Aareal Bank AG
Q1 2017 Earnings Call Transcript

Published: 11 May 2017

[Executives:]

Juergen Junginger - Managing Director and Head of IR Hermann Merkens - Chairman and CEO

[Analysts:]

Benjamin Goy - Deutsche Bank Johannes Thormann - HSBC Britta Schmidt - Autonomous Research Philipp Haessler - Equinet Bank Tobias Lukesch - Kepler Cheuvreux

[Operator:]

Ladies and gentlemen, welcome to the Q1 2017 Analyst Conference Call. At our customer's request, this conference call will be recorded. As a reminder, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. [Operator Instructions]. May I now hand you over to, Juergen Junginger, Managing Director and Head of HR - sorry, Head of IR, who will lead you through this conference. Please go ahead sir.

[Juergen Junginger:]

Welcome, good morning. Not HR really, IR. That's why I'm here, if not I would have a different job certainly. I am very happy to have here with me Hermann Merkens, who is doing presentation regarding our Q1 figures, and if you have any question, I think, we will be able to answer them all. Let's go for it, Hermann, please.

[Hermann Merkens:]

Hello. Good morning, everybody. Welcome to our Q1 presentation. Hope that you have our presentation in front of you. So starting on Page 3 of the presentation. Short summary, as always. First quarter, €71 million operating profit, fully in line with our expectations. The net interest income is reflecting strong performance in new business, and on the other hand very robust margins on new business, 250 basis points, as you see in the presentation, quite very good and strong, as indicated during our full-year preliminary number presentation. With respect to Aareon, they are fully on track due to the products are increasing and hence the operating EBIT for profit and net commission income in line, as I said. And last point, we increased our full-year guidance and are confirming this with €310 million to €350 million due to the one-off from the Coreal transaction. And now on Page 5, no really further comments on that because I touched on everything, I think in my intro, so that we could go into the Slide 7, which is referring to the structured property finance segment. And as always, some side comments to the market situation. First of all, overall commercial real estate market observations. Transaction volume is sharply down on a worldwide level. It's across the board. U.S. minus 9%; UK minus 40%; France minus 36%; Italy minus 38% on a quarter-on-quarter basis. If I would compare that within 10-year average, it would be a little better picture. U.S. plus 8%; Europe plus 2%; U.K. minus 27% already and France minus 34%. So there are two exemptions, if you like - sorry, I forgot Italy with plus 10%. There are exemptions. Germany, and little bit as a surprise, Spain, with quite strong Q1. On question who invested, from European perspective net investments throughout every sector of public, private, institutional, fairly flat, so to speak. On the U.S., more or less the same. There is one exemption in U.S., cross-border business picked up in the U.S. and a large chunk of this cross-border investments was driven by Chinese investors. And one other observation, REs in the U.S. invested a little bit more compared on a quarter-on-quarter basis. You may remember they've been on the disinvestment side for a long while, but interestingly enough, not in those buckets where the cross-border investors are interested, and they are investing more in logistics and B locations, so to speak, to avoid word the hotspots of cross-border investors. All in all, our debt is, to a certain extent, reflected in the early prepayment fees, which are in line with the lower end of our expectations, €35 million but we will see how that transaction volume behavior will develop throughout the full-year. Second remark on that slide with respect to gross margins, 250 basis points, I've already mentioned, driven by the large part of the U.S. business. Very solid. Fairly low LTVs with 58 basis points. Overall real estate portfolio is some €30 billion, whereas we have commercial real estate portfolio of some €28 billion, if I recall that correctly. So on Page 8, consulting services. Strong start into the year 2017 here as well. We have done a small addition, as an acquisition, in the Netherlands, Kalshoven, which is a strategic investment to strengthen our footprint in Netherlands. Small one, but for the market in the Netherlands, important one. Aareon revenues with €52 million, as already mentioned, fully in line with our expectations. Driver here again, digital products, which will account in for markedly number on a full-year basis and we expect that to increase over time, as already explained in previous calls. So if I now step into the details on Page 10. Net interest income including GreCon [ph], little bit different picture, if I may, because we are now reflecting the upcoming IFRS 9 reporting standard just to make you a familiar with that, which at least will cause a breakdown of fewer net interest income, if you like, and effect on derecognition, difficult words, but at the very end that means that you have to separate early prepayments and the effects from early repayments from the pure net interest income. We've done that for a while and hence here we are showing the full, so to speak, derecognition effect. And as you see, €9 million as the early prepayment effect in first quarter 2017 and the full-year derecognition effect would be €10 million, so hence the derecognition is, so to speak, more or less the early repayment effect. But I think that we are one of the first banks showing that in detail, just to get you a little bit more familiar with the IFRS 9 reporting standards, otherwise nothing to add on that slide. So the next is loan loss provisions, €2 million. Yes, clearly caught by very low Q1, yet more or less in line with Q1 2016, so to speak, but we are sticking to our full-year guidance on that. Net commission income, I'll elaborated a little bit on that once I explain the contracting services numbers, so I would “skip that”. On Page 13, just to remind you, admin expenses €139 million, including €22 million European bank levy and the Deposit Protection Guarantee Scheme expenses and €4 million for project costs. So if you calculate that through, you would end up in the midst of our full-year target, meaning €139 million minus the €22 million minus €4 million, multiplied with €4 million plus the Deposit Protection expenses, plus the €30 million and minus €10 million for the relief from our WestImmo admin expenses that I already explained during our preliminary figures. In the first half year of 2017, we have some €10 million in our admin expenses from WestImmo, which we will not see during the second half of 2017. Balance sheet structure. I think quite strong numbers, especially, if I may, skip to Page 16 with respect to common equity tier-1 ratio of 16.2%, as always not including the current income and not including the improvement of retention liabilities, which we've shown on the OCI - that's not included in those numbers as always. So 16.2%, a strong number. Short side comment to Basel IV. As you may have noticed on Bloomberg, there was a short kind of thing that effect is now ready to talk again. The comment from the European members [ph], okay, the radio silence mode is stopped and one restart to talk but it is still to be seen whether they end up with some agreement or not. I'd like to remember, we are prepared for Basel IV anyhow and that will not affect our plans with respect to dividends payment and so on. Asset/liability structure. No major changes here. Even capital market funding some activities on Page 19, which are recorded here, some €100 million. So we are pretty much funded as we like to be and no major activities here. Our refi situation, Page 20, is still solid. Asset quality, I think we put - going to Page 23, just one remark on that. If you look into Turkey, we are now down with €533 million and we've seen some additional repayments. So we are now slightly below €500 million. As I indicated during our last call, we are moving that portfolio down without any additional costs. LTV is okay and we improved our yield on debt at the same time. U.K. LTV-wise, more or less flat. Yield on debt a little bit higher. So given our portfolio, no developments at all, I could say, and especially not in London, so no headaches on that portfolio in our case. Turkey. I elaborated a little bit on that. As I indicated, we are now below €500 million and improvement on the yield on debt up to 13.4%, and even the LTV average 46% is a little bit down from 49% with respect to previous quarter - in comparison to previous quarter. Italian portfolio. No new additions on the NPL. Slight improvement on yield on debt. Average LTV is 74%, a little bit down. So as I indicated, leveling out, so to speak. Still lot to do on that front. I think we've seen the bottom here. And next page is familiar, I guess, spotlight Italy. As indicated, no changes on that. 28 overall NPL ratio and volume, little bit down again. We've been - or will be able, I think, to move the 3.4%, which is indicating - which cases we've already fully fund and are approved on our Italian NPA portfolio. I think that will improve during the course of 2017, so no new news on that. 29, the familiar slide, treasury portfolio, nothing to add. So I am now with outlook, 32. Just as a reminder, we increased our outlook due to the one-off effects from our Coreal acquisition, plus €50 million operating profit, minus €26 on the tax line items, so net positive effect of €24 million. That is included. Otherwise we could keep this outlook stable. Included are project costs of €30 million, whereas we've spent €4 million in Q1, Aareon some €2 million, project costs not included restructuring costs and so far. And just one short comment on Aareal 2020, which you find in the annex. It's on page 36 and 37. So with this program, I indicated what will be our focus in 2017, and still everything is on green light. Some small remarks on Page 37 with respect to optimization of group structure and set-up. If you may remember, as I presented our preliminary figures 2015 in February 2016, we ended up in our achieved target admin expenses for 2018 with €450 million. Now we are one year, so to speak, rolling forward. So I would expect end of 2019 somewhat above the long-term level of €400 million to €410 million number, so maybe it's somewhat €420 million, €430 million. But we will not adapt maybe at the long-term number. It's simply the fact, as you know from WestImmo, we are booking restructuring costs in one year 2016, and that example, but we have to carry on salary expenses until, in WestImmo case, first half 2017 that other aforementioned €10 million and maybe that we have those effects on that and as well. So what you should expect in 2017? As indicated, I think we have a quite good chance that we will end up with full-year, including restructuring cost within our guidance, the €310 million to €350 million. It's clearly little bit depending on transaction where volume and early prepayment fees. At the very end, I would expect some low double-digit number for restructuring costs in 2017. The number for ongoing restructuring cost, it's always a little bit hard to calculate. It's clearly depending on speed of the transformation. But if I may go back to the €450 million number, it would intend to bring the admin expenses down to €400 million to €410 million, you could, so to speak, calculate what's the potential restructuring costs will be. But as I said, it's really hard to say whether it's 2018 or '19. That we will see. It's clearly depending on our negotiations with representatives of the labor force. But as indicated, Focus 2017 green light on our full program, so we are well on our way. And yes, that's my short remark to Q1. As indicated, we had a quite successful and strong start. We've done quite good new business margin and volume-wise. And that's it pretty much from my end, and I'm happy to take your questions.

[Operator:]

Thank you. We will now begin our question-and-answer session. [Operator Instructions]. One moment please for the first question. Our first question comes from the line of Benjamin Goy of Deutsche Bank. Please go ahead. Your line is now open.

[Benjamin Goy:]

Good morning. Two questions from my side please. First on the new business and the U.S. in particular, that remains a dominant share of your new business and also of the stock of the portfolio now. Maybe you can share some thoughts around the U.S. real estate market and how you are positioned here going forward? And then secondly on capital, continues to grow up strongly even in quarters without profit inclusion into capital. Should we expect the RWA rundown in non-core and in core to continue more or less along these lines throughout '17, or was it exceptionally strong in the first quarter? Thank you.

[Hermann Merkens:]

Yes, thank you, Benjamin, for your questions. If I may start with the second one. We had, so to speak, one-off with respect to RWA calculation. There was clearly an element of reduction in the portfolio, which was reflected here. On the other hand, we had quite strong reduction or relatively strong reduction on operational risk due to new guidance from the regulator how to calculate the operational risk or what's - how could we include it in the operational risks, and hence we reflected that here. That's, so to speak, a one-off some €300 million, if I had that correctly, which one should not expect as a running, so to speak, unfortunately, but the other effects should be continue, so to speak, rundown of WestImmo portfolio and hence a matter of relief, which would, at the very end, improve our common equity tier-1 ratio towards year-end as expected, so to speak, and as always, indicated clearly in 2017, we are looking we have business opportunities to employ the additional or maybe excess capital because I am clear with my statement that the 15.7 that we've seen during year - for the year-end 2016 should be enough even if one were to calculate the Basel IV effects. So we're building up excess capital throughout 2017, which hopefully could be employed by the one or other opportunities. If not, we clearly have to decide throughout maybe 2018 what to do with this excess capital. So with respect to U.S. real estate market, clearly we've seen throughout more or less last decade, a very, very strong rally in the U.S. real estate market from a value perspective, but on the other hand, from the rent perspective, net operating income perspective as well. So, so to speak, from that view no real surprise that one see some important effects in the market situation in general. On the other hand, as I already mentioned, quite strong interest especially from cross-border perspective, fuelled by the Chinese investors, which we think will remain throughout 2017 because even the capital controls in China, I think, most of the investors have some offshore from a Chinese perspective, offshore money at hand which they intend to recycle into the U.S. or German commercial real estate market. So from that angle, strong - relatively strong support for market values throughout 2017. Nevertheless, as you should expect, we are cautious and in that market looking into whether we should accompany deals in every case. And yes, we shifted throughout the years our investment appetite - from our end, the investment appetite quite heavily. So until 2013/'14, we accompanied a lot of five-star hotel investments in New York. So we stopped that in 2014, was a right decision because hotel values has been down 2014 - sorry, '15/'16. Heavily removed from - little bit from the Park Avenue deals into other areas in New York which we've seen as much more interesting. We've been relatively cautious on shopping centre deals which are still under debate with respect to digitization whether one should be invested and hence accompany B shopping centers. So we are clearly, so to speak, trying to anticipate, which are the pockets one should be invested and which we should accompany and which ones are those one should avoid for, because one could expect further market volatility. And there was one interesting shift in, so to speak, Q4 to Q1 with respect to U.S. investors and REIT. As I said, REIT are now, so to speak, not anymore divesting them on a neutral basis, and interestingly what I've found interesting is that they are now investing into logistics and B locations simply to avoid, so to speak, the somewhat overheated hotspot which are fuelled from offshore money. But that's the normal course of business, Benjamin. One has - in my view a strong market but on the other hand with weak pockets and what we try to avoid is the weak pockets to be invested.

[Benjamin Goy:]

Very comprehensive. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Johannes Thormann of HSBC. Please go ahead. Your line is open.

[Johannes Thormann:]

Good morning, everybody. Johannes Thormann, HSBC. Three questions. First of all looking at the continued decline of your total asset base. We are now at the lowest point in the Coreal and WestImmo integration back to 2013 levels nearly. What could be the low point in your view in this respect? And secondly on the reduction of the Turkish exposure. How did you manage this? What has been driving this? If you could provide more details probably on property types and so on? And the last thing is on your new business margin. Any progress [ph], any reasons to become more careful on margins, or what is your view on that one? Thank you.

[Hermann Merkens:]

Yes, thank you, Johannes, for your questions. If may start with the margins. So it's really, so to speak, mixed figures picture. You have fairly strong competition, which remarkably increased end of Q1 April in Europe. We clearly see that a lot of deposit banks are now increasingly pushing into the market, which the business that we are investing in the more or less complex structured type of business, is somewhat not that much effective but it's always a kind of relative game, if you like. So I would expect for Europe, if that inflow will continue, a quite competitive 2017, which might be come to little bit of an abrupt and if somebody agrees on Basel IV, so - or something like that. So there are always some triggers which could make that hold. Otherwise in the U.S., as I said, clearly one has to pick a [indiscernible], but on the other hand, relatively stable margin situation here. Same is true for U.K. Now the time is - there one has to be on the one end careful with selection, on the other hand might be that we will see some upcoming opportunities. Clearly one should avoid some potentially very volatile areas like London office, but on the other hand uncertainties are a little bit of opportunity at the same end. Turkish portfolio is now fairly below €500 million. We indicate [ph] on shopping centers and hotels, so more or less a fair mix of our portfolio. [Indiscernible] payments, as I little bit indicated in previous quarters, we have a lot of upcoming maturities in 2017 and even though in 2018, and the onshore general liquidity for commercial real estate fueled from Turkish banks is still there. So, so far customers do not have real problems to refi us on an onshore basis. And we are managing that clearly with early expectation management, meaning we are not simply waiting that the maturity is coming up but we are informing our customers well above the upcoming maturities that we are not really prepared to prolong on that worked out quite smoothly so far. With respect to total asset base - but without any discounts or something like that - with respect to total asset, as we indicated long-term target is somewhat is €25 billion to €30 billion in this manageable comfortable [ph] area. So one should expect on the long-term, I would say, somewhat in the middle of that range portfolio-wise. But as indicated at the same time, we increased our syndicated portfolio. We are now with some €6 billion and that should increase up to €10 billion over time, so that our asset under management base will be somewhere in the region of €34 billion and €35 billion. So hence given the somewhat volatile outlook across the world, I think with this aforementioned portfolio size, we could manage our portfolio quite well doing some of outsourcing with respect to servicing, we could manage our assets under management quite well. So we could keep our new business line open on the average levels as you already know, and could, so to speak, switch a little bit between syndicated loan portfolio and balance sheet portfolio. That's, so to speak, the general - more general strategic idea behind that.

[Johannes Thormann:]

Okay, understood.

[Hermann Merkens:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Britta Schmidt of Autonomous Research. Please go ahead. Your line is open.

[Britta Schmidt:]

Yes. Hi there. I've got three questions please. Firstly on capital. You reconfirmed that you're comfortable with the 15.7% and hinted us potentially discussing during 2018 what to do with any excess. Does that mean ahead of the 2017 AGM, or is that a topic for discussion later on during 2018? So could it impact 2017 dividends basically? The second question I have is also certainly related to capital. There are still some old-styled tier-1 instruments outstanding that are losing capital credit. You've taken some action already. Do you think there is further action to come? And then thirdly on the U.S. portfolio, could you give us a bit of an idea as to where regionally you are doing business perhaps differently from before. I think one of the strategic ideas in Aareal 2020 was to go more into the regional markets. How are you progressing on that?

[Hermann Merkens:]

Yes. Thank you for your questions. If I may start with the dividend question, I clearly think that we are talking about the full-year 2018 translating into, as far as I could foresee nothing for the AGM 2018, meaning which is dealing with 2017 numbers. With respect to old-styled tier-1 instruments. Yes, they are phasing out into tier-2 but on the other hand, spread-wise they are - and hence cost-wise, they are very close to tier-2 instruments. So I not necessarily see that we would take further actions on that specifically. If we are, so to speak, fully packed with tier-2 and our overall capital ratio is on that end would be by far too high, I would not exclude that one would take action here. But on the other hand, as you know, as a silent participation, it's the kind of perpetual where the other tier-2s have clear upcoming maturities and that's a thing one have to look into because it's somewhat of value if you have well-priced tier-2, which is perpetual with all the other features, loss absorbing, etcetera, etcetera compared to tier-2s which are, at a certain point in time, maturing. And therefore our view on that so far is we should keep that, but if you are really overloaded the tier-2, that might trigger another decision on that. With respect to the U.S. portfolio as such, we are clearly somewhat concentrating on liquid markets, meaning the mega or the MSA areas, simply driven by, A, one should be invested in market where transactions are taking place, and B, where some credit liquidity is still in. That's one, so to speak, hint or comfort [ph] or explanation on how we look into markets because even in those markets we would not necessarily do a Class C shopping center or the other carve-out, for example, is New York, we wouldn't enter into a five-star hotel refi situation. So even in those markets, we are trying, so to speak, to avoid those weak spots, I already mentioned. Otherwise main investment areas are clearly still New York, Philadelphia, so the bigger agglomerations. And from a U.S. perspective, clearly Philadelphia is not New York, so therefore one would say that's a clearly smaller market. From a European perspective it's already a very huge one, which I think is absorbing the entire market size of, for example, Poland. So that's, so to speak, the comparison. Hopefully I could answer your questions.

[Britta Schmidt:]

Yes. Very clear. Thank you.

[Operator:]

Thank you. [Operator Instructions].

[Hermann Merkens:]

Okay, I hear - there is somebody else?

[Operator:]

Yes, our question from the line of Philipp Haessler of Equinet. Please go ahead. Your line is now open.

[Philipp Haessler:]

Yes, good morning. I have two quick questions. Firstly a follow-up on the margin development. In Q1, margin on your business was down by 20 bps year-on-year. Am I right in assuming that this is mostly due to the non-American business, so in North America the business remained stable year-on-year? And secondly also on new business. Germany, you had a proportion of 2% of new business. Southern Europe of 4%, that was significantly down though full-year proportion of 2016 of around 30%. Was it purely a quarterly effect, or do you think this will continue during the course of the year? Thank you.

[Hermann Merkens:]

Philipp, thank you for your questions. Your first answer to your question was, it's fully correct, so it's the average of 250. U.S. business remains very strong, if not improving little bit. With respect to new business ratios, I wouldn't say that Germany was excellent but by saying so, it's clearly given the strong competition here and that's not intended to do very much new business in Germany, whereas I would not exclude that one would see additional new business in Southern Europe if an opportunity is here. And could you repeat your second question, please?

[Philipp Haessler:]

Yes, that was also in the new business margin in the U.S., but I think you've already answered this.

[Hermann Merkens:]

Okay.

[Philipp Haessler:]

So that's all. Thank you.

[Hermann Merkens:]

Okay. Thanks.

[Operator:]

Thank you. Our next question is from the line of Tobias Lukesch of Kepler Cheuvreux. Please go ahead. Your line is open. Tobias, please go ahead and ask your question. If you have your line on mute, please unmute it.

[Tobias Lukesch:]

Very sorry. Good morning. One follow-up on the U.S. business. So given that you have this big pipeline of U.S. business now coming through in Q1, is there a chance that we see that kind of trend going on in 2017 and would you have a different view now on the total portfolio split with regards to different regions? So basically, will the U.S. have a chance maybe to even increase above 25% stake in sometime?

[Hermann Merkens:]

Yes, thank you for your questions. With respect to 25%, so we are sticking to a portfolio target on a nominal basis, which is somewhere between €6 billion and €6.5 billion. Yes, I know we are now on €6.5 billion [ph], but that is clearly some currency exchange effects and an effect from underwritings which we are on the way to syndicate. So we are more or less on a nominal basis at the point, if you like. On the other hand with respect to percentage share, one should expect we think about €25 billion to €30 billion portfolio. That could increase over time a little bit. So portfolio goes down a little bit, so that's on a relative basis one could see here clearly a potential increase of the U.S. overall portfolio. So deeper trend [ph], yes, still strong, but as indicated, you should expect that we are here selective as we have known for to do the right pick.

[Tobias Lukesch:]

Thank you.

[Hermann Merkens:]

Thanks.

[Operator:]

Thank you. As we have no further questions, I would turn the call to Hermann Merkens for closing comments.

[Hermann Merkens:]

Yes, thank you very much for your questions. And the short summary is strong start in 2017. Clearly challenging and volatile environment, but I think we are well prepared to maneuver through that. Strong capital ratios, as discussed, which would open up opportunities as discussed as well, and with our Aareal 2020 agenda what we are focusing in 2017, we are fully in line and on our way. Thank you very much for your attention.

[Operator:]

That concludes our call. Thank you for attending. Participants you may disconnect your lines.