UmweltBank — Awaiting an earnings inflection point

UBK’s FY18 preliminary results show continued solid lending business and customer deposit base growth, accompanied by persistent earnings pressures translating into a declining net interest margin (NIM). The bank’s new lending volumes reached an encouraging €542m in FY18 (of which €311m in H118), up 26.3% from €429m reported in FY17 (see Exhibit 1). Importantly, this has been driven equally by sustainable construction and green projects, in particular smaller solar projects of up to 750kW (which are not subject to the auction system and are still entitled to receive a fixed feed-in tariff), but also wind projects, of which a significant part represent those that participated in the earlier auctions. This is important given that the number of submitted bids in these auctions was higher than in the most recent tenders, when bottlenecks related to prolonged regulatory approval times started to become visible. Consequently, UBK’s loan book (including commitments) reached €2.9bn, up c 8.6% vs FY17. Simultaneously, customer deposits increased by a strong 8.0% y-o-y (vs our estimate of 7.5% y-o-y).

Net interest and financial income decreased 5.3% y-o-y in FY18 to €51.9m and was c 6% below our estimates. This figure includes several P&L items, including net interest income, net financial income excluding net trading income and provisions for credit losses and the impact of net valuation changes. UBK has not provided the corresponding breakdown in its press release, but has shared some supplementary information in its announcement, which suggests that the decline in net interest margin was somewhat less pronounced than in FY17 (and slightly stronger versus our expectations). In this context, it is important to note that UBK’s H118 results were assisted by early repayment fees on two sizeable loans (we estimate the impact at around €0.5–1.0m). Net commission and fee expense declined by 13% y-o-y to €2.6m in FY18 amid the lack of arrangement fees (as current market conditions make it difficult for UBK to charge those), as well as the change in recognition of distribution fees related to equity funds, now booked under net trading income.

With the ongoing expansion of the team (172 employees at end-2018 compared with 153 at end-2017), personnel expenses grew by 14.1% y-o-y to €9.2m (close to our growth estimate of 11% y-o-y). Other administrative expenses increased by only 5.9% y-o-y to €8.5m, predominantly on the back of higher banking tax and deposit insurance in conjunction with the healthy customer deposits growth. We suspect that some expenses related to the sustainable consumer credit product were pushed beyond 2018, as the product launch was postponed until 2019. As a result, CIR reached 32.9% in FY18 (broadly in line with our forecast at 33.0%). FY18 results were also supported by net other operating income of €571k (compared with net operating expense of €1.4m in FY17), which we understand was driven by provision reversals.

Consequently, pre-tax profit was down 7.4% y-o-y to €37.3m vs our expectations of a 4.2% y-o-y decline to €38.6m. Net income after allocation of reserves for general banking risks stood at €16.9m and was up 1.6% y-o-y. However, it must be noted that the amount allocated to reserves is determined by the management board and usually adjusted to smooth out bottom-line growth in the long term. In fact, earnings before allocation of reserves fell by 8.4% y-o-y to €25.3m.

To strengthen its capital base and facilitate further loan portfolio growth, the bank launched the issue of its 2.0% unsecured subordinated bond (Green Bond Junior) in July last year. So far UBK was able to raise €25m in proceeds (as per the press release dated 4 February). Based on our discussion with the management, we understand that c €13.2m of this amount represents the result of exchange offers to holders of UBK’s profit participation rights (Genussrechte) issued in the period 2003–05 and 2006 (see our previous update note for details). This implies that c 70% of the eligible profit participation rights were exchanged, while the remaining securities were already called and redeemed by the bank (as they were about to lose their tier 2 capital status soon anyway). The remaining c €12m was subscribed for by other retail investors. The issue is still ongoing and will be concluded in July 2019, which means UBK may still raise up to €15m of incremental tier 2 capital (we conservatively assume €10m in our forecasts). Moreover, the bank has raised an additional €20m through the issue of subordinated debt to an institutional investor.

As a result, UBK was able to increase its TCR to 14.0% from 12.5% at end-June 2018 and 12.4% at end-2017. We estimate that this translates into c €0.4bn (or c 17% of current customer loan book) of balance sheet headroom for further loan portfolio growth (in risk-weighted asset terms). This does not account for net profit accumulated or new capital issues. Additionally, UBK is strengthening its capital base through scrip dividends introduced in 2017, which contributed €3m of new capital in 2018. Finally, management still considers a share issue to further improve the CET1 ratio and potentially allow for a reduction of UBK’s special buffer (1.5%) added by the German regulator on top of the standard Basel III TCR requirement of 10.5% applied in 2019.

Our forecast revisions are summarised in Exhibit 2. As we believe the decline in UBK’s net interest margin was only slightly more pronounced than we have originally anticipated, we have marginally reduced our NIM expectations for FY19e and FY20e by 6bp and 5bp, respectively. In our opinion, this translates into relatively conservative estimates, given that the management’s neutral scenario assumes that the interest margin should flatten out from FY19e onwards. This is supported by the fact that the interest rate on UBK’s loans is usually fixed for 10 years (and subsequently adjusted for market rate movements). As the ECB interest rate cuts were executed over 2008–2012, most of it should be reflected in UBK’s interest income by 2020/2021. Moreover, the prospective ECB rate hikes (even if their exact timing is hard to predict) should assist UBK’s income on floating rate assets and new sustainable loans.

Similarly, UBK remains on its growth path with respect to loan book and deposit base, even if we acknowledge that a significant proportion of the business volume growth was attributable to irrevocable lending commitments rather than finalised loans. Moreover, the development of onshore wind projects in Germany is subject to bottlenecks related to extended regulatory requirements and approval timelines, a deficit of approved regional plans and an increase in legal actions against capacity allotments during already closed auctions. However, it seems that UBK’s pipeline of project financing is full at the moment. Also, we believe the bank’s lending activity in the smaller photovoltaic projects segment (which also command a higher interest margin) may potentially offset more muted new lending volumes in the wind segment. The delay in sustainable consumer credit launch (initially planned until end-2018, now expected in 2019) will not impact our forecasts materially, as the proportion of loan book growth attributable to the consumer credit we have pencilled in for FY19e was negligible. Hence, we introduce only minor changes to our forecasts of new lending volumes and new customer deposits.

Based on our discussions with the company, we understand that in 2019 UBK intends to be more active in corporate fixed income securities, where it is experiencing increased customer interest. Consequently, we have raised our net commissions and fee expense estimates accordingly, assuming a few small to mid-sized transactions executed per year. We have increased our G&A expense expectations in FY19e and FY20e by c 6.5% and 2.5%, respectively, assuming that some expenses related to the newly launched products might have been postponed last year. As a result, we expect the CIR ratio to go up to 37.3% in FY19e and 36.0% in FY20e. Our UBK share valuation remains unchanged at €11.3 per share, as our long-term forecasts (i.e. beyond 2020) remain broadly unchanged.

We estimate UBK’s ROE in FY19e at 10.1%, which compares with an average ratio for listed banks from the DACH region at 9.1% (based on Refinitiv consensus). We note that UBK’s FY19e ratio is below our long-term sustainable ROE estimate of c 11.7% due to depressed NIM (which may bottom out soon though as discussed above) and higher OPEX amid the launch of new products. At the same time, UBK’s FY19e P/BV stands at 1.0x, slightly below peer average of 1.1x (see Exhibit 3).