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Andreas Treichl – Chairman

Andreas Gottschling – Board Member

Erste Group Bank AG (OTCPK:EBKOF) Q2 2014 Earnings Conference Call July 31, 2014 5:00 AM ET

Andreas Treichl

Good morning ladies and gentlemen. Welcome to the presentation of the first six months of 2014. May I ask you to move on to page six of our presentation where we have an overview of the result 2014 on 2013 in the first six months of 2013, we had a profit of EUR302 million and in the first six months this year, a negative result of EUR930 million and there you’ll see how this has all come about. It’s the operating income and expenses, the income has come down by EUR61 million on past year but as the expenses rose – went down by EUR64 million so a slightly improved operating result, EUR911 million were behind last year and in addition EUR361 million of additional charges from taxes. Let me explain to you page six a little later. I’ll move on to page three where you have an overview of the one-off effects.

EUR911 million and here are the most important components listed which are divided this into two groups, one that has an effect on the regulatory capital and the other one that has no effect on regulatory capital. Let me explain this to you because this is not easy to understand that you have a loss and yet the Tier 1 capital rises which is quite positive.

First, the effects on the regulatory capital that is to say the part of a negative result that actually will be deducted from the regulatory capital. These are the additional risk provisions in Romania.

In addition to the budgeted write-off of EUR80 million then EUR130 million comes under other operating income that is the effect from the new Hungarian law on consumer loans. Here for the second six months, we expect yet another EUR170 million and since we do not know what the law will be worded whether this will be included in the impairment or whether this will be deducted directly from the loan volume.

So, we’ve got this in here and it will certainly have an effect on regulatory capital. And then another EUR164 million, a negative change in deferred taxes. So, these are the three items that will be included in the regulatory capital.

Goodwill has been deducted already EUR854 million of intangibles in Romania that’s about EUR300 million of the goodwill that we have impaired over the past years, so the goodwill is at zero now and at the same time the value of customer relationships and the brand has been reduced to zero and thus in Romania we have no intangibles any more. And in addition we have goodwill in other subsidiaries that was written down an amount of EUR101.8 million and this is also shown in the balance sheet that all intangible assets went from EUR2.4 million to EUR1.4 million. What remains now is about EUR500 millions of goodwill for Česká spořitelna which we consider sustainable, about EUR300 million in the Slovenská sporiteľňa and the remaining EUR600 million are in SN Software and some minor participations.

What we did not include in the first six months because we do not know about this and it’s against the decision of the Supreme Court in Hungary what the effects are on what has been reported in the media and by some politicians what is planned for the autumn that is to say and accelerated conversion of foreign exchange loans in Hungary. So, this is the major chunk of the EUR900 million and a smaller part of this will be written off against the regulatory capital.

Some important key figures. The net interest income has gone down slightly because in all our markets we have a lower interest rate landscape but on the whole this is stable and the interest margin although it’s gone down slightly over the past year has now stabilized. It’s flat now on this level.

As to the operating results. Again this is brought stable and we stick to our forecast that it will go down slightly. The cost income ratio on last year has improved substantially from 57% to almost 54% and the loan deposit ratio has also remained stable and the banking levies, the additional levies that we pay in Hungary and Slovakia have come down by EUR30 million because of the reduction of Austrian banking levy.

Why we find this to be so much lower in the second quarter than in the past quarter is that in the first quarter the entire Hungarian banking levy was booked and the remaining quarter the situation will resemble that of the second quarter as to a more detailed explanation Gernot Mittendorfer is going to take over.

A short overview of the operating income of the first half year 2014 here you see the breakdown according to business segments and countries, operating income has remained stable year-on-year but a slightly declined net interest income have slightly increased commission and fee income. And if we look at the individual countries, positive development can be found in Austria slightly negative development in Czech caused by the devaluation of the Czech koruna which the National Bank made in 2013.

In Romania we have long performing loans were reduced and this results in a better net income, all the other operating income is positive. If we took the cost development that the operating expenses of the first half year of 2014 that is to say the second quarter, the development is rather positive or expensive have gone down and are partly stable from instance in Austria and there has been a market decline in Romania for instance the savings that we executed last year now come to in [Beia] in Czech here.

On the second quarter of 2013 we have this foreign exchange translation effect because the Czech koruna was divided by 7%. If we look at the operating results altogether second quarter 2014 a positive development, our cost income ratio went down to 62.9%. That is to say in an environment weather has been no significant growth we’ve nevertheless managed through a strict cost discipline to make up to offset the flat results by reduced cost developments and the cost income ratio was also reduced.

As to the breakdown in countries, it’s similar to the income and expenses situation a better environment Austria, very stable Austria and Czech here and in Slovakia and also downtown in Romania for the reasons that have just been mentioned.

If we look at page 10, take a short glance at the Group balance sheet performance, the balance sheet total as of the 30th of June 2014 is at EUR200 billion there have been no major changes. We’ve reduced our cash by the end of the year which corresponds to the downturn in debt securities. There were few issues because we have loan deposit ratio of below 100% and there is a slight loan growth via an additional growth in deposits.

You see that customer deposits have gone down, this comes from the de-consolidation of the Czech pension fund, the customers of the pension fund in terms of the decision of Czech auditors and authorities this is not consolidated in the bank balance sheets.

And now onto development of the customer loans and let me mention this before, my colleague will take over and report on the risk positions we’re always talking about nonperforming loans. These are the subjects that we already had over the past quarters. The NPL have gone down but let me point out that what you see in middle here the performing loans we see a growth in a quarter EUR115.7 billion of performing loans in an economic environment that we find ourselves in at the no moment with very low growth rates and a very low credit demands. This is a very good result and I think that we should view this very positively because this is our core business and most of our loans extended show a very positive development. The geographical development loans grow in Austria, in Czech here, in Slovakia and in Romania and Hungary, the reduction is slowing down as stabilization of performing loans is taking place.

And now on Andreas Gottschling.

Andreas Gottschling

Thank you very much. Page 12 risk costs. Could I ask you to take into the consideration that this increase in risk cost which was referred to – was booked at EUR80 million in this quarter and the majority of this will be brought in the next quarter so there is a distortion here if we do a quarter on quarter comparison we see an increase of Group level of EUR68 million, however I should like to point out that this is in commercial real estate only in SME, only in geographically in Romania and in Austria other because this is where commercial real estate is being accounted for. And this overlaps the good news that in retail including Romania but in all countries risk costs have dropped significantly 50% as you can see and in the large corporate segment there was a reduction of risk costs by 25%.

I move on to the nonperforming loans as was mentioned by my colleague earlier on, here we can see again that we see a decrease less than EUR12 billion and given the stability of performing loans we see that the ratio has dropped to 9.4%. The management of those nonperforming loans was driven 50% by sales EUR135 billion and geographically this happened in the second quarter mainly in Hungary and in Austria. And as a late event, I can report early July as in the – as we mentioned in the first quarter, we sold a corporate portfolio in Romania. This was signed EUR240 billion involved. This package I correct myself so to speak it’s million and not billions of course. EUR240 million that was the worth of the package.

Now, when composing the package in local currency we have EUR1 billion loans to customers and EUR500 million in suspended interest and off balance sheet items are 50-50. So, this is 1,355 loans to 575 borrowers, to P&L impact of EUR145 million warrant was accounted for June. The closing of this portfolio say will happen in August and we are planning a recognition in the third quarter. This deal as the one I mentioned which has been signed now and which will be recognized in the third quarter a similar deal is in the pipeline to ensure speedy workout.

Page 14 let’s have a look at the coverage and we see that the coverage ratio given higher provisioning and other factors has risen to a multi-year high both at Group level and also in all business segments and geographically also in Croatia.

Our announcement that further increase will go hand in hand with further provisioning in Romania is correct however we should take into account that by the sale and by write-downs which have an offsetting effect when it comes to raising the coverage ratio by higher provisioning, the final ratio for this year is not easy to assess the more successful we are in selling provision NPLs, the – more this will have a positive effect on the coverage ratio. So, we cannot assess a clear figure as of now.

This now takes us to page 16. Our capital position I’d like to ask you to look at the very right hand column Basel III, the end of the first quarter we had a ratio of 11.1% and total assets are 15.5% and at the end of the second quarter we have a core capital ratio of 11.7% and a total capital ratio of 16.5% what you see below and that is important for us as well is the 10.8% which we have in the Basel III fully loaded calculation as is required as of 2019. So, this brings us a big step forward.

Given this development of our capital position and just takes me to the outlook, we confirmed of what we have stated in our, at half release in June and we are even more certain today that this 10% market can be kept. We are currently at 10.8% and this figure seems to be quite secure and this is good because in the third and the fourth quarter we might be in for a small medium or large scale surprise from Hungary I do not hope this happens but this is something we’d have to then take in strides.

Apart from that, we retain our forecast for 2015 where we expect a return on tangible equity of between 8% and 10% and all this is based on substantively lower risk costs in 2015 owing to the impairments we have done in 2014 so far and which will also be done in the second half of 2014. This brings me to the end of my presentation and we are available for any questions you may have.

Question-and-Answer Session


(Operator Instructions).

Unidentified Analyst

I have two questions as to your last remark possible surprises from Hungary in the autumn, could you be more explicit on this? What dimensions and the reasons and at the beginning income statement negative changes with deferred taxes you mentioned EUR160 million, could you explain this in more detail?

Unidentified Corporate Participant

As to deferred taxes, deferred tax assets were written-off that is to say recognized tax policies because this is based on a tax calculation that we have adjusted according to the half year losses and then we wrote down the assets.

As to Hungary there is a Supreme Court ruling that what is in the media now would not make this possible but over the past months and weeks we’ve heard a lot about this that the government in Hungary is planning for the autumn to a push an accelerated conversion of foreign exchange loans. There is no option for us and we do not know what effects this will have on us. At the conference of analysts so we’ve asked why we stick to the 10% and because of the higher ratio why we did not write this up and this is the reason because we do not know what’s in the pipeline and we cannot express this in figures and at the end of the third quarter we’ll be able to tell you more about this.

But does this mean that because of the Hungary the annual losses higher than EUR1.6 billion, could be higher than EUR1.6 billion. Well, I would consider this to be highly improbable.

Unidentified Analyst

As to trust and confidence you said that this is a one-off action and so we have seen yet another action how to explain this to your shareholders, how do you keep up their trust because again this is a one-off action, this is not.

Unidentified Corporate Participant

Well I believe that the response that we had from the shareholders shows us that quite a lot of shareholders who actually expected this and there have been a lot of discussions on this with our major shareholders so what we are going to do with the fair value in Romania and now we’ve just written-off the goodwill altogether. And this has also brought a positive impact on the income statement because our customer – a value of customer relationships was also written down and this in future will be a reduction of EUR160 million per year.

Unidentified Analyst

So many shareholders have actually expected this and many of us told us why you don’t do it all in one go? Have you not made mistakes with your expansion to these, and also they would not have done investments into Kazakhstan et cetera.

Unidentified Corporate Participant

Well, if you look at the situation in Hungary and Romania and what has happened there over the past years of course this is a justified question but what you should not forget is that we had a very clear goal and this goal still is to become the largest retail bank in the East of the European Union. And in the very last stage where banks were sold, we brought this bank in Romania and we paid through the – for that. It just depends on the periods that you are thinking of in periods of five years. The past five years just doesn’t look too good but let’s discuss this again in three years from now, so it was not a mistake but of course it was a mistake. We invested a lot of money and I think is a big difference between loan write-downs and fair value and goodwill. A lot has changed in 2006 but seen from today the situation is as it is and in three years for now things may turn for the better or may have turned for the better.

Unidentified Analyst

And then for the better purchase you got a special bonus as a CEO and there will be no repayment on this.

Unidentified Corporate Participant

Well, I don’t know who actually expressed it that way but there are a very few CEOs who paid back their bonus. We’ve done this and we will not get any bonus for this or either. However...

Unidentified Analyst

What about your main shareholder as Stiftung come how will this go on because they’ve accumulated a lot of debt?

Unidentified Corporate Participant

The Stiftung is actually half its debt and of course it has been rather painful for them not to get any dividend but the cash situation, liquidity situation is okay and it also includes that for 2014 there will be no dividend payment.

The disbursements in the foundation in Stiftung what has passed on to people and regions throughout the crisis have not been stopped.

Unidentified Analyst

That’s okay. I am just getting the feeling looking at your results, you’re still dealing with legacy problems from the crisis and I am wondering whether you see the 2014 being a turning point when these legacy problems are finally dealt with and maybe the legacy problems in the whole sector in emerging Europe maybe 2014 might be a turning point for other banks also?

Unidentified Corporate Participant

Well, in the last years I have – I’ll tell in English. In the last years I have term rather careful with predictions given on what happened. What we did and what we announced on the 3rd of July was very, very clearly our wish that with that we put the financial crisis behind us. And I think it is fair to say that we did everything within our power and everything within our knowledge to make sure that as of 2015 we will not have to deal with legacy issues any more. So, from that point of view we will look at 2015 and the years beyond very positively.

However I have to say we have been eased and our shareholders have been thankfully also gotten use to the fact that nasty surprises have come up along the way. I think what I can say there will be no nasty surprises from our part but I cannot exclude that there might be nasty surprises in certain countries all in the region due to political decisions or political developments. I am not in a situation right now to tell you what the effects of prolonged and deepening Ukrainian or Russian crisis might have on our business for the moment is relatively subdued but if the crisis accelerates of course we will probably have to revise forecast all over Europe in 2015 and 2016.

So, we’re living in insecure times and we as a management see our task to prepare for everything that we can actually influence and that I think we’ve done to a fullest extent to the fullest extent with what we did.

Unidentified Analyst

I’d like to follow up on that. From your perspective from the view of the bank you don’t expect any nasty surprises as the one of 3rd July?

Unidentified Corporate Participant

Yes, I think that everything we have done so far to make sure that we finally deal and come to terms with the crisis for our business. This has been done. Things that may happen in Hungary in fall, something we don’t know and what will happen in other countries things we are still in for something I cannot forecast. And this is something we have to live with. It may happen that suddenly we have 50% banking levies being introduced on the hedge count or whatever I don’t know but apart from the risks which we have given the overall political developments within the European Union and political actions against banks, against lines of industry you cannot make any provisions for that. I think we’ve done everything and anything we can do as a management team.

Unidentified Analyst

Follow up question given the problems in Hungary what is your strategy? Will you roll back the business, dismiss people; close banking outlets?

Unidentified Corporate Participant

But we do that with regard to Hungary, we will be seeing return for the better. A positive development of the country as a whole and we as a bank in recent years have continuously brought down our costs in Hungary. Today we are at a level where we could make good money if the Hungarian economy work to develop soundly. It’s something which we strongly hope and many foreign investors are attracted to Hungary to actually revive the economy.

Unidentified Analyst

Can you tell us if you add everything up together how much including this year in terms of loss have you recorded in Hungary about EUR1 billion?

Unidentified Corporate Participant

Well, I can say is that in the past three years in Hungary we have spent more or loss, more money than what we’ve earned since we are there.

Unidentified Analyst

How much is that? Can you give us a figure?

Unidentified Corporate Participant

This is nothing I calculated, foreign loan, outstanding foreign loans EUR2 billion in Hungary.

Unidentified Analyst

Next question. What needs to happen in Hungary to make you leave that country?

Unidentified Corporate Participant

We have a long-term strategy and this strategy is based on a long term story. In 1826 the first savings bank was founded in Hungary so you see there is a long history, a long tradition with that country. Hungary is a country that belongs to us and I think we will stay there. And we also believe that Hungary will be very successful.

Unidentified Analyst

You didn’t mention a lot of Croatia today. Could you please explain the eventual plans and strategy there has been change in regulation because of that followed increased provisions and do you consider change of management in Croatia?

Unidentified Corporate Participant

The goodwill related to Croatia was the goodwill write-down was triggered by the effect that capitalization ratios in the banking market are higher and goodwill calculations are dealing with cash flow models and higher capital level that you have to keep is taking a way to pay-out option of this elevated capital levers. So, there is no change in the underlying business plans or profitability of the bank. It’s just simply a reflection of higher capitalization levels which does not imply any negative developments.

So, Croatia, the bank in Croatia is operating in a difficult environment because the economy is not growing for the last couple of years but it’s performing quite well given the environment and we are satisfied with the colleagues in Croatia. So, it was an event that was driven by higher levels in our calculations and nothing else. No material deterioration.

Unidentified Corporate Participant

When Ms. [Radkovich] will retire, we will replace it. Which will not happen this year but she is even older than me and last point I think these days is pretty good if one doesn’t talk too much about somebody. You can be actually quite happy.

Unidentified Analyst

Okay. Just one last question. There has been some unofficial talk in the banking industry that ERSTE running another acquisition in Croatia post Danske Banca. Can you confirm or deny that?

Unidentified Corporate Participant

Well, it’s very clear that we have been interested in post Danske Banca and we actually made an offer the government did not accept it.

Unidentified Analyst

Are you still interested?

Unidentified Corporate Participant

We don’t express any interest unless there is something available and at the moment post Danske Banca doesn’t seem to be available.

Unidentified Analyst

Okay. Thank you.

Unidentified Corporate Participant

A question in the back.

Unidentified Analyst

My name is Jacques Romania. Two question please? ERSTE Group subsidiary have very different NPL levels, is it because of the management of the local business environment or is it something goes that generates as GAAP. And then second question, consider as the record NPL ratio in Romania are you seeing that personally layoffs and getting the numbers of branches are the main method from saving these activity, please?

Unidentified Corporate Participant

Regarding the NPL levels I think that is to a large extent due to the different business mix and the history of the various banks in the different countries I don’t think that is systematic in ways that you can easily attribute to individual management decisions I think there is always a component of the particular country involved in it. It has to do with the interest rate it has to do borrowing environment and it has to do with the security of the borrowers which varies quite a lot across countries which we are operating and but I don’t think you can specify down to the individual management decision.

The second part of the question that I didn’t understand was the branches in Romania. I just didn’t get it acoustically I am sorry. Could you repeat that please?

Unidentified Analyst

I repeat one another question. Considering the record NPL ratio in Romania, do you think is that personal levels and cutting a number of branches are the main measures for trembling activity?

Unidentified Corporate Participant

We were reducing the number of branches already in the past and reducing the staffing. Current level of the Romanian operation is reflecting the current business opportunities and there is nothing on top of that what happened planned at the moment.

We are even renovating our branches in Romania and doing clean up and want to make it more customer friendly. And we could see in the second quarter in Romania for the first time since couple of quarters an increase in our retail lending overall in the bank which is a very positive sign for us.

And don’t forget that the NPL ratio is a result of the healthy portfolio and a healthy lending vis-a-vis they are nonperforming loans if the healthy loans are decreasing faster or at the same speed as the nonperforming loans, the ratio does not improve.

Given that we expected particularly the retail loans to grow in the future, the NPL ratio will also come down.

Unidentified Analyst

What’s the amount of the exposure in Russia? I know that you do not have a subsidiary in Moscow but do you have Russian exposure?

Unidentified Corporate Participant

Yes, we do the Russia exposure is less than EUR200 million. It’s bank trade finance related with account of parting banks for import export businesses that belong to our region and Ukraine exposure is around EUR400 million or was this reduced. This was reduced in Russia and the Ukraine together are around 355 exposure.

Unidentified Analyst

For how long will you remain in office as CEO and is there a succession plan for you?

Unidentified Corporate Participant

Well, my contract ends at the end of June 2017 and you have to ask this questions to my Supervisory Board and of course we do have a succession plan. This is one of the most important tasks that we have. Any further questions?

Unidentified Analyst

I assume that you know more about the European sanctions vis-a-vis the Russian banks and the Russian banking sector with the knowledge that you have do you see any danger to the banking sector in Eastern Europe and in Austria if there might be counter measures et cetera or do you expect that Austrian subsidiaries might be effected?

Unidentified Corporate Participant

Well, this is a rather serious issue and it will have an – may have an impact on the Austrian banking sector. However it’s early to say what will happen because the different speeds in the sanctions and counter sanctions development between the U.S. and Europe.

Other past weeks a few things have happened and I hope that this will all come down and calm down and that one does not enter in negative spiral where sanctions trigger counter sanctions et cetera because this would not help anyone especially not if there are no clear statements as to what goal these sanctions actually have.

We personally not directly confronted with this, but we do hope that the escalation will take place for the good of the entire Austrian banking sector. If there are no further questions, we should like to thank you for the interest that you have shown. And we do hope that things will be looking up in future.

Thank you for joining us and have a good day.

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Source: Erste Group Bank (EBKOF) Q2 2014 Results - Earnings Call Transcript

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