Umweltbank — Solid H118 lending volumes stabilising earnings

UBK reported robust H118 results ahead of initial management expectations despite the continued low interest rate environment, with a broadly stable pre-tax profit of €18.4m (up 1.0% y-o-y). UBK’s loan portfolio (including commitments) rose by 6.2% ytd to €2.88bn and 8.6% y-o-y, which is ahead of our earlier conservative FY18 growth forecast of 2.1%. This was a result of strong new lending volumes in H118, which reached €311m vs €154m in H117, largely assisted by solid performance in the green construction loans segment, in particular rental housing (which is fuelled by the considerable structural apartment shortage in Germany). However, renewable energy financing (mainly wind and solar) also provided meaningful tailwinds, contributing nearly 40% to new lending volumes, despite recent regulatory changes introducing the auction system for wind projects with a capacity in excess of 750 kilowatts. Importantly, UBK also experienced good business progress in the segment of smaller projects up to 750 kilowatts. The expansion of the lending business was accompanied by solid growth in customer deposits, which rose by 5.0% ytd (or 7.2% y-o-y). Overall, UBK’s customer base as at end-June 2018 was broadly comparable with end-2017. Despite the lending business growth, UBK’s capital adequacy ratio improved slightly to 12.5 from 12.4 as at end-2017.

Net interest and financial income improved 5.4% y-o-y to €26.1m. Management has highlighted that interest income increased slightly, although it was assisted by one-off effects, in particular early repayment fees achieved on two sizeable loans and the recognition of distribution fees related to equity funds in this line (previously it was booked under net commission and fee income). UBK also benefited from the solid increase in loan commitments, which triggered additional commitment interest. On the other hand, the net commission and fees result was visibly below last year (€1.2m vs €1.6m in H117). The two main factors behind this are the fact that current market conditions do not allow UBK to charge arrangement fees on new loans and the lack of recognition of the above-mentioned distribution fees.

Furthermore, personnel expenses were higher at €4.5m (up 8.6% y-o-y), which is not surprising given UBK’s agenda for team expansion (average headcount was up to 161 employees from 149 in FY17). There was also some drag from higher other administrative expenses (€4.5m in H118 vs €3.8m last year), mainly due to higher banking tax and deposit insurance (see Exhibit 1), as well as investments in IT systems as part of UBK’s strategic initiative related to the digitalization of processes. As a consequence, the cost income ratio reached 33.5% compared with 29.1% in H117 and our original FY18 expectations at 32.7%. Net income came in at €12.4m, slightly below H117 (€12.6m).

In line with its earlier intentions, UBK recently announced details of a junior green bond offering. The bank plans to issue up to €40m in the form of unsecured subordinated bonds in order to strengthen its capital base and facilitate further loan portfolio growth. The offering consists of: 1) two exchange offers directed to holders of UBK's profit participation rights issued in the period 2003-05 and 2006 of up to €18.8m (with a 1:1 parity); and 2) a public offering for both (semi)professional and retail investors of at least €21.2m and up to €40.0m (as the amount unallocated during the exchange offers will be moved to the public offering). UBK’s tier 2 capital increase under different allotment scenarios is presented in Exhibit 3. Please note that in our calculations we assume (in line with management intensions) that the profit participation rights which are not exchanged will be called and redeemed by UBK.

The exchange offer is aimed at refinancing the profit participation capital, which is gradually losing its tier 2 status under the new regulations (as it includes a put option). Consequently, the exchange offer will not translate into additional cash inflow for UBK. The coupon rate will be set at 2.0% (fixed over a period of six years) and constitutes up to 0.75pp of upside to the current interest rate offered by the profit participation rights. After the initial six-year fixed rate period, the interest rate will be set once every five years based on the prevailing five-year swap rate plus the respective margin established during the bond offering. The issuance will be also directed to new retail investors, as the minimum bid price stands at an accessible €2,500.

The bond has no defined maturity, but may be callable after 10 years (or earlier on meeting certain regulatory conditions) on every interest payment date. UBK intends to create a secondary market for the junior bonds by working as an intermediary between potential buyers and sellers, but will not purchase the bonds on its own book for subsequent re-sale. The expected costs of the offering equal c €22,000 (or 0.1% of raised proceeds in the case of full allocation).

The table below shows our projections for UBK's capital adequacy ratio (TCR) as at end-2019 depending on the final volume of the exchange offer and the public offering. We believe that with no additional tier 2 capital raised (and the not exchanged profit participation rights being called and redeemed), UBK’s TCR would reach the level of 12.5 (compared to the regulatory requirement of 12.0). Assuming that all holders of the profit participation capital decide to accept the exchange offer and there is no demand for the remaining bonds, UBK's equity capital will increase by €11.3m as at end-2019 and translate into a TCR of 13.2 (but with no cash injection though). If the exchange offer is conducted in full and all remaining bonds are purchased by new investors, the equity base will increase by €32.5m and result in a TCR of 14.1 (as well as gross cash proceeds of €21.2m).

In addition to the debt issuance management does not rule out a share issuance over the coming months to broaden the equity base in line with current board authorisations. This could further improve the CET1 ratio and potentially allow for a reduction of UBK’s special buffer (1.5%) currently added by the German regulator on top of the standard Basel III TCR requirement of 10.5% by 2019

Finally, some contribution to the strengthening of UBK’s capital base comes from the introduction of a stock dividend, which investors may choose as an alternative to a cash dividend. In the case of the dividend paid out of 2017 earnings, the stock dividend adoption rate was 50%, up from 35% last year when it was introduced for the first time. This provides UBK with additional c €3.0m of equity.

On 24 April, UmweltVermögen Beteiligungs announced that it had entered into an agreement to sell its 15.6% stake in UmweltBank to GLS Bank, one of UBK’s competitors in the sustainable banking sector. It remains to be seen whether GLS intends to be a minority shareholder or decides to acquire a majority stake in UBK at some stage. Irrespective of which scenario materialises in the end, an extension of the supervisory board to accommodate GLS’s representative(s) seems quite likely. GLS has already made an unsuccessful attempt to introduce two representatives during the last AGM and UBK’s management board is open to prospective discussions on this topic. From a business perspective, closer co-operation between GLS and UBK may translate into certain synergies, eg in the area of investments funds or current account products.

Our forecast revisions are summarised in Exhibit 5. The solid new loan volumes in the green construction segment in H118, coupled with the favourable outlook for the German residential market (most notably in the affordable housing segment), has encouraged us to increase our forecasts for UBK’s green construction loan portfolio growth in FY18 and FY19 to 15.0% and 10.0% y-o-y respectively (compared with our earlier assumptions at 7.0% and 8.0% y-o-y, respectively). We have also slightly raised our expectations with respect to wind and solar project portfolio growth in FY18 and FY19. For wind projects, we now forecast growth of c 1% y-o-y in FY18 and FY19 (vs our earlier estimates of -2.5% and -1.3% y-o-y, respectively). The higher average feed-in tariff (FiT) premiums seen during the last onshore wind capacity auction in May (5.73 ct/kWh vs 4.64 ct/kWh on average during prior auctions), coupled with lower average project size (5.4MW vs c 9-16MW during earlier auctions) should support UBK’s lending business, as the former improves the creditworthiness of the projects while the latter translates into a growing market niche for projects that are too small to attract the interest of large banks (and which often constitute citizen projects). On the other hand, the fact that the allocated capacity was below the tendered capacity still leaves a degree of uncertainty. We now anticipate UBK’s solar project portfolio to post an increase of 3% y-o-y in both FY18 and FY19 (compared with 0.5% y-o-y earlier). On the back of solid customer deposit growth in H118 (5.0% ytd), we increase our expectations for FY18 to 7.5% y-o-y.

The current pressure on UBK’s net interest margin seems to be broadly in line with last year, but it is too early to conclude that it is bottoming out. Consequently, we have made only a minor upward revision to our NIM assumptions (+4bp in FY18 and +3bp in FY19), also associated with the fact that the coupon rate offered by UBK’s junior green bonds is below our initial assumptions. We have adjusted our net commissions and fee expense forecasts downwards to reflect the lack of arrangement fees and distribution fees mentioned earlier. Finally, we have increased our G&A expense projections, arriving at a cost income ratio in FY18 at 33.0% (compared with 32.7% previously). Consequently, our pre-tax profit forecasts have been moderately revised upwards. Our new lower estimates of capital adequacy ratios shown in Exhibit 5 are largely a function of higher loan portfolio growth expectations. The above revisions resulted in a moderate increase in our UBK share valuation to €11.3 from €11.1 previously.