given the refixing structure of our assets, it takes around 4 to 5 months to see the full effect of a rate increase reflected on our run rate, which means that the NII improvement will gradually materialize in the coming quarters, and we expect NII run rate to reach the peak around Q2 or Q3 based on the current market rates. Net commission income was very stable at EUR 75 million in the quarter, which also seems to be a good run rate in the current market environment. Despite an overall subdued customer loan growth outlook, we have a very positive view on the coming quarters and expect core revenues to grow by more than 12% in 2023, mainly driven by an increase of net interest income to over EUR 1.2 billion. Moving to Slide 13, operating expenses. We continue to maintain operating expenses at stable levels despite significant inflationary headwinds. We will also continue to focus on absolute cost-out targets through multiple initiatives, including continued process streamlining and ongoing centralization of group functions. For 2023, we are confident to manage operating expenses at plus 2% year-over-year considering wage inflation effect and consolidation of Idaho First Bank. Taking into account significant improvement of operating leverage, we target a cost income ratio of under 34%. Slide 14, risk costs. Overall, stable underlying trends and strong asset quality with a record low NPL ratio of 0.9%. The underlying risk cost run rate stands at EUR 18 million for the quarter. We added another EUR 18 million to our ECL management overlay, which now stands at EUR 100 million and is equal to a full year of normal risk cost which we believe is a very prudent and comfortable buffer for any unexpected developments. For 2023, we expect an underlying risk cost ratio of around 20 to 25 basis points assuming no releases of the management overlay provisions. And with that, I'll hand back to Anas to go through the outlook and our performance since IPO.

Thanks, Enver. On Slide 16, our outlook for 2023 and targets. As we enter a normalized interest rate environment, we are targeting core revenue growth in 2023 of greater than 12% with a net interest income of over EUR 1.2 billion while containing operating expenses to 2% growth despite significant inflationary headwinds. Based on stable underlying trends and solid asset quality, the underlying risk cost ratio is expected to be between 20 and 25 basis points. With the strong momentum on the back of a record year in 2022, we are setting the volume targets for 2023, a profit before tax greater than EUR 825 million, return on tangible common equity greater than 20% in the cost income ratio under 34%. We are also targeting earnings per share of greater than EUR 7.50 and a dividend per share of greater than EUR 4.10, which excludes any potential buybacks. On Slide 17, our first 5 years as a public company. Despite the changing sentiment in equity markets, navigating a once-in-a-century pandemic, dealing with significant inflationary headwinds and escalating geopolitical conflict, we have stayed the course of focusing on the fundamentals of running a good business, not chasing the latest fad or short-termism and focusing on the things that we can control. We strengthened our franchise by consistently growing earnings, improving our operating performance and being good stewards of capital. When comparing 2017 to 2022 results, we grew absolute core revenues by 32% and reduced operating expenses by over 10%, resulting in absolute pre-provision profit growth of 43%. In 2017, we delivered a return on tangible common equity of 15.6% and a cost income ratio of 47%. Five years forward, we've improved return on tangible common equity by 3 percentage points to 18.6%, reduced our cost income ratio by 11 percentage points to 36% and reduced our NPL ratio by over 50% from an already starting low point of 1.8% to a record low 90 basis points. We improved on every operational and financial metric by focusing on the things that we can control, being patient and prudent and pursuing sustainable and profitable growth. On Slide 18, a summary of capital generation and distribution since our IPO. Since 2017, we have generated an average of 220 basis points of gross capital per year despite the volatility of the pandemic years. We take pride in being good stewards of capital and aim to always be disciplined in our capital allocation. We paid EUR 1 billion in dividends, equal to EUR 10.96 in cumulative dividends per share. We completed share buybacks worth EUR 725 million, reducing our total share count by 17.5% to 82.5 million shares. We executed our buybacks at an average cost of EUR 41 per share. We will be proposing to the AGM a dividend payment of EUR 3.70 per share for 2022 equal to EUR 305 million to be paid on April 6, 2023, subject to shareholder approval. Therefore, this will take total distribution since our IPO in October of 2017 to over EUR 2 billion. We also completed 7 M&A transactions that were all self-funded and continue to build out our customer franchise. During the same period, our total shareholder return was over 30%, outperforming the benchmark European bank indices, the 70 and the 70 by 38 points and 43 points as of year-end 2022. For 2023, we are targeting an EPS of greater than EUR 7.50, a DPS of greater than EUR 4.10 and expect gross capital generation of over 275 basis points. With that, operator, let's open up the call for questions.

[Operator Instructions] We And your first question comes from the line of Hugo Cruz from KBW.

Just wanted to ask about the NII and then M&A opportunities. On NII, can you please tell us the big assumptions behind your 2023 guidance around your [ rival ] rate, deposit EBITDA, loan growth? And then has your sensitivity to further rate changes changed versus 3Q results? And related to these, the current interest rate forward imply a lower ECB deposit rate in 2024 versus 2023 year-end. Do you think this could mean lower NII for BAWAG in 2024 versus 2023? And then on M&A, and this is related to capital return, it sounds like you're assessing a few opportunities. Could you give us just a little bit of color there and what kind of businesses or portfolios that are looking to acquire and what could be the potential size?

Thanks, Hugo. Enver, you want to take the NII, and then I'll take the...

Yes, sure. So I think there were a couple of things on NII. The thing for this year, so our assumption is based on the current [indiscernible] forward, which are around 340 at the peak and then going down below 3%. And then next year, as you pointed out, will go down, I think, to 280 or 260. So starting with '23, I think we said on the call, it's -- we expect muted loan growth. So we do not expect a significant recovery on that front. So it's kind of based on stable to slightly increasing asset base. On the deposit betas, we don't disclose the exact number, but we said, on average, this is going up to 40% on the deposit betas itself. And just in terms of timing, I think which is important to understand, so we are always lagging a bit behind the current NII -- in the current NII. So what you see like in Q4 is pretty much based on Q3 rates. So what you are going to see in '23 is always a quarter almost behind the current market curve, which then going into the question '23, '24, helps a bit because you benefit from the tailwind. We don't give exact forecast for the other years, but I would look at it in the context of kind of stable, not declining NII in '24. I hope this was helpful.

Thanks, Enver. Hugo, on the M&A front, I'm sure we'll get a number of questions. So I'll try to be consistent. We are looking at a number of opportunities from small bolt-on acquisitions to potentially larger opportunities. We won't share more details than that. But you've seen our track record, we've done 12 deals since 2015, and we've tried to be kind of consistent in our approach. So hopefully, if one of these things materialize, we'll be able to provide more detail, but that's why we're being prudent at the moment in terms of our excess capital. We've been committed to buybacks over the years. We've done EUR 725 million of buybacks. I think we've been -- we tried our best to be good stewards of capital, but we also see potentially unique opportunities. And we're going to see how it develops over the course of 2023.

And your next question comes from the line of Gabor Kemeny from Autonomous.

Just following up on the share buybacks. When you say you would not do more than 100 basis points in the absence of M&A., can you elaborate a bit further on this? I guess the starting point is more than 100 basis points of excess capital above your CET1 target. And just looking at your capital generation, the year looks like that is actually close to 100 basis points on the basis of what you delivered last year, for example. So I guess my question is why would you want to end the year at a similar capital buffer and not pay out more potentially if your capital generation remains similar. That's the first question. And my second question is also on the share buybacks. If -- I'd like to understand if the valuation of the shares play into your decision to buy back shares at all. I guess your shares are trading at around 1.7x tangible book as we speak. It seems to be more like 1.3 in the middle of '22. And my final question is just a technical one on the TLTRO accrual. Did I understand correctly that the quarter-on-quarter impact from lower accrual was down EUR 5 million, EUR 6 million.

Thanks, Gabor. Do you want to go and take the technical piece?

Yes, sure. So I think the -- you're correct, Gabor. So it's EUR 5 million to EUR 6 million. So it would compare the NII of EUR 270 million would like-for-like be at EUR 254 million, EUR 255 million in Q3. Going back to the capital questions, 100 basis points or up to 100 basis points versus, technically, we would have 125 basis points versus our CET1 target, right? But if you consider Idaho First Bank, which will consume 25 to 30 basis points, that's why we gave the guidance of the 100 basis points, which is simple math, the 125 less 25 to 30 gets you to the bill 100 basis points. You also asked, I think, will we end the year-end '23, I guess, at the same capital buffers and why we don't do more on buybacks. Just a technical timing, right? So you will have -- we will have generated very likely earnings and gross capital generation by year-end, but then that goes into the next year distribution and capital distribution discussion, not this year. I think the last one was on the valuation.

Yes. No. Gabor, on the valuation, look, we try to be, again, good stewards of capital. When you're making over a 20% RoTE as we're guiding for 2023 and kind of that's what our normalized return outlook is going forward, you put whatever cost of equity on what you believe the company is. We still think at these levels, it's accretive to buy back your stock. And it's going to be part of our capital framework or part of our capital tools to buy back stock. That's not the -- that's not what's driving our consideration in terms of how we're treating our excess capital. It's about the opportunities set that we see. That is the single-largest factor in terms of why you're not seeing more of a discussion on the buyback today is we just see some interesting opportunities. But if those don't materialize, what we always say during the course of the year, we'll look to execute hopefully on the buyback. I hope that's not the case, but we'll see what happens.

And your next question comes from the line of Mehmet Sevim from JPMorgan.

I have a couple of follow-ups, please, to the previous questions. Firstly, on the NII guidance for 2023. May I please ask about your guidance, particularly in relation to your previous sensitivity of 200 million uplift for the 200 versus -- sorry, for the first 200 basis points of rate hikes? Because if you look at what rates are, and I understand you're using the forward curve in this guidance, it seems beyond the first 200 basis points, your guidance implies a very, very small benefit. So is there any color you can provide, particularly in relation to your previous sensitivity? And if I may also on the costs, what are the assumptions underlying the 2% cost growth target, which is obviously very impressive still and which I'm sure is still on the conservative side. So are you able to talk about the individual components there and how you see trends this year? And finally, if I may, on the buyback again. Your guidance of up 200 basis points, I think, brings the total payout to just 100% of last year's adjusted earnings, if you take into account the 60% dividends as well. So does this decision have anything to do with the level of payout relative to earnings going forward, particularly taking into account the difficulties of getting the approval last year, because it [indiscernible] and how you're thinking about? Therefore, can we think that the strategy shifting towards a more regular ordinary buyback with total payout below 100% going forward.

Thanks, Mehmet. I'm going to turn it over to Enver.

I'll start with the last one. Your rightfully right, Mehmet. So in the past, we had a situation of building up significant amounts of excess capital, which was due to different reasons. I think in the future, we would like actually to be more regular, have a regular cycle in distributions including dividends and buybacks, which in most of the cases should end up below 100% of earnings, which should also help with the overall process. On the NII guidance, on the sensitivity, nothing has really changed. So if I just go back a bit, right, so if I look at the world kind of before the rates started going up, so we had an average NII for the quarter, even not considering the TLTRO and everything, but around EUR 240 million used to be a run rate. Currently, we reported EUR 270 million, okay? So that's EUR 30 million up or EUR 120 million up for the year. And that, if you go at the Euribor in Q3, that was pretty much where we have seen the first kind of 100 basis points uplift. If I look at the forward rates, there is another compared to that level, 200 basis points, right, that will go from 100 to kind of 300 level. And if you look at our guidance, we are guiding for another pretty much EUR 200 million uplift on the NII. So it's been very consistent. It is 100 basis points delivers EUR 100 million of NII. So nothing has really changed there. And I think on the cost components, the underlying assumptions, I think, that the biggest 2 drivers is wage inflation and also taking into account the consolidation of Idaho First Bank. So net-net, we would have been probably stable without Idaho First Bank on the other underlying. And the wage inflation is going to be in our forecast between 7% to 8% is the underlying inflation that we considered.

And your next question comes from the line of Máté Nemes from UBS.

I have 2 questions, please. The first one is on loan growth and expected volume growth in 2023. I hear your comments regarding perhaps some slower growth in this year. I'm just wondering, did you explicitly expect the situation on the retail side, the outstanding loans decline from current levels, i.e., fairly subdued origination in consumer loans and maybe still some fairly tight underwriting in housing loans? That's the first question. And the second one is just going back to the potential M&A. I understand you can't really go into the details, but just conceptually, wondering if the fact that we are in a higher interest rate regime now perhaps changed a little your desired profiles for the businesses that you're looking at. And also, I'm just wondering that in this environment, you're still looking to perhaps get around mid-teens or high-teens type of RoTEs when deploying capital into M&A or has that also gone up and then should be more or less in line with the 20% that you're targeting.

Will you take that?

Yes. Sure.