ProCredit Holding — Strong rebound in profitability in Q123

PCB’s Q123 annualised ROE of 13.3% (or 11.6% excluding Ukraine) is in line with management’s mid-term target of 12% (recently raised from 10%). PCB’s management recently raised its FY23e ROE guidance to 8-10% from 6–8% previously. This may still look somewhat conservative at first glance. That said, management remains cautious due to (1) the expected NIM compression in the coming quarters, (2) a possible pick-up of cost of risk after the low level in Q123, and (3) inflationary pressure likely to further feed through to PCB’s operating expenses. Moreover, management does not want to draw premature conclusions in terms of the market dynamics based on a single quarter. Nevertheless, we forecast an FY23e ROE of 9.3%, slightly above the mid-point of the guidance.

PCB’s loan book was repriced more quickly in response to the rising interest rates across its countries of operations than its customer deposit base (a development commonly seen across the banking sector). This resulted in a strong annualised NIM of 3.4% in Q123 (vs 2.9% in Q122 and 3.1% in Q422). The NIM increase was particularly strong in some countries (eg Bosnia and Herzegovina) where repricing of some currency loans occurs in bulk twice a year (last repricing occurred in January 2023). Management expects the NIM to moderate towards the end of the year as deposits are further repriced. In this context, we note that, unsurprisingly, Q123 deposit growth was dominated by term deposits as customers looked for higher-interest products. At the same time, the increasing share of deposits in PCB’s funding mix may offset some of the NIM pressure.

We expect the FY23 NIM to come in at 3.3% and moderate further to 3.2% in FY24, even in the absence of any major central bank rate cuts (though we note that the National Bank of Georgia has already started cutting rates in response to moderating inflation). Nevertheless, the current margin level should provide a good tailwind for PCB’s results in the near term and we expect its net interest income to increase by c 12% to €297m in FY23.

While management’s FY23 guidance assumes a cost of risk of up to 45bp, Q123 stood at just 12bp, representing €1.9m in loss allowances, with just €0.5m in South-Eastern Europe and €1.6m in Eastern Europe (and a slight €0.2m net provision release in Ecuador). The share of credit-impaired loans across PCB’s portfolio was 3.2% at end-March 2023 (or 2.3% excluding Ukraine), down slightly from 3.3% (2.4%) at end-2022. Excluding Ukraine, the share was also slightly down from 2.4% at end-March 2022. The stage 3 coverage ratio stood at 62.3% at end-March 2023 versus 61.8% at end-2022 and significantly up versus 51.5% at end-March 2022.

As the global macroeconomic slowdown unfolds through the year, PCB’s cost of risk may also increase. However, we note that PCB already booked sizeable management overlays in FY22 of €39.6m related to macroeconomic risks (eg energy, inflation, geopolitical risks) and the Ukrainian loan book is well covered by provisions (see below). We assume a cost of risk at 46bp in FY23, ie at the upper end of management’s guidance, implying loan loss provisions of €28.4m in FY23 (vs €104.6m in FY22 and €6.5m in FY21).

PCB’s personnel and administrative expenses excluding extraordinary items were up 19% y-o-y in Q123 but still below the 20.7% y-o-y increase in operating income. Therefore, its cost to income ratio (CIR) excluding one-off items reached 57.0% in Q123, down from 59.5% in Q122 and on par with management’s mid-term guidance. The headline figure was 59.7% (slightly up vs 59.1% in Q122), with €1.9m in one-time administrative expenses for consulting and legal services in conjunction with PCB’s planned change of legal form (see our previous note for details). We note that PCB’s operating income included a €1.1m negative extraordinary effect related to the fair value of derivatives and derecognition of financial assets.

PCB’s personnel costs increased by 12.6% y-o-y, which (after adjusting for one-off items) was due to a 10.4% headcount increase and a 10% average salary increase (as PCB continues to experience high competition for employees). Management highlighted during the Q123 earnings call that another salary review will be conducted across PCB’s local banks in July, likely leading to a more pronounced increase in personnel costs in H223. We also note that PCB continues its marketing spend to further enhance the positioning of ProCredit Direct (to attract customer deposits, among others). Management now guides to a FY23 CIR at 62-64% vs FY22 at 64.0%. We expect a CIR of 64.4% in FY23, as cost inflation coupled with muted loan book growth (we assume 2.5% in FY23) may limit the opportunity to realise economies of scale in the near term.

PCB’s FY23 guidance assumes that ProCredit Ukraine will post a nil net profit this year, as still-elevated cost of risk and operating expenses offset operating income. However, the local bank reported a Q123 net profit of €3.1m (vs a €23.4m loss in Q122), implying an annualised ROE of 21.7%. This was a function of a broadly stable operating income of €12.4m (vs €12.3m in Q122), a decline in operating expenses by c 18% y-o-y (most likely due to a high base from one-offs last year) and moderate loan loss provisions of €3.1m (vs €35.3m in Q122), the latter coming from updated macroeconomic parameters amid a subdued outlook for Ukraine’s economy. The local bank retains capital buffers of more than 6pp at end-March 2023 and its liquidity position remains stable, according to PCB’s management. Its share of credit-impaired loans stood at 12.5% at end-March 2023 (vs 11.9% at end-2022), with the bulk of portfolio reclassification complete. The already incurred loan loss provisions cover 16% of the total loan book and 130% of the default portfolio. As new lending remains limited, and amid steady loan repayments, ProCredit Ukraine’s loan book reduced further by €29.5m since end-2022 (also partly due to a €7m negative FX impact). As a result, the local loan book made up 9% of PCB’s total loan portfolio at end-March 2023 (vs 12% at end-March 2022). Nevertheless, the outcome of the war remains uncertain and further significant credit losses at ProCredit Ukraine cannot be ruled out.

Given PCB’s sustainability orientation, we believe it is also instructive to examine the key highlights from the company’s Impact Report 2022 released earlier this year.

PCB’s €1.2bn green loan portfolio represented 20.2% of its loan book at end-March 2023 and grew at a CAGR of 16% between FY18 and FY22 (and c 9.1% y-o-y in FY22 alone, accounting for more than 50% of total loan portfolio growth). After reaching its previous 20% target, management now aims for PCB’s green loan book to represent 25% of the total loan portfolio in the medium term. Its green portfolio includes loans to fund energy efficiency projects that reduce energy consumption by at least 20% (these made up c 49% of the green loan portfolio at end-March 2023), renewable energy (33%) and other green investments (18%), including investments leading to the prevention of air, water and soil pollution, waste management and organic agriculture and production. The renewable energy projects in operation that were financed by PCB led to a reduction of greenhouse gas equivalents of 144.7 kilotonnes in 2022.

We note PCB’s strong emphasis on the environmental and social approach in its lending decisions. This is, for instance, illustrated by its Plastic Strategy launched in FY20 and fully implemented in FY22, with single-use plastic items included in PCB’s exclusion list, with the exception of items for which there are no substitutes with a lower environmental impact. As a result, the company devised an exit strategy for some of its clients operating in the plastics production business (even though they represented a small proportion of PCB’s overall portfolio). PCB aims to have an exit strategy for all its blacklist clients (whose operations relate to all types of plastics banned by the European Union from 3 July 2021) by end-2023. We also note that PCB recently introduced an animal welfare assessment to its client evaluation process.

Moreover, PCB started to consider the recommendations of the Task Force on Climate-Related Financial Disclosure in FY21. As part of this, PCB completed the screening of its portfolio for (1) physical risk to strengthen its analysis at client and portfolio level using geographic information systems and (2) transition risk, executing a stress and scenario analysis to define sector activities that need to be prioritised on the decarbonisation pathway and identify new business opportunities to guide and support its clients in this transition. The company is also working towards aligning its environmental and social scoring methodology with the EU Taxonomy over the medium term.

Management reaffirmed its target to become carbon neutral in its own operations by 2023, prioritising the transition to renewable energy sources and environmentally friendly solutions. PCB is in the final stages of construction of its own 3MWp photovoltaic park in Kosovo (to be commissioned in 2023), which will compensate for 85–90% of its stage 1 and 2 emissions. The remaining CO2 emissions at group level, which management expects will be very small, will be covered by carbon offset certificates.

In 2022, PCB specified the carbon neutrality of its operations as Scope 1 and 2 emissions, in line with the Science Based Targets initiative (SBTi) and Net-Zero Banking Alliance (NZBA) standards. PCB reduced its Scope 1 and Scope 2 CO2 emissions by 44% between 2018 and 2022 (or by 42% including flight emissions, see Exhibit 2), facilitated, among other things, by green building (ie EDGE) certifications (there are currently five buildings with EDGE-certification at group level), installing photovoltaic panels at eight of PCB’s locations, expanding its electric and hybrid car fleet to c 52.4% of the total (77% including hybrid plug-ins) in FY22 and making 272 e-chargers freely available for the public. PCB has also started reporting client emissions (Scope 3 financed emissions) in accordance with the Partnership for Carbon Accounting Financials (PCAF) standard since 2021 and included the updated data for FY22 in its latest Impact report. Moreover, it joined the NZBA and committed to setting near- and long-term emissions reduction targets companywide in line with the SBTi Net-Zero Standard.

On the social front, PCB’s focus remains on comprehensive staff development, reflected in the average number of training hours that its employees have per year (c 134 on average between 2018 and 2022) and its competencies (eg 100% of employees had a minimum B1/intermediate English proficiency in FY22). We believe that PCB’s strong corporate culture is reflected in the high average tenure across its staff, reaching 7.7 years for women in FY22 (vs 7.9 years in FY21) and 6.6 years for men (6.6 years in FY21), as well as a turnover rate of 11% in FY22 (vs 12% in FY21). Moreover, management highlights the diversity within PCB, with over 30 nationalities in its German head office and c 38% and 48% of the group’s board members and middle management being women, respectively. The company promotes equitable pay and its renumeration policy is aligned with PCB’s long-term oriented business objectives, and therefore does not include any short-term, performance-related bonuses.

Since the beginning of the war in Ukraine, the company has provided accommodation outside the country to some of its staff (with 150 Ukrainian colleagues and family members living at the academy at its peak) as well as essentials and medical supplies to employees in the country. Management highlights that ProCredit buildings in Ukraine are equipped with emergency shelters and remote working is used whenever necessary.

ProCredit Holding is managed by ProCredit General Partner (the personally liable managing partner of ProCredit AG & Co KGaA), an independent company owned by the core shareholders: Zeitinger Invest (a strategic shareholder since inception), KfW (a German development bank), DOEN Participaties (a Dutch entity focused on supporting sustainable and socially inclusive entrepreneurs) and the European Bank for Reconstruction and Development. These entities hold c 61.3% of all listed shares at ProCredit Holding AG & Co KGaA.

In March 2023, PCB announced that the European Bank for Reconstruction and Development (EBRD) will purchase the 5.06% stake held by IFC. This transaction has now been completed with EBRD replacing IFC as a core shareholder with an 8.7% stake (EBRD has held a 3.6% minority stake since 2018). We believe that having EBRD as a major shareholder should further support PCB’s business in the South-Eastern and Eastern Europe regions given EBRD’s regional focus and emphasis on funding climate change adaption and SMEs. PCB is already participating in EBRD programmes in all its countries of operation in the region.

In October 2022, ProCredit General Partners agreed with PCB’s shareholders to prepare a change of ProCredit Holding’s legal form into a stock corporation. The general partner believes that the change will provide greater alignment of ProCredit Holding as an internationally oriented, listed financial holding company and offers the opportunity to realise efficiencies in its corporate governance structure and the work of the company’s executive bodies. PCB obtained shareholder approval for the change during the 2023 AGM held on 5th June 2023.

Finally, we note that PCB recently joined the United Nations Global Compact to align its operations and strategies with 10 universally accepted principles in the areas of human rights, labour, environment and anti-corruption.

We have raised our net income forecasts for PCB in FY23 by c 13%, reflecting the lower cost of risk assumption in line with company guidance. For FY24, we have reduced our net income expectations by c 6% to reflect the full-year impact of the ongoing cost inflation (pressure on salaries, in particular), with our new FY24 CIR at 63.6% versus 62.3% previously.