Ladies and gentlemen, welcome to the Hoist Finance Q2 Report 2020. Today, I am pleased to present CEO Klaus-Anders Nysteen. Sir, please go ahead.
Thank you, a very good morning to you all, and welcome to this second quarter review for Hoist Finance. Long story short, the key takeaways today are that, first of all, I'm very pleased with the way we have handled the COVID-19 situation. Secondly, we have seen improvements week by week through the quarter. As a last message, this leads us to believe in a good recovery for the next quarters to come. With me today, we have our CFO, Christer Johansson. Good morning, Christer.
Good morning.
Our Head of Investor Relations, André Ljungberg. Good morning, André.
Good morning.
Let me first go to the presentation on page four. Given the uncertainty of COVID-19, one of the priorities of the quarter has been to strengthen the capital in Hoist. We left the first quarter with a CET1 ratio of 9.5%. Due to the strong cash flow generation and a very cautious approach to investments, the CET1 now is at 10.1%. Secondly, we are pleased to see that collection performance is picking up. We are expected to deliver around 90% collection performance, and we are happy to have done so. There is, as I mentioned, significant improvement during the quarter, with several markets now performing at a normalized level. We expect the positive development to continue. Let me assure you that we are committed to our cost-savings targets.
When we launched the program, we also made it very clear that there would be some upfront costs to deliver the necessary improvements. These costs are visible in the quarter, but with a lot of the benefits coming later. What I can say is that the underlying cost development is trending the right way. We are becoming more efficient, and we will talk more about this later. In order to continue to simplify and focus operations, we have decided to close our 3PC business in the U.K. This will have a positive impact on the cost base from 2021. As we have discussed before, our ambition is to be the digital leader in the industry. If you want to succeed in building a true digital value proposition, it is important to think about digital as a business in its own right.
Digital cannot be a project, a program, an initiative or something that the IT department is responsible for. Hence, we are now building on our experience of creating customer journeys that are truly digital, cross-border, and where products and services are tailored to a customer's needs. I believe that our approach to digital must be called end to end, and that we need to treat digital as a business in its own right. It starts with investments and continues all the way through to collections and helping people back to financial inclusion. This will drive performance, profitability, speed and innovation and make sure that we better, more holistically, find ways to help our customers. We are now recruiting a new member to the executive team to be responsible for this business line. We are looking forward to keeping you updated on our progress.
As far as the financial performance is concerned, I will leave the details to Christer, just say that we are pleased to see that underlying profit generation is strong, that we have taken some prudent forward-looking write-downs to adjust for the timing effect of delayed collections. More about this later. Moving on to slide number 5. I am very proud of the way we have been dealing with COVID-19 in the second quarter. We have been protecting the health of our professionals, also the well-being of our customers. We haven't lost production time, productivity has been somewhat hampered by working from home. We have to accept that for some of our people, it is not easy to be as productive as normal when the working conditions are less than optimal.
As we speak, I'm happy to report that staff is returning to our premises. In Germany and Italy, around 50% of our people are now back in the office. It's also positive that courts are opening up again. Naturally, when 50% of our collections is through litigation, this makes a difference. As the courts are catching up with the backlog, we expect to see a positive development from legal collections. As you can see from this tornado diagram, the U.K. has been a bit of a special case for us during COVID-19. There is a positive and important improvement in collections through the quarter, the impact from COVID-19 on collections is more visible in the U.K. compared to some of the other markets. From what we understand from our competitors, they more or less observe the same thing.
Given the size of the U.K. book, this consequently has an impact for Hoist overall. Courts are now open in the U.K., but they haven't been processing our types of claims as a matter of priority. We are in very close dialogue with the regulators and expect this to change, hopefully already in August, September. The shortfall from litigation or lack of litigation, I should say, in the U.K. is around 10% in that market. This has an overall impact for Hoist of around 5%. It's important. Moving to slide number six. As mentioned, we are committed to our cost reductions and to becoming more effective and more efficient. We have introduced a common operating model in Hoist, and we are increasingly relying on our shared service center in Wrocław and on nearshoring operations in Romania. The benefits are related to both scale and skill.
In a short time period, we have ramped up our operations in Romania, and we have now close to 100 employees. They are now both doing back-office support and customer calls. To date, our Romanian operations cover both Italy, Germany, and France, and we are in the process of expanding this to other markets as well. The plan is to have around 150 employees by year-end. On the next slide number seven. The slide shows a roadmap in how we're becoming a truly data-driven company. I said before that in 2018, we had to catch up fast. Our legacy is not one of operational excellence, and there was a clear need to leapfrog into the future. We have done so by fixing the basics and establishing a strong foundation.
When I look around the industry today, I cannot really see any competitors with a more harmonized approach to digital than we have. I clearly cannot see that our competitors are offering the same functionality across borders as we are doing. Part of building a safer and better and more cost-efficient infrastructure is going to the cloud. We are well underway, and we expect to move 80% to the cloud by year-end. Slide number eight. As you will remember, 2019 was a year where we had to deal with regulatory challenges, both changes in the risk weights, but also the introduction of the NPL backstop. We were able to introduce and implement the right countermeasures, and we are obviously very happy to successfully have completed the first investment grade-rated securitization structure in Europe based on NPL assets.
For Hoist, this has been an important instrument to deal with the regulatory changes. We are now working on deploying the same structures that we have successfully applied to our unsecured NPL back book, also to the front book opportunities in the various unsecured NPL markets where we are present. What is very important. We are of course proud to report that the assets in this structure have performed really well during the crisis. The performance shows the low risk and the stability in these portfolios, as well as the quality of our operations. Cumulatively, we are ahead of the forecast. The collections held up really well during the most challenging weeks of the second quarter. Let me now hand over to Christer. Over to you, Christer.
Thank you, Klaus-Anders. On page 10, before diving into the figures, I would like to put them into context. The business we run is stable. We collect small amounts month by month. It's very granular. It's predictable. It's diversified across thousands of portfolios. On top of that, we have over the last few years implemented significant changes to improve efficiency, and there's no doubt that these measures have worked. Consequently, earnings should be on a steady and increasing trajectory. As they should, because in reality, we have had some things to deal with. COVID-19 is one of them, but it's not the only one. We've also dealt with a 50% increase in risk weights, and we've dealt with extending the deposit duration, and we've had to pursue securitization as a way to future-proof the business model.
In that context, we are pleased to see the underlying earnings capacity being intact, and we believe that the prudent impairments we are taking now will clear the way for a speedy return to healthy profitability. With that introduction, let's move to page 11, P&L for the quarter. Top line income is stable, reflecting a book which is on par with 12 months ago. As we've said many times, front book margins are improving, and this will be more visible when acquisition volumes are back to normal. On interest expense, we have extended the average duration compared to a year ago. This is good from a risk perspective, but longer funding is also more expensive. With that in mind, it's of course also important to not have too much funding.
In Q2, we have taken action to manage excess liquidity down, that is one of the factors which have helped us to push interest expense down by a total of SEK 30 million in Q1. We're happy with that, we can reduce liquidity further. Impairments are significant, they're fully related to COVID-19, I will come back to this in a second on the following two slides. First, costs are up 4% versus last year, it's down 2% versus Q1 2020. Activity in the courts have not been running at full steam in Q2, which temporarily reduces the level of collection costs. On the other hand, we have been running at full steam when it comes to IT projects and the digital agenda, incurring around SEK 20 million of costs on top of the normal level.
Make no mistake, these are all projects with a clear link to our 2022 saving target of SEK 400 million. It's money well spent. All in all, and as a direct result of impairments, profit before tax came in at negative SEK 64 million. On page 12, I'd like to comment on the composition of impairments. We mentioned that collection came in at around 90%. For the unsecured part of our book, this translated into a realized shortfall of SEK 147 million, accounted for on the impairment losses line. Overall, collection performance was at its weakest in April, but improved to May. In fact, all the markets improved from May to June. We have also revised our predictions for future collections, these changes, which I will illustrate on the next page in a second, came with a SEK 91 million impact.
This accounted for against the impairment losses line. Both parts are a direct result of COVID-19, adding up to SEK 238 million impact. Finally, just to be clear, we have no net impairment on secure performance in Q2 that was dealt with already in Q1. For further transparency, let's turn to page 13. In connection with the Q1 release, we were clear about the challenging outlook, but we also felt that there wasn't really enough data to conclude on far-reaching implications for a book whose cash flows extend over 15 years. I think had we at that time insisted on a conclusion, chances are we would have overreacted. Today, we find the situation much more clear and are confident in our ability to stay open. We can see how the courts are managed, and we see collections improving month by month.
I should add that July is trading in line with this development. With these observations and data at hand, we have updated the predictions for our portfolios, and we've done so in a detailed and prudent way, reflecting a continued gradual recovery. As is clear from the graph, we saw shortfalls in Q2, and we've also lowered our expectations somewhat for the coming quarters. Now our aim is certainly to recover all of that, even if it's with a delay. However, given the pandemic uncertainty we have in our revised predictions, taking a more prudent approach and only assume that we will recover about 50%. As a final comment, I want to stress that since this adjustment is now accounted for, the coming quarters and years are measured against that revised target.
In practice, performance which meet the solid line will come with zero impairments and will come with profits similar to the steady green bars illustrated on page 10. Turning to page 14 and commenting on cost. Our work to reduce long-term cost has not at all been put on hold. On the contrary, there's been a high level of activity in Q2, and I'll give three examples. To start with, we've decided to discontinue our third-party collection in the U.K., as Anders mentioned. The reason is poor profitability, and turning that around would have required investments that we could not leverage elsewhere. The associated cost base amounts to circa SEK 30 million annually. We expect the savings to reach full run rate by end of Q4 2020. It's not in the aggregated numbers just yet. There is no significant restructuring charge related to this.
Second example, moving on, we see good progress in Romania, and we have expanded our shared service center in Poland. Those two combined currently include 150 employees, and that will exceed 200 by year-end. Thirdly, I mentioned that we are running with a high level of investment into IT in Q2. These investments are key to push digital collections up from its current 19%. Taking a somewhat wider perspective, one can note that when it comes to cost to achieve, we are roughly halfway. When it comes to realization of benefits, we have two-thirds to go, and this is best understood by looking at some of the key work streams in our savings program. Let's turn to page 15. These are all work streams where we've done most of the work and we've taken most of the costs. On some, we've also captured most of the benefit.
For example, site optimization. On others, we are only halfway. In regards to the shared service center, we have established it from a legal and managerial position. We've done a lot of recruitment and training, migration of tasks is still in progress. We also have some where most of the benefits are still to be realized. On digital collections, we have the portals in place. The functionality is expanding to capture more and more use cases, a key aspect from here and onwards is to truly integrate this in our onboarding of new portfolios. On IT outsourcing, the benefits are very tangible. They stem from contractually agreed prices, right now, transition costs, which are temporary, mean you don't see it. In short, knowing that the work is done gives us a lot of confidence in the realization of benefits. Turning to page 17 on funding.
Interest expense to book value is coming down from 2.6 to 2.3, so very attractive levels. The strength in the banking model is that we can adapt to the current funding needs. With lower acquisitions, we need less funding, and in Q2, we have taken decisive actions to reduce excess liquidity. This helps, of course, and in total, funding cost came down by 30 million SEK versus the previous quarter. There's still room to do more. We could reduce liquidity by another 2 billion SEK and still be within our internal target range. Within our capital market funding, there's been no real change in the quarter. As you will have seen, Q2 was a busy quarter also for the rating agencies. The banking sector has seen its fair share of downgrades.
On our side, we note that on July 1st, Moody's affirmed their investment grade rating for Hoist, although with a negative outlook. We've had a close dialogue with Moody's throughout the crisis, we are committed to maintain our rating and plan accordingly. Continuing to capital and liquidity on page 18. Despite exceptionally difficult circumstances, we come out of Q2 with capital ratios which are higher than we had coming into the crisis. This is the result of us having taken a very selective approach to new acquisitions in the quarter with additional support from the stronger Swedish krona. Looking ahead, we see interesting market opportunities, I expect acquisition to go back to normal towards the end of the year. In past years, Q4 acquisition has been around SEK 2 billion-SEK 3 billion. That is within our capacity also for this year. Over to you, Klaus -Anders.
Thank you. Thank you, Christer. Let me just summarize with a few important takeaways before we turn to Q&A. We're glad to see collection performance trending towards normal levels in most markets. That's important for us, of course. Hoist has a strong and robust capital situation and definitely strong liquidity, as Christer just alluded to. We are well prepared for the second half of the year. I mentioned legal collection is important for us, around 15% of total collections. Of course, these are claims that we expect to bring back to collections. We also mentioned operational improvements and cost savings. We are committed to delivering on this. As a point number 3, which I think is also very important, we are creating digital as a business line for unsecured collections.
In short, we stand ready to support our clients and share balance sheets across Europe and to help our customers keep their commitments. With that, we are ready to engage in the Q&A sessions. To the operator.
Thank you. Ladies and gentlemen, if you wish to ask a question, please press zero one on your telephone keypad. Our first question comes from Amyn Derek. Please go ahead.
Thank you. Good morning. Thanks for taking my questions. First, just on the third-party collection that you are closing down in the U.K., do you expect any income effect on closing that unit down?
There will be a little bit of income impact, yes. Let's put it this way, that we don't believe that this business was actually adding any profits.
Okay. I was just thinking what we should think about the net, because you said some SEK 30 million, I believe in cost savings.
I would say that the net will be at least half of that.
Okay, thank you. Then on the liquidity portfolio, we already saw interest expense coming down quite substantially quarter-on-quarter. Should we expect that to trend further downwards? Because I believe that the liquidity portfolio is still at elevated levels compared to what you've considered to be optimal historically, at least.
That is correct, and I do expect liquidity to come down further. However, the SEK 30 million impact is also the result of other factors, so you shouldn't take that x2 .
Understood. Lastly, just on the SPV, it looks like cumulatively, the headroom to your business plan has been reducing somewhat over the months. Could we just get some kind of update on how the, let's say, June collection were in relation to forecast isolated? Are you now actually trending on run rate for the last couple of months where you're close to 100% as well? I would expect you being some kind of underperformance that you had some headroom coming into COVID-19.
If I understand you correctly, you're asking about collection performance. If so, there has been an improvement week after week. As mentioned in my section, most markets are now almost back, or basically back to normalized levels. It's also important to understand what Christer showed. That there is a reset in what we expect in the quarter. That's also an important thing to have in mind. I'm not sure if I really answered your question now. Are you happy for you to clarify?
Sorry. What I referred to was the SPV in Italy, more specifically on slide eight.
Marathon.
When you show us the sort of collection versus business plan. There it looks like the cumulative collection ratio, but the headroom there is decreasing relative to your business plan, and it's sort of approaching 100% in June. Just wondering, so how does June stack up versus its original forecast? Should we expect the SPV to actually trend cumulatively under 100% the coming months before it starts to recover?
Oh, yeah. No, we don't expect that. Of course, I wouldn't go too strongly about this, but we don't expect it to go below cumulative 100%, no.
Okay, perfect. That's all for me. Thank you very much.
Thank you.
Thank you. Our next question comes from Borja Ramirez, Citi. Please go ahead.
Hello, I am Borja Ramirez from Citi. Thank you for your time.
You're welcome.
Good morning. I have two quick questions, if I may. The first one is if you could kindly provide some guidance on the financial performance into the second half of 2020. For example, collections or the portfolio acquisitions. My second question is, given all of the fact that we have low rates in Europe and also there's been some optimism with the recent Next Generation EU, do you think that maybe banks will be more eager to sell NPLs in the rest of the year? Thank you.
Thank you, Borja. I think we don't really guide too much. That's something that we've as you're aware of. I think there's one slide that kind of answers a lot of your questions, I believe, is the one that Christer showed with the green bars. I don't have the slide number in front of me, but maybe Christer can help me. Is it slide number 12, is it?
Slide number 10.
Slide number 10, the underlying earnings capacity is intact. I think that should give you a lot of comfort. All right? It shows the stability, it shows the impact from impairments. Of course, the slide that also shows the revised forecast, I'm thinking that collection performance should be in line with the new line. We shouldn't expect any impairments, basically. That kind of gives you the answer, doesn't it? Right. I think that's the best way to think about what we're going to deliver in the next two quarters. That should really give you some comfort. On the market opportunity, yeah, I think what we see is that a lot of banks are surely taking a lot of loan provisions which are necessary due to the crisis.
We expect there will be a lot of NPLs coming to market both in the third and the fourth quarter. From that point of view, there is a significant opportunity.
Understood. Thank you very much.
Maybe add, Borja, in terms of investment volumes, as I said, we expect things to go back to normal towards the end of the year. In a typical year, we've been able to acquire between two and three billion SEK in Q4, so that would sort of bring us towards replacement rate level.
That is very clear. Thank you.
Thank you. Our next question comes from Sandeep Kaur, SEB . Please go ahead.
I think that was me. Ramy here from SEB. Thank you for the presentation. A few questions, if I may. Starting off on slide five here. Is it unsecured Italy really back at 100% of original full cost levels, or am I missing anything here? Perhaps tying into that, how's your asset split between secured and non-secured in Italy? Does that include the SPV?
Right. I can start. Christer can fill out the details. Generally speaking, we are actually very happy with the Italian performance. I can see that some competitors are having a different experience than we have. Italy has held up really strong through the whole second quarter. The Italian market is our largest market. It's important. It's not like it's been completely at 100%. It's not far away. There's been improvement basically every week. We are very close now to, let's call it, the normalized level also in Italy. That's evidently very important for us. Christer, do you want to add something?
I think what I can add is just, the majority of our book is the unsecured portfolio, of course, and then we have secured investments primarily in Italy and in France. On these portfolios, we revised our projections already in Q1. It seems we were actually a little bit too pessimistic on delays. In the quarter, we collected better than we had anticipated on the secured portfolios. That's a good thing. It doesn't change the net contribution to the P&L a lot, it seems like there's no reason for worry on the secured portfolios.
Okay. Then tying to Borja's previous question about investment levels I had in replacing your deteriorating book in 2020, could you provide us with any flavor about how you reason about potential book expansion in the years beyond, and perhaps, how you reason around the capital situation as well currently?
In reality, we haven't changed our long-term financial targets. We still want to grow our business, going forward. Try to come back to normalized earnings, which I think we can reasonably quickly. When we have more to say about long-term financial targets, we will communicate of course. For now, we see that what we have done in the past is around SEK 6 billion to basically SEK 8 billion Swedish investments per year, and I see no reason why we can't return to those levels. I think our CET1 is certainly stronger now than it was at the end of Q1. I think we are in a good position. I think we've been really prudent. That's important. I think we have acted on the information that we had at hand, and that gives us a good place to continue the growth.
That's clear for Sandesh. Then, you're obviously closer to banks' NPL departments. What are you hearing from them in terms of timing? You've mentioned Q4 being a big quarter for you. Have you seen any sort of postponements of potentially closed deals that you were expecting pre-pandemic? Also in terms of pricing? Are you seeing any deals being closed? Could you address anything in numbers here as well on the pricing situation?
Yeah. The second quarter was a bit softer than what we typically see. It wasn't a lot of volume. Also, we see from reports or competitors that everybody's been really cautious, which I think was the prudent thing to do in this quarter. On the sales side, volume is there. Some deals were pulled, naturally. These volumes are coming back in the third and the fourth quarter for sure. The reason for this is that the regulator is seeing what we are seeing, and the banks are seeing themselves that the loan provisioning that is necessary will expand the NPLs again on banks. The regulator is not really keen to see that happening, so they are pushing the banks to keep on selling whatever was left from before, as their non-performing exposures are increasing again.
I see nothing else than non-performing loans coming to market in big volumes. That's a positive. We see that competitors are somewhat financially restrained, pretty high leverage. I expect a very rational competition, and I expect margin improvements. From that point of view, it's a pretty good picture for us.
Just on the volume side before going to price. What are you seeing the non-listed competitors doing? Mainly, the big credit firms buying large ticket items, but also to some extent competing with you guys. Have they stopped buying as well?
Good question. I think they are active, but they are typically active on portfolios that we are not really head-on-head in competition. They typically buy sort of the portfolios of over EUR 200 million, EUR 300 million, EUR 400 million, and we are definitely below that level. If we do EUR 100 million, that's a high number for us. We are not so much head-on-head with the credit funds. I don't have a lot of accurate information to give you. Sorry for that.
No worries. That's helpful anyway. Finally, just on pricing, and perhaps you've mentioned it, but could you address the risking in numbers here? What are you seeing in terms of pricing volume, pricing coming up or coming down, gross IRR levels coming up? Have you seen any spread that you could quantify so far?
We have seen spreads, of course, and the improvement is significant, but I don't think I will comment on specifics. It is a good improvement.
Crystal clear. Thank you. Finally, just on the cost situation here. You have a decent run rate of cost savings going into the quarter on top of that you have some legal savings from court systems being shut, et cetera.
Yet the cost trend isn't magnificent. Down 2% quarter-over-quarter, and was it up 4% year-over-year? What am I missing here? You've mentioned that earnings should gradually come up over time, et cetera.
I assume there shouldn't be a massive step down in OpEx in Q3, but what am I missing in reported figures so far? Perhaps now should we reason moving forward, is it indeed a gradual improvement on the OpEx side, or should we expect any lumpiness on that side?
Yeah, I can start and Christer can fill me out. What I would say there is that I recognize this issue, right? It's not like we're trying to shy away from this. We've been very clear that we want to improve our efficiency and effectiveness and to reduce our cost. Our cost-saving target is we are fully committed to deliver the SEK 400 million. What gives me a lot of comfort is that the projects are real, the projects are specific, and the savings are tangible. Everything we do around site consolidation, around nearshoring, shared service centers, digital, all those things are specific, and even the things are contractual, as Christer said, for instance, on the IT outsourcing. Costs will come down. Unfortunately, in the first and second quarter, there are some quite cost investments to bring down costs and the benefits are coming later.
When you're training 50, 60 people to start doing back office support in Romania, that takes cost and effort to do, right? You have to recruit, you have to train, but you don't get any benefits. Those benefits are coming later when you're reducing the number of FTEs in the other markets. That's coming, there's no doubt. Right? The 3PC business in the U.K. has now been closed. That has a benefit. We are taking some costs, but the benefits are coming later. I realize that the proof is in the eating, and we have to show that this actually happens, and we will. Christer, maybe you want to add something.
I can say that, of course, with income taking quite a hit here in the first few quarters, it's tempting to hold back on investments which we need. We have not done so to any significant extent. We have continued to execute on the plan we had. It hurts us a bit right now, but I'm sure it will pay off over time.
A follow-up to that. Thank you both. Final follow-up here to Christer. Stripping out the collection cost, which naturally should follow the book trajectory, but give some, take some, of course. On the personnel and admin side, what's the underlying cost inflation on a sort of like for like basis? I can imagine that's a difficult question, but any flavor is helpful.
I don't know from the top of my head, to be honest.
Okay. That's fair. No worries. Thank you so much.
I would figure that salary inflation is 3%.
We are shifting people out, right? There are fewer people in Stockholm now than used to be, frankly, because we replaced the more expensive FTEs with lower expensive FTEs in shared service centers, to mention one. We will see improvements also on the admin line now. That's for sure.
Thank you. That's very clear.
Ladies and gentlemen, as a reminder, if you wish to ask a question, please press one on your telephone keypad. There are no further questions at this time. Dear speakers, back to you.
Okay. Thanks for your questions, and thanks for spending the time with us today. I wish you all a great day. Bye-bye. Bye for now.
Bye.