Ladies and gentlemen, welcome to the Hoist Finance Q2 report 2018. Today, I am pleased to present CEO, Klaus-Anders Nysteen, and CFO, Christer Johansson. For the first part of this call, all participants will be in listen-only mode, afterwards, there will be a question-and-answer session. Gentlemen, please begin the meeting.
Thank you, operator, a very good morning to all of you. Thanks for spending time with us today as we will go through our Q2 presentation. With me here today, as the operator said, I got Christer, our CFO, but also Michel Fischier, our head of investor relations. A very good morning to everyone. Let me then start on page three, which is really just today's agenda. I will spend a few minutes just go through the key highlights for the quarter, but also share with you some observations, after having spent some time in the company now, also the priorities going forward. Christer will definitely take us through the details regarding our financial performance, then we will at the end, as usual, do some wrap up and turn to Q&A. Let's then move to slide five in the presentation.
The title of our quarterly report this time is Continued Growth, Expansion into New Asset Classes and Good Progress on the Operational Agenda. Somehow I think that this title summarizes the quarter reasonably well, with the key words for the quarter being one, growth, two, operations. I'm sure you have looked at the numbers already, indeed this quarter is characterized by significant growth. It is an all-time high capital deployment for Hoist Finance, a total of SEK 2.3 billion, also diversified across several asset classes. As we have discussed in the past, diversifying across asset classes has been one important priority for us, given that our classic core, the unsecured consumer, only represents 10%-12% of the total non-performing loan market opportunity. I'm particularly happy that we were able to acquire a performing retail portfolio in Poland.
I can also mention that the acquisition of a secured non-performing portfolio in France. Please note that this French transaction closed in July and is of course locked down part of Q2. The last 12 months growth in portfolios is 37%, significant growth, that's for sure. Please have in mind that a lot of the growth came very late in the quarter and is consequently not contributing with earnings in the quarter. In terms of financial performance, I think it came in more or less as expected, it's fair to say also that we have a job to do regarding our costs. Some of the costs are for good business reasons, Christer will come back and discuss this more. I would say not all of it. I will definitely talk through our priorities in terms of operational efficiency.
In terms of collection performance or overperformance, I am reasonably happy at the level of 103. And for the quarter at 105 year to date. The outlook is very positive. We see a significant and healthy pipeline at the moment, and I believe that we are in an excellent position now with our low cost of funding to take our lion's share of the market share growth. I have seen that some of the competitors are commenting on a somewhat reduced margin pressure on the front book. And as an annex to this, I can also share that almost half our deals year to date are exclusive. And this is surely not something I have seen or experienced in this industry before. I think that tells you something about the opportunity. Moving to slide number six.
This is obviously my first full quarter as CEO in Hoist Finance, and I thought it could be useful to share some of my observations and priorities going forward. But first of all, let me just establish that we are committed to this year's guidance of 17%-18% return on equity, and with a longer-term target of 20% return on equity. And secondly, also let me just establish that regarding portfolio growth, we will deliver more than the previous guiding of 15%-20% portfolio growth. I think I mentioned this before, but worthwhile just recapping that we believe that there are some key trends that are currently impacting our industry. One is definitely growth. And there is more growth in the relatively new asset classes compared to the traditional core, the unsecured consumer. Secondly, industry consolidation is ongoing. We see it basically every week.
As a point number three, the price pressure. However, currently somewhat reduced at this point in time. And as this industry is becoming more professional, more mature, more sophisticated, we have in Hoist now developed a strategy that will deliver on the three overarching goals. To take the top three position in our priority markets. To provide investors with attractive returns relative to the competitors in the industry. And ensure that Hoist Finance becomes the leading company in terms of operational efficiency. Just to make it clear, at this point in time, we are not launching new financial targets, but we will at our capital markets day later in the year present both strategy in more detail, but also update you on our long-term financial targets and ambitions. Moving to slide number seven, Hoist Finance has a unique position in the marketplace.
I believe that we stand out relative to our competitors, at least in three ways. First of all, regarding funding. We have a diversified funding with a significant portion from retail depositors, hence providing us with the lowest average cost of funding in the industry. Secondly, we are focused and specialized. We focus on debt purchase and only for non-performing loans originated from finance institutions in relatively few markets. And I believe that there is a lot of merit in prioritizing simplicity and scale as synergies are found in markets more than across markets. And don't forget that by operating in the most important markets in Europe, basically six most important markets in Europe, we still compete for 80% of the market opportunity. As a point number three on this slide, we welcome regulation, and there is more regulation that is coming for sure.
We are confident that being a regulated entity ourselves, regulated as a bank, is strengthening our position as the preferred partner to other banks in our markets. Slide eight is an important slide for us. It shows, in many ways, the strength of the Hoist Finance business model. As you clearly can see, Hoist has the lowest weighted cost of debt in the industry and a very comfortable net leverage given the low cost of our debt. In this current market condition, we are confident that the value of our strong balance sheet and our funding model will be increasingly recognized. Moving to slide nine and building on the previous page, and now having spent some time reviewing our current level of profitability. One should think that our funding cost advantage should be visible and also in our earnings. However, that's not really the case.
Our EBT margin is on par with peers. That means that our funding cost benefits are offset by a lack of operational efficiency. The important news, if I can use the word news here, is that we see no reasons why Hoist Finance cannot be more effective and efficient. We are committed to make up the lost ground and become the most effective and efficient operator in the industry. We see a significant upside here, and we have already taken more important steps to close the gap. I will speak more to this now and starting with the next slide 10. To the right on slide 10, you see six of the strategic cornerstones of our strategy. I think it's clear that understanding our performance gap is the most and the first important step to make change happening.
Having worked with the team and engaged with all employees in all markets, I am confident that we will pull together as one organization to deliver on our ambitions. We'll continue to reduce complexity and to realize the benefits of scale and skills. We will continue to expand into new asset classes. We'll professionalize and industrialize our processes. Everything based on the unique foundation of being a bank. To add more color to the strategic cornerstones, let me then briefly take you through them one by one. Moving to slide 11. The essence of the One Hoist Finance initiative is to work, I would say, in a harmonized, consistent, and standard way across all our markets. Experience has taught us that where there's little collaboration and harmonization, we immediately get duplications, and we know also that duplications are costly. What have we actually done then?
Well, what are we in the process of doing? We have removed one layer in the organization. We're taking away the regional level in Hoist Finance. We are going from having subsidiaries to introducing branches, simplifying our legal structure. We are doing a site consolidation. I think you're aware of the site consolidation that is happening or has happened in Germany. We are now in the same process in the U.K., and we are establishing shared service functions in low-cost jurisdictions. The benefits from this will be found in better performance management, improved collection performance, and reduced costs. Moving to slide 12. We are convinced that size matters. What matters more than geographical presence in many markets is market share in individual markets. As mentioned, there are of course synergies across markets, but, in brackets, the in-market synergies are more important.
We will consequently prioritize to strengthen our value proposition to our clients. Again, as I mentioned, being specialized and focused is better than being complex and scattered. The next page, slide number 13, a few comments there. Again, as our industry matures and the level of sophistication increases, the need to have, I would say, a consolidated, consistent view of the business increases too. Just too many companies don't really know what they know because the complex data models, variety of IT systems, it's just really too hard to navigate for everybody. We are taking the steps to standardize and harmonize to ensure that we quickly are able to capture the best ideas, accumulate knowledge, learn fast, and deploy our insights to the best of clients and customers. This will drive improved collections and lower our cost-to-income ratio. Moving to the next page.
I will not spend a lot of time on this, page 14, as I already have talked about the strength of our funding model. We have documented over time a strong capability to bring down the average cost of funding. While maintaining a strong rating, we will continue to see how we can use our regulated status as a competitive advantage also going forward. I started our presentation today by talking about the trends affecting our industry, I'll move to slide number 15, by the way. I talked about growth, I talked about consolidation, I talked about price pressure. I did not mention digitalization, but it's quite clear that digital is a very important factor also for our industry. I think it is fair to say that the potential is both material and very tangible.
There are solutions available almost off the shelf that do not require massive investments, but with a very meaningful business case. Let me just mention here that we have, for instance, just now installed a cloud-based dialer in our Polish market, also with very promising results. I think this is the first or second cloud-based installation in Europe. In Poland now, we are able to engage with 2 times as many customers for the same number of employees compared to the situation prior to installing this new dialer. Also our self-service portal in the U.K. is delivering results above expectations, both in terms of average installments paid and also the number of installment plans established. Going digital and spearhead the industry is consequently an important ambition for Hoist. Again, prioritizing simplicity is important to succeed in digital.
Moving then on to slide number 16, and to wrap up sort of my presentation about observations and priorities and strategy, let me make it crystal clear that we are committed to operational efficiency. Our preliminary review or the cost savings show that we can realize cost savings of SEK 150 million-SEK 200 million. This will bring our cost-to-income ratio below 70%. We will, of course, provide you with further transparency on our initiatives at the time of our capital markets day later in the year. With that, let me then hand over to Christer, who will take us through the second quarter financials. To you, Christer.
Thank you, Klaus-Anders. Starting on page 18. Year-on-year net operating income and cost both grew approximately by 20%, but these comparisons are impacted by a few one-off items. To start with, operating income in Q2 2017 was negatively impacted by bond restructuring in an amount of SEK 67 million. Adjusting for this net operating income increased by 9%, reflecting a growing book but at lower margins. A fair share of portfolio growth in the quarter took place the very last week of June and has as such not given any substantial contribution to income. On the expense side, the current quarter is burdened with SEK 24 million in items affecting comparability. Adjusting for those extra costs, total expenses are up by 14%. I will provide more details on the next slide.
Our profit before tax of SEK 141 million corresponds to an increase of 36%. Adjusting this for items affecting comparability in both periods, profit before tax is down 4%. Return on equity ended at 12% during the quarter and 15% when adjusting for items affecting comparability. The effective tax rate in the quarter was high at 27% due to adjustments related to previous periods. Had the tax rate been more in line with our long-term average level, which we believe to be valid also going forward, this would have added 1% to Return on equity. Strong acquisition volumes during the quarter amounting to SEK 2.3 billion is almost 3 times as large compared to the same period last year and translates into portfolio growth of 37% over the last 12 months. This takes our carrying value on acquired loan portfolios up to almost SEK 18 billion.
I'd now like to turn to slide 19 and discuss the cost and operational efficiency development in more detail. As Klaus-Anders mentioned in the beginning, we are not satisfied with the level of operational efficiency. Cost income in the quarter amounted to 75% after adjustment for one-offs, and although this is more or less in line with previous periods, it's simply put, not good enough. As stated, we believe that this level should be at least below 70% and this is a priority for us. That said, I'd like to elaborate a bit on the underlying cost drivers for costs in Q2, starting with growth in personnel expenses. This is to a fair share fueled by growth in our business and our investments into new capabilities for secured SME and performing assets. During this build-up phase, we take on costs, but income generation is only gradual.
Furthermore, there is a significant ramp-up of staff in Poland, where we have seen strong portfolio growth. Over the last 12 months, we've added more than 100 FTEs in Poland as part of our transition towards amicable collection, which is more staff intense. The category of personnel expenses also include provisions of SEK six million for restructuring, primarily related to U.K. site consolidation. Moving on to collection cost, the level of SEK 167 million includes an exit fee of SEK 16 million in Poland incurred in order to transfer portfolio to in-house collection. In this case, in-house collection allows us to increase the level of customer engagement. After adjustment for this one-off, collection cost decreased by 4% year-on-year. Comparing collection cost with the previous quarter, Q1, the reduction is explained by two things.
There has been a foreseen reduction in legal collection fees in Poland, and secondly, the lower collection performance, 103% compared to 108%, has meant lower collection expenses. With regards to collection expenses, it may also be noted that we do expect a bit of variation over time due to the mix-in and timing of portfolio acquisitions. Lastly, administrative expenses have increased with 35%, and I would like to highlight two points. First, as described, the quarter included extensive acquisitions in new asset classes. We are incurring costs to establish these business areas, for example, in relation to our new offices in Paris and Warsaw. Exploring these growth opportunities has also been supported by external resources.
Secondly, during the quarter, we have been pursuing additional simplifications in our corporate structure, and we have, with the help of advisors, mapped the best way forward, taking amongst other things, regulation, tax, and internal efficiency into account. Turning to the next page, I would like to reiterate our communication on restructuring. We are in the process of closing the Bremen site. We expect to complete this in the third quarter and hence in the second quarter, we are still carrying the full cost. On a similar theme, we are also evaluating a consolidation of our U.K. operations, which will add further cost reductions. With that, I would like to turn to page 20. Moving on to our segments. In the first chart, you can see the composition of acquired loan portfolios where the strongest growth continues to be in the Italian, Polish, and U.K. markets.
Looking at contribution to group operating income, Italy has increased its operating income the most since Q2 last year, driven by the strong portfolio growth. That seen in operating income also translated well into profit for tax, where Italy is in fact the largest contributor followed by the U.K. In Germany and Poland, we see a decline in profit before tax. In Germany, the main reason being lower than anticipated collection levels. Also, as mentioned, the site consolidation has not yet had effect, but will be completed during the third quarter. Looking at Poland, the comparison is significantly impacted by the SEK 16 million exit fee already mentioned. Other segments consist of Belgium, the Netherlands, Spain, France, and Greece. In the second quarter, we benefited primarily from strong VAT-related collections in the Netherlands, which exceeded expectations. Now let us turn to page 21 to look at the funding side.
During the quarter, we established a commercial paper program with a ceiling of SEK 2.5 billion. The first issue was well-received, and we issued in total EUR 93 million at three, six, and nine months with interest rates of 17, 25, and 30 basis points respectively. The commercial paper program further diversifies our funding base and introduces another option for short-term funding. During the quarter, we also issued additional Tier 1 capital to enable future growth of our business. EUR 40 million was issued at the coupon of 8%. Our funding from deposits has increased by 14% since the beginning of the year. There has been a shift towards euro deposits, which now make up one fifth of total deposits. This is the result of our strive towards improved currency matching.
Our interest expense in relation to book remains well below 2%. As illustrated by Klaus-Anders, it's clearly a very competitive level. To wrap up, let's turn to capital and liquidity ratios on page 22. With regards to capitalization, our CET1 ratio stands at 11.1, which is just slightly below the middle of our targeted range. As you can see in the second chart, the CET1 ratio has decreased somewhat since year-end 2017. This is mainly driven by the strong balance sheet growth during the last six months, but also an effect of Swedish crown depreciation since beginning of the year. The Tier 1 capital ratio and our total capital ratio have instead increased since beginning of the year. This is of course the result of the mentioned EUR 40 million AT1 issuance which in turn is part of our ongoing efforts to enable strong organic growth.
Our liquidity reserve remains strong and despite sizable acquisition, it has in fact increased by roughly SEK 600 million since the beginning of the year. With that, I'd like to conclude our financial review and I hand the presentation back over to you, Klaus-Anders.
All right, thanks for that, Christer. On the last page then, page 24, the summary and the key takeaways. I thought this morning to say that two most important words in this quarter report were growth and operations. I think it should be no surprise that it'll be more of the same also going forward. We see several opportunities to continue to grow by deploying capital in a profitable way, and we are committed to improving our operations. Currently, our low cost of funding is a sustainable competitive advantage, and we are confident that our healthy and strong balance sheet is a great asset in the current market environment. With that, we open up for questions and answers. It's over to the operator.
Thank you. Ladies and gentlemen, if you have a question for the speakers, please press the zero one on your telephone keypad. There will be a brief pause while questions are being registered. Our first question comes from the line of Armin Klee from Nordea. Please go ahead. Your line is now open.
Good morning. Thank you for taking my questions. The first one is kind of could you give us any more color on how we should view the road to the SEK 150 million-SEK 200 million in cost savings? Will we need to take further restructuring charges to reach that target? I mean I think actually slide 19 is quite a good highlight of what has been somewhat of an issue that every second quarter you've taken items affecting comparability, affecting quite negatively on your cost-to-income ratio. How should we view that going forward?
Yes. The indicated level of cost saving has a few underlying components. There is one part related to digitization and self-service platforms. There is one part related to a more effective organization. There is one part related to other items, including site consolidation. I would not rule out that there could be a need for restructuring charges, but we don't think that they would be massive.
Okay. Thank you. Also on your interest margin. If we just look on the interest income margin from acquired portfolios, that slide rather substantially now, quarter-on-quarter, but also if we include the 19.2% you mentioned when you were changing your reporting structure. What's kind of driving this rather fast decline in the interest margin?
Yes. Thank you for the question. Margins on the front book during 2018 is in fact now very in line with margins from 2017. That is however, somewhat lower than the average of the book, which we've written over the last 10 years. To counter this cost savings, it's our priority as we've mentioned.
how should we view it going forward then? If you have a 30 basis points drop quarter-on-quarter, is there anything kind of one-off character impacting Q2, or is this a trend we should expect to stabilize already from Q3?
Ladies and gentlemen, I'm sorry about this, but it looks like the call has just disconnected. I will bring them back in. Just please give me one moment. Ladies and gentlemen, the speaker is now back into the room. Please carry on with the meeting.
Thank you, operator. This was definitely an unscheduled disconnect, so sorry for that. can we just ask Armin and Lode to repeat the question, please? We didn't get it fully.
Yes, of course. Do you hear me now?
Yes, much better. Thank you.
Perfect. My question was, if we just look quarter-on-quarter, according to my calculations, we see the interest income margin sliding by some 30 basis points from Q1 to Q2. My question was, should we see that stabilize somewhat towards Q3, or was it anything sort of extraordinary impacting the Q2 level?
I think the only extraordinary item that's worth mentioning here is the large performing books that we've bought in Poland, which clearly comes with lower risk and somewhat lower margins. Other than that, we would be hesitant to guide too much on margins since we're not yet sure which acquisitions we will complete in Q3, so to speak.
Understood. Thank you. That's still helpful. Then the final part was on the U.K. self-service platform you launched. I believe in Q3, you said that somewhere about 20%-30% of new plans were set up through that self-service platform. Could you give us any update if that number has been sustainable or where it is currently at? Thank you.
No, it's picking up very nicely, and it's definitely a slight ahead of our business case. As I was mentioning or I can confirm. We are definitely expanding this now and see how we can add more services to the digital portal. This is like a one-way route to digital as a very high priority.
Excellent. Thank you. That's all for me. Thanks.
Thank you.
Thank you. Ladies and gentlemen, I remind you that if you want to ask a question, you will have to press 01 on your telephone keypad. There will be a further pause while more questions are being registered. Our next question comes from the line of Owen Jones from Citigroup. Please go ahead. Your line is now open.
Hi. Thank you. Good morning. Just a follow-up question on the cost savings. I appreciate it seems to be relatively early stage in terms of what you're saying about them, and you said that you're going to be able to provide us some more information with the Capital Markets Day, but just in terms of how we should think about the SEK 150 million-SEK 200 million savings, just in terms of the bottom line contribution. I think in the statement you mentioned cost avoidance in future versus cost savings, and you've outlined the drivers of those, but how should we think about those from a modeling perspective? Thank you.
Yes, thank you. As we've discussed, we're on quite a steep growth journey here. I think on this kind of journey, we will definitely invest into new areas and we will certainly bring in staff. The SEK 150 million-SEK 200 million should not be seen as a reduction from the current cost level to the future cost level. It's more the sum of the initiatives that we intend to drive.
Okay. Are you in a position whereby you can provide some sort of split?
I think we would prefer to get back to that in the Capital Markets Day.
Yeah. I think what Christer said, he indicated three important sources, and I think that's as far as we would like to go right now. We will go into more detail as we approach Capital Markets Day. We definitely feel that there is a job to be done here. I think the one slide that shows that our great advantage on the funding side, unfortunately being offset by lack of operational efficiency tells the whole story. We are committed to make up the lost ground.
Okay, thank you. Then in terms of the areas that you outline in terms of the drivers of those savings, so the digital and service platforms, the organizational changes and the site consolidation, from any of those, should we be thinking about any sort of revenue uplift, or is it just an efficiency point that you're targeting?
Well, these are efficiency measures.
There wouldn't be any associated revenue uplift that you would target?
Well, with this cost savings program, it's definitely targeting our level of efficiency. As such, we don't expect revenue uplift from it. However, of course, we will always look for transferring best practices, right? How can we improve collections? How can we improve collection performance, overperformance, stuff like that. We haven't indicated any specific targets for it.
Okay. Thanks very much.
Thank you.
Thank you. Our next question comes from the line of Adedapo Oguntola from Morgan Stanley. Please go ahead. Your line is now open.
Yes, good morning. This is Adedapo from Morgan Stanley. Just one question from me. I don't know if it's already been asked already, but sorry, excuse me. Just in terms of the guidance for loan purchase for the year. I think earlier on you indicated that you are targeting about between SEK 4.5 billion to SEK 5 billion. With this work acquisition in Q2, does that guidance still stand or you expect to do above that?
Thank you. Christer Johansson here again. With such a strong start to the year, we will exceed the previous guidance. We've not given any further guidance.
Sorry, just to confirm, you now expect to exceed the previous guidance you provided?
Yes.
Okay.
Thank you. Our next question comes from the line of Victor Lindgren from Carnegie. Please go ahead. Your line is now open.
Yes. Thank you. Good morning. Some questions from my side, starting with Germany. Can you quantify the impact on a quarter-to-quarter basis on the OpEx from the closure of the German site that you now say will give you a benefit already starting in Q3 instead of Q4?
Yes. On a full year basis, this should be in the range of SEK 20 million to SEK 25 million.
We should expect that to start already now in the beginning of July on a quarterly basis then, of course.
We expect to complete the site consolidation in Germany during Q3. As of today, it is still work in progress.
Okay. All right. On the 20% return on equity target that you have, and you also reiterate this target. You have identified cost savings of SEK 150 million-SEK 200 million, maybe not net, but still you reiterate the 20% level. Implicitly, something has happened underlying because 20% was also the case before you found this SEK 150 million. Can you take us through the thinking of this and why you don't see any upside to this target? Is it that you expect more price pressure going forward that you did not see before, or is this something else?
We do not expect price pressure to increase from where we are today. As I mentioned earlier, the margins on the 2018 front book is in line with the margins on the 2017 book. Nevertheless, as we communicated, this is a somewhat lower level than the average underwritten level. To counter this and get to the 20% return on equity, we will work on our efficiency.
Yeah. On the 20%, it's still the same target, but there's a SEK 150 million in benefit. We should see some changes to that or I don't understand what you're targeting here.
We are not changing our financial targets with the communication that we've given now. We will return to the financial targets in the Capital Markets Day, and up until that point, the 20% return on equity is our target.
Okay. On margins, then you say they're flat year-over-year. Is that when you refer to IRRs on portfolios?
Yes, correct.
Are these defined in the same way now? It's 10-year ERC curves that you model or is it any revision to that?
This is on a like for like basis.
Okay. I'll get back in line. Thank you.
Thank you.
Thank you. There are currently no more questions in the queue, so I will hand the call back to the speakers. Please go ahead.
Right. Thanks for calling in today. Thanks for spending time with us. Really appreciate that, of course, and I would just like to thank you again and wish you all a great weekend and a great summer. Talk to you later. Bye.
This now concludes our conference call. You may now disconnect your lines. Thank you all for attending.