Earnings Call: Q2 2018

Jul 27, 2018

Ladies and gentlemen, welcome to the Hoist Finance Q2 Report 2018. Today, I am pleased to present CEO, Kraus Anders Neistein and CFO, Krista Johansson. For the first part of this call, all participants will be in listen only mode and afterwards, there will be a question and answer session. Gentlemen, please begin the meeting. Thank you, operator, and a very good morning to all of you. And thanks for spending time with us today as we will go through our Q2 presentation. So with me here today, as the operator said, I got Kriste, our CFO but also Michel Fischer, our Head of Investor Relations. So a very good morning to everyone. So let me then start on Page number three, which is really just today's agenda. I will spend a few minutes just go to the key highlights for the quarter, but also share with you some observations after having spent some time in the company now and also the priorities going forward. Kristian will definitely take us through the details regarding our financial performance. And then we will, at the end, as usual, do some wrap ups and turn to Q and A. So let's then move to Slide number five in the presentation. And the title of our quarterly report this time is Continued Growth Expansion into New Asset Classes and good progress on the operational agenda. And somehow, think that this title summarizes the quarter reasonably well with the key words for the quarter being one, growth and two, operations. So having I'm sure you have looked at the numbers already and indefinitely this quarter is characterized by significant growth. It is an all time high capital deployment for hoist finance, a total of billion and also diversified across several asset classes. And 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% to 12% of the total nonperforming loan market opportunity. I'm particularly happy that we were able to acquire a performing retail loan portfolio in Poland. I can also mention that the acquisition of a secured nonperforming portfolio in France. Please note that this French transaction closed in July and is, of course, not then part of Q2. The last twelve months growth in portfolio is then 37%, so significant growth, that's for sure. But 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. But 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, and Kristi will come back and discuss this more. But I would say not all of it. So I will definitely talk to our priorities in terms of operational efficiency. In terms of collection performance or overperformance, I'm 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 growth. I have seen that some of the competitors are commenting on a somewhat reduced margin pressure on the front book. And I can confirm that we are seeing the same. And as an annex to this, I can also share that almost half of our deals year to date are exclusive. And this is surely not something I've 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 Kreuz 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% to 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 to 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's more growth in the relatively new asset classes compared to the traditional core, the unsecured consumer. Secondly, industry consolidation is ongoing. See it basically every week. And 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 Hoyt 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. Horst 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, 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 nonperforming loans originated from financial 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 to part number three on this slide, we welcome regulation and there is more regulation coming for sure. And 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 number 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. And 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 number 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. So that means that our funding cost benefits are offset by a lack of operational efficiency. But the important news, if I can use the word news here, is that we see no reasons why OIT Finance cannot be more effective and efficient. And 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 stick more to this now and starting with the next slide, slide number 10. So to the right on slide number 10, you see six of the strategic cornerstones of our strategy. And 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 will continue to reduce complexity and to realize the benefits of scale and scale. We will continue to expand into new asset classes. We will professionalize and industrialize our processes, everything based on unique foundation of being a bank. And to add more color to the strategic cornerstones, let me then briefly take you through them one by one. Moving to Slide number 11. So the essence of the One Horse Finance initiative is to work, I would say, in a harmonized, consistent and standardized way across all our markets. Experience has taught us that where there is little collaboration and harmonization, we immediately get duplications. And we know also that duplications are costly. So what have we actually done then? Well, and what are we in the process of doing? So we have removed one layer in the organization. We're taking away the regional level in Horiz Finance. We are going from having subsidiaries to introducing branches, simplifying our legal structure. We are doing site consolidation. I think you're aware of site consolidation that is happening or has happened in Germany. We are now in the same process in The UK. And we are establishing shared service functions in low cost jurisdictions. And the benefits from this will be found in better performance management, improved collection performance and reduced costs. Moving to Slide number 12. We are convinced that size matters. Because what matters more than geographical presence in many markets is market share in individual markets. As mentioned, there are, of course, synergies across parties, but in brackets, the in market synergies are more important. So 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. And just too many companies don't really know what they know because of complex data models, variety of IT systems, it's just really too hard to navigate for everybody. So 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. And 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. And 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. And 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. And also, do very promising results. I think this is the first or second cloud based installation in Europe. And in Poland now, we are able to engage with twice as many customers with the same number of employees compared to the situation prior to installing this new dialer. And also, our self-service portal in The UK is delivering results above expectations, both in terms of average installments paid and also the number of installment plans established. So going digital and spearhead the industry is consequently an important ambition for Horst. And again, prioritizing simplicity is important to succeed in digital. So 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. And our preliminary review of the cost savings show that we can realize cost savings of SEK 150,000,000 to SEK 200,000,000. And 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. So with that, let me then hand over to Kristor, who will take us through the second quarter financials. So over to you, Kristor. Thank you, Klasanders. And starting on Page 18. Year on year net operating income and cost both grew approximately by 20%, but these comparisons are impacted by Q1 off items. To start with, operating income in Q2 twenty seventeen was negatively impacted by bond restructuring in an amount of 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, current quarter is burdened with million in items affecting comparability. Adjusting for those extra costs, total expenses are up by 14%, and I will provide more details on the next slide. Our profit before tax of SEK141 million corresponds to an increase of 36%, but 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 billion is almost 3x as large compared to the same period last year and translates into a portfolio growth of 37% over the last twelve months. This takes our carrying value on acquired loan portfolios up to almost SEK18 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. Updated, 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 buildup 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 twelve months, we've added more than 100 FTEs in Poland as part of our transition towards Amecammer collection, which is more staff intense. Finally, the category personnel expenses also include provisions of SEK6 million for restructuring, primarily related to UK site consolidation. Moving on to collection cost. The level of SEK167 million includes an exit fee of SEK16 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. When 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 of 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 advisers, mapped the best way forward, taking, amongst other things, regulation, tax and internal efficiency into account. Before 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 UK operations, which will add further cost reductions. With that, I'd 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 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. Patents seen in operating income also translated well into profit before tax, where Italy is, in fact, the largest contributor followed by The UK. 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 16,000,000 exit fee already mentioned. Other segments consist of Belgium, The Netherlands, Spain, France and Greece. And in the second quarter, we benefited primarily from strong VAT related collections in The Netherlands, which exceeded expectations. Now let's turn to Page 21 to look at the funding side. During the quarter, we established a commercial paper program with a ceiling of SEK2.5 billion. The first issue was well received and we issued in total €93,000,000 at three, six and nine months with interest rates of seventeen, twenty five and thirty 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 one capital to enable future growth of our business, euros 40,000,000 was issued at a coupon of 8%. Our funding from deposits has increased by 14% since the beginning of the year, and there has been a shift towards euro deposits, which now make up onefive 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%. And as illustrated by Trans 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 krona depreciation since beginning of the year. The Tier one capital ratio and our total capital ratio have instead increased since beginning of the year, and this is, of course, the result of the mentioned €40,000,000 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 600,000,000 since the beginning of the year. And with that, I'd like to conclude our financial review. And I hand the presentation back over to you, Trans Anders. All right. Thanks for that, Kristian. So on the last page then, Page 24, the summary and the key takeaways. I started this morning to say that two most important words in this quarter report were growth and operations. And I think it should be no surprise that it will 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. So with that, we open up for questions and answers. So it's over to the operator. Thank you. Our first question comes from the line of Armin Karitch from Nordea. Please go ahead. Your line is now open. Good morning and thank you for taking my questions. So the first one is kind of could you give us any more color on how we should view the road to the 150,000,000 to €200,000,000 in cost savings? Will we need to take further restructuring charges going to reach that target? Because, 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 income ratio. So how should we view that going forward? Yes. So the indicated level of cost saving has a few underlying components. So there is one part related to digitalization and service platforms. There is one part related to a more effective organization. And there is one part related to other items, including site consolidation. And 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. And then also on your interest margin. So if we just look on the interest income margin from acquired portfolios, that's slightly 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, no, very in line with margins from 2017. And that is, however, somewhat lower than the average of the book, which we've underwritten over the last ten years. To counter this cost savings, it's our priority, we've mentioned. But I'm so how should we view it going forward then? I mean, if you have a 30 basis points drop quarter on quarter, is there anything kind of a one off character impacting Q2? Or is this trend we should expect to stabilize already from Q3? I will bring them back in. Just please give me one moment. Ladies and gentlemen, the speaker is now back into the room. Please begin with the meeting. Thank you, operator. This was definitely an unscheduled disconnect, so sorry for that. But can we just ask Alvin in Nordea to repeat the question, please? We didn't get it course. Do you hear me now? Yes, much better. Thank you. Perfect. So 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. And 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 book that we bought in Poland, which clearly comes with lower risk and somewhat lower margins. But other than that, we would be hesitant to guide too much on margin since we are not yet sure which acquisitions we will complete in Q3, so to speak. I understand. That's still helpful. And then the final part was on The UK self-service platform you launched. I believe in Q3, you said that somewhere about 20% to 30% of new plants 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 slightly ahead of our business case. And as Daryl mentioned in our I can confirm. And we are definitely expanding this now and see how we can add more services to the digital portal. So this is like a one way route. Digital is a very high priority. Excellent. Thank you. That's all for me. Thanks. Our Our next question comes from the line of Owen Jones from Citigroup. 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 150,000,000 to 200,000,000 savings just in terms of the bottom line contribution. So 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? Yes. Thank you. So 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. So the SEK150 million to SEK200 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. And do you 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 Yes. I think what Krista said, he indicated three sources, three important sources. And I think that's as far as we would like to go right now. We will come into more detail as we approach Capital Markets Day. But 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. And we are committed to make up the lost ground. Okay. And then in terms of the areas that you outlined in terms of the drivers of those savings, the digital and service platforms, the organizational changes in 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. So there wouldn't be any associated revenue uplift that you would target? Well, this cost savings program is definitely targeting our level of efficiency. And as such, we don't expect revenue uplift from it. However, of course, I mean, we will always look for transferring best practices, right, how can we improve collections, how can we improve collection performance, other performance, stuff like that. But we haven't indicated any specific targets for it. Our next question comes from the line of Adidas Pol Augentura Kade from Morgan Stanley. Please go ahead. Your line is now open. Yes, good morning. This is Aditya Appel from Morgan Stanley. Just one question for me. I don't know if it's already been asked already, but sorry, excuse me. Just in terms of your the guidance for loan purchase for the year, I think earlier on, you indicated that you are targeting about between SEK4.5 billion to SEK5 billion. With this record acquisition in Q2, does that guidance still stand or you expect to do above that? You. Kristian Wasson here again. With such a strong start to the year, we will exceed the previous guidance, but we have not given any further guidance. Sorry, just to confirm, you now expect to exceed the previous guidance you provided? Yes. Thank you. Our next question comes from the line of Victor Lindbergh 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 basis, this should be in the range of SEK 20,000,000 to SEK 25,000,000. And we should expect that to start already now in the July on a quarterly basis then, of course? So we expect to complete the site consolidation in Germany during Q3. So as of today, it's still work in progress. Okay. All right. Then on the 20% return on equity target that you have, and you also reiterate this target, but you have identified cost savings of SEK150 million to SEK200 million, maybe not net, but still you reiterate the 20% level. So implicitly, something has happened underlying because 20% was also the case before you found this SEK150 million. So 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? So I think we do not expect price pressure to increase from where we are today. And 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. And to counter this and get to the 20% return on equity, we will work on our efficiency. Yes. But on the 20%, it's still the same target, but there's a SEK150 million in benefit. So we should see some changes to that? Or I don't understand what you're targeting here. So 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. And on margins, then you say they're flat year over year. Is that when you refer to IRRs on portfolios? Yes, correct. And are these defined in the same way now, its ten year ERC curves that you modeled? Or is it any revision to that? So this is on a like for like basis. There are currently no more questions in the queue. So I will hand the call back to the speakers. Please go ahead. Right. So 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 bye. This now concludes our conference call. You may now disconnect your lines. Thank you all for attending.