AIB Group plc (A5G) Earnings Call Transcript
October 28, 2022
Earnings Call Speaker Segments
Good day and welcome to the AIB Q3 2022 Trading Update Conference Call. [Operator Instructions] And finally I would like to advise all participants that this call is being recorded. Thank you. I'd now like to welcome Mr. Colin Hunt to begin to conference. Mr. Hunt, over to you.
Thank you very much indeed. Good morning, ladies and gentlemen, and welcome to our Q3 Trading Update Call. Donal and I will make some brief opening remarks before we turn over to you for your questions. We're pleased with the performance of the group, and we are confident in our outlook, notwithstanding external uncertainties. At the start of the year, I described 2022 was the hinge year for AIB, the year when we would conclude on legacy issues and better inorganics and reduce NPEs decisively below 5%. That's precisely what we're doing and the results are very clear and tangible in the statement. Reported strong profitability in the third quarter, good income momentum and loan book growth, EUR 9 billion in new lending year-to-date at the end of September, up 25% in the prior year period, with new lending up 33% in Q3 over Q3 '21. With EUR 3 billion new lending in Republic of Ireland mortgages, up 60% and we are demonstrating clear volume growth alongside pricing discipline. Our NPEs are now down to 3.9% of gross loans and we're well on track to reach our medium-term target, or end '23 target of 3%, at the same time, demonstrating ongoing strength and resilience in our balance sheet with our CET1 ratio at 15.4%. Turning to the economy, while there has been a scaling back of growth forecasts for the main world economies in '22 and '23, Ireland remains relatively resilient. The latest forecasts now see Irish GDP growth above 8% for 2022 with modified domestic demand growing by more than 4 -- sorry, 6.5%. For '23, the combination of emerging capacity constraints, a weak global economic backdrop, tightening of monetary policy and overall financial conditions as well as the negative impact of higher inflation are expected to see a moderation in Irish economic growth momentum. Nonetheless, on a relative basis, we still expect the economy to perform relatively well in '23 with estimates of between 1.5% and 2.5% growth before recovering to around 3.3% in 2024. In terms of the implementation of our strategy, we're making good progress on the embedding of our inorganic transactions. We have now have migrated over EUR 1.5 billion of the Ulster Bank corporate and commercial customer loans. The transfer is going well. We're very pleased with the progress there, and we expect to complete that migration in the spring of next year. On the Ulster Bank tracker portfolio of EUR 5.7 billion, we are in an approvals process with the CCPC at the moment and we expect a positive response, which will see those loans migration in towards the end of the first half next year. And our plans to launch JV with Great-West Lifeco to significantly enhance our range of products in savings, investments and pensions, we expect that to launch by the end of this year. In terms of customer recruitment, we're very pleased with how that's going. We have something on the order of 350,000 new accounts opened, which is an increase of 82% over the prior year period. And given the significant changes in the Irish banking landscape, the evolving operation environment and the increase we've seen in interest rates, it is appropriate now for us to refresh our medium-term targets. We'll be bringing that through internal governance over the course of the next number of weeks. We'll update the market on the 2nd of December, so in about 5 weeks' time. But with income growth exceeding what we're seeing on the cost side, we see upside potential to RoTE, which we describe as our North Star. I'll now hand over to Donal.
Thank you very much, Colin. I think the Q3 numbers represent growth from an organic basis, on an inorganic basis. That ECB meeting yesterday was well-received within AIB and all of the items very much within our own expectations. On the cost side, we're obviously seeing some inflationary pressures. Some of them are one-off in nature. Some of them with respect to AIB are temporary. And as we move towards December 2nd, we will update the market with our revised cost numbers there. Capital obviously remains strong, 15.4% at the end of the third quarter, obviously due to strong profitability. So I think I'll leave it at that. I'll hand it over to questions from any of the participants.
[Operator Instructions] First question comes from the line of Raul Sinha from JPMorgan.
I've got 2, please. Firstly, I was just wondering if you could give us a little bit more color on NII in terms of the guidance change. What are you assuming now in terms of your base case assumptions around the 15% to greater than 15% growth? Obviously, there's been some pricing change in the market as well as in terms -- any color you can share in terms of what do you expect on deposit pricing? And then the second question I had was just on the ECL charge and the outlook. I was wondering if you could talk a little bit about the drivers as you see maybe just looking beyond this year, particularly around the U.K. if you've got any thoughts on -- you've very small book in the U.K., obviously, but what might be that kind of risk attached to that and going into next year?
Thanks very much, Raul. Obviously, guidance for AIB throughout the year has upgraded because we started the year with a base case assumption that the ECB depo rate would be minus 0.5%, and things have moved really quickly from that front. The guidance to 15% is imagining a year-end depo rate of 1.5%. And obviously we have said greater than 15% in our NII guidance given the trajectory for that rate is obviously a little bit higher than that. But obviously will only feed into the last quarter of the year. So I think the -- within the NII guidance, we hadn't assumed any benefits from TLTRO because there was great uncertainty. I think now we do have a little bit more certainty around that. The benefit to AIB in the calendar year of 2022 will be probably EUR 20 to EUR 30 million. And that will obviously cease as at the 23rd of November. In terms of our interest rate sensitivities, obviously, I last published those at June at the half year and they really haven't changed much to date as in euros from an endpoint. But there is some moving parts on that. Obviously when the form of the TLTRO changed, and that would have reduced the sensitivity somewhat. Throughout the year, we have also as the yield curve steepened quite aggressively put on more structural hedges. At the end of the year, we might have had EUR 10 billion of structural hedges in euros. I think towards the end of this year that could be more like EUR 22 billion or EUR 23 billion. So that's given us some interest income benefits throughout '22. Obviously that will flow into '23 as well. And then on pricing, the changes to date in Euroland in Ireland have not really fed through into market pricing as of yet. Post the last ECB change, we would have changed our fixed rate mortgages, new business offers by 50 basis points, reintroduced a fixed term deposit rate. And obviously on the pricing side, we keep these things under constant review with respect to the external environment and indeed, the domestic competitive environment as well. But needless to say, I think that the trajectory from rates from the ECB seems quite clear. With respect to asset quality, we're maintaining the guidance for the year for a small charge. There's underlying business, we see very little signs of stress in any of our portfolios or in any of the books. But we have to accept that the impact of higher rates, higher inflation have really yet to begin to bite. So we will be cautious as we come to the end of the year. We've come into the year well-provisioned and we want to exit the year well-provisioned as well, which is why we're maintaining that small charge for the year. Specifically to the U.K. as you mentioned, we obviously would have exited the U.K. SME business last year. So the quantum -- balance sheet quantum is smaller in the U.K. And we haven't done significant new business in the U.K. The main activities that we have there in the wholesale space in energy, in quasi government-related property lending transactions, we're pretty comfortable with those positions at the moment, but do accept that the macro environment in the U.K. has been quite volatile of late. But our expectations in the U.K. -- from the U.K. perspective, we are, I would say just taking quite a cautious approach as waiting for things to bed down a little bit over there, and we don't really have significant growth assumptions for the years ahead.
Our next question comes from the line of Grace Dargan from Barclays.
Maybe if I could just firstly come back on the hedge. I note the comments about increasing the hedge into the year-end. I guess do you still see scope to increase that into 2023? Or would you say that year-end position is broadly where you want to be positioned in terms of notional? And in particular, I guess, of what you've pushed on kind of what's the average weighted life of that? Or how has that changed to your hedge? And then secondly, I just like to ask on TLTRO given the news yesterday, would you potentially look to repay what you have early? Or do you think you could utilize that in another manner and kind of invest elsewhere with that excess liquidity?
Yes. Thanks very much. Obviously, arguably through the COVID period, we had come into that period I would argue somewhat under-hedged. We had imagined a more normalized environment and then through COVID everything looks negative out in perpetuity by which time it was too late to be considering a serious hedging activity. So what it effectively meant is, as we have come out of that environment and the rate environment has changed, we had a lot of capacity to put on hedges. We had avoided doing any hedging at either negative rates or what we would have considered suboptimal rates, just falling into that trap of locking in duration, in an ultra low environment. So that's what really changed this year. And the capacity is, in fact, created from the growth and liabilities, which obviously, grew through COVID. We had a thought that they might be that would dissipate or that those liabilities would be spent in some shape or form. And in a large part, they did. But then we had the change in the Irish banking environment where 2 or 5 banks decided to leave town. So our liabilities continue to grow, which just creates more capacity for structural hedges. But given the fact that the environment is pretty volatile, we kind of put on our hedges on a roll in 1-month basis, which we will continue to do for 2022 as the liabilities continue to grow. But the duration of those hedges are really only 2 or 3 years. So the short date is in nature, really reflecting the uncertainty around the environment and trying to figure out what balances will endure and which ones will not. Going into 2023, I don't believe that we will be putting on any new hedges of that size because I don't believe that the liability side is going to grow at that same pace. Rather we'll just be doing normal standardized rollovers and reinvestments. On the TLTRO you asked we would repay us. News only out yesterday, we're going to consider this from a holistic perspective. Our loan-to-deposit ratio is 61%. Our TLTRO is up in the 160%s. We have a really strong liquidity position, always good to have contingent liquidity. So I think we'll keep it on the review. The only benefit per se is obviously a visually might improve your net interest margin number, but it's actually not an income effect. So we'll weigh up those items. But look, nevertheless, TLTROs will legally mature throughout 2023, anyway. So I don't think we'll be talking about it for too much longer to be honest.
Next question comes from the line of Diarmaid Sheridan from Davy.
I have questions too as well if I may. Firstly, just around maybe returning to net interest income for a moment. Donal, you talk about the interest rate sensitivity. If we just concentrate on the euro side, the EUR 300 million for 100 basis points, obviously, you've had 200 basis points increases so far. Is it too simple to just say that, that equals EUR 600 million of NII benefits on an annualized basis? Or is there something else that we need to consider on that? That's the first question. And then the second question is maybe to push parameters or some manners on us around what to expect in December and specifically on capital returns. At that point, do you think you'll be in a position to maybe more tangibly set out your plans on a holistic capital return model? Or do you think that will still be something that during 2023, you're going to need to consider and work on?
Okay. With respect to the sensitivities, I said the reason I like the sensitivities is because they aggregate an entire balance sheet into one number and allow me to speak to it at a very high level. And at that highest level, the sensitivities in Euroland as of now remain the same as what they were at the half year, with some of those moving parts which I mentioned earlier, reduction from TLTRO, reduction in the sensitivity from structural hedges and obviously an increase from just accumulating liabilities as we onboard more and more bolstering KBC customers. The question on whether to lift and drop those numbers to the outer years, I think -- I mean, that is very much for you. It's based off a various set of assumptions. And those assumptions then will depend on whatever market consumer behavior is going to be throughout 2023 and 2024. But ultimately, I think in '23, and '24 we will come into or reenter a more normalized banking environment, with assets and liabilities being priced differently than what they were in the negative rate environment. So you're going to see on the liability side, the reintroduction of term products, notice products, et cetera. And obviously, you're already seeing on the mortgage side, changes in the rates there whether it would be on trackers automatically from the ECB or from fixed rates, new fixed rate business mortgages rising overall. But I think if you look at the sensitivities and if you look at our net interest income and how guidance has changed throughout the year, I think you'll be able to see that the pass-throughs is quite well reconciled between those items. So that's certainly -- and the reason why I would have given the interest rate sensitivity tables from Q3 of last year was really to use that or to help you use that as the best guide for our NII trajectory. I think with respect to December the 2nd targets updates, I think you can reasonably expect that there's going to be an update to costs and costs of risk given the inflationary environment. I think all of the balance sheet trajectory should be well understood by this stage. And really, it's going to be back solving this into an RoTE endpoint, which is what we're busy working through at the moment. Obviously, one of the inputs to the RoTE calculation is going to be the CET1 ratio, which is currently 13.5%, and we will provide an update and some color around that at December the 2nd.
And in terms of capital returns, Donal, sorry, is that something that you'd like me to do or is that going to be later into '23?
Well, I think that I mean, for -- I mean let's call it the return story remains consistent, okay? For us this is really focused in 2022 on ensuring the performance is as strong as possible and utilizing our normal dividend policy payout ratios as for 2022. The medium-term targets that we update are going to be beyond that. And when we define a CET1 targets around that we will obviously -- we will talk to ways in which we would imagine reaching that over a period of time.
Our next question comes from the line of Chris Cant from Autonomous.
If I could just come back on a couple of minor points on the hedge. So when you -- from a terminology perspective, when you say duration of 2 to 3 years, do you mean you're using 2 to 3 year swaps? Or do you mean that you're using kind of 4 or 6 year swaps and the duration in half of that? I just wanted to clarify what you meant by that. And in terms of the size of your structural hedge, you speak specifically to hedging derivatives. Should we be assuming that the Irish fixed mortgage book sort of EUR 11 billion and EUR 12 billion is also part of your effective structural hedge position? I'm just trying to think about comparing to peer banks where we get commentary around structural hedge size. I think they would include anything that is effectively part of the structural hedge even if it's not specifically a derivative. And then on cost and targets, in terms of the cost guidance you've given for this year, you mentioned some of the inflationary pressure is kind of structural, some of it sort of one-off in nature, I guess, the temporary hedge that you've taken on to manage client onboarding during this period of change in the market. Should we be expecting that cost number of 165 for this year to be increasing into next year because, obviously, the previous cost guidance and I appreciate it was given quite a long time ago is some way below what you're pointing to for 2022 specifically now just wanted to test the water there. I appreciate you're going to give us an update. But how are you thinking about those pressures that seems to have been building progressively?
Just to -- thank you, Chris. But just in relation to the cost guidance, I think that the cost guidance was given at a time when the group looks fundamentally different. It was prior to the various inorganic transactions. And of course, it wasn't a fundamentally different inflation environment. So we are not comparing like with like at this particular point in time. Like on an underlying basis, our costs are up 2%, up 7% in total, but that takes into account the impact of the transactions that we have been engaging in. Where we have a potential to influence and control our cost line, we have been taking very decisive action. Earlier this year, we concluded an agreement with our trade union, which was balances upon to have a 3-year pay deal, 4, 3 and 3, '22, '23, '24. So we have pretty decent certainty in relation to the labor cost inflation across the group. And of course, we've also now concluded a power purchase agreement, which will cover 80% of the group's energy requirements over the course of the next 15 years.
And then I think on the -- if I look at the cost for 2022, there's a few ways to look at it, but we recently made a one-off payment to, let's say, our non-managerial staff cost of living adjustments that will have an effect of EUR 10 million, which obviously wasn't imagined at the half year. And then we have other items, which I would consider they kind of straddle 2022 and 2023, and they're very much related to, whether it be inorganic activities or surge capacity to capture market share from some of those exiting banks. And obviously, because it's straddling over the years, it is going to have a '22 and '23 effect. But I do -- at the December the 2nd update, I will do a look back and reconcile from the old targets, notwithstanding we're in a very different environment and give a forward-looking trajectory. Our real focus is ensuring that all of the inorganic activities we said we were going to capture and land, we do that as expeditiously and as safely as possible and also with respect to the opportunity from the departing banks that we really focus on trying to capture as much of those customers as we possibly can. And you can see like overall new accounts opened for it to look at that as a metric up 85%, 250,000. I think of the market share of the banks that are leaving, we believe that we are taking a very large market share of those customers who are moving. So customer acquisition strategy is the focus for us. So that's on the cost side. Specifically to your structural hedge questions, when I look at the sensitivities, that's obviously completely bank-wide. So incorporated in that, you could have a fixed rate mortgage and a derivative. But I specifically wanted to mention the derivative piece because that would have been something that has grown and accumulated quite quickly this year. And that quantum that I referenced was all interest rate derivative-related, so on top of everything else. So when I say the duration was 2 to 3 years that is fixed rate, receive fixed 3-year, 2.5-year, 2-year type of hedging that we put in place as the liabilities continue to surge. So it wasn't a case of doing a series of swaps from 10 years out to 1 week with a lower duration. It was very targeted in that 2- to 3-year area, as interest rates spiked in that part of the curve and our liabilities surged really through Q2 and Q3.
That's really helpful. If I could just ask one follow-up, please. In terms of the comment around rate sensitivities, you said the rate sensitivities are unchanged versus the first half. But obviously, if you're applying structural hedges that would tend to reduce your stated 1-year rate activity. So is there offsetting kind of positive underlying adjustments going on in the background, i.e., the hedge is growing, but your assumptions around deposit meters, rates pass-through, et cetera, have become more favorable, resulting in kind of a round trip back to where we started? Or was it that the hedge expansion was primarily something that happened at the end of the first half?
No. I mean the -- we didn't make any changes to the assumptions in our sensitivities other than, let's say, adjusting the form of the TLTRO, okay, from its legal maturity to just an overnight type of exposure. That was the only, let's say, methodology change. And the sensitivities haven't per se changed either because I've made any assumption around deposit betas. Just given the fact that our liabilities have continued to grow -- that has been the main offset, which in euros leads us back to a similar enough position than where we were at the end of June.
Our next question comes from the line of Borja Ramirez from Citi.
I have a 2 quick questions, if I may. Firstly is regarding the deposit pricing. So I would like to ask the competitive dynamics, given the fact that some banks are exiting the market. Is this impacting positively in the cost of deposits? And then my second question would be, if you could please update on the amount of macro overlay provisions? And what are the GDP assumptions in your IFRS 9 model?
Just on the competitive dynamics in terms of deposit pricing, I suppose the key thing to remember here is where our LDR is like we are awash with liquidity at this stage. And we did want -- as we adjusted our rates on the asset side, we did want to introduce some adjustments on the liability side with change our pricing in terms of new fixed rate mortgages going forward, but we also announced our intention to introduce a 25 bps rate for deposits above EUR 15,000 with a 1-year term. So we are alert to the competitive dynamics, while very be conscious of the fact that we are in an exceptionally strong liquidity position with an LDR as I said, in the very low 60s.
Yes. I think with respect to asset quality, I think at the half year, we would have had gross model adjustments of around EUR 400 million. I've been quite focused this year on trying to ensure that COVID-related PMAs that were put in through the crisis, that they all either perform or underperform and we take them out and not to conflate them with whatever we're coming to in the future years. So as we come in -- as we look towards the end of the year, like I said, asset quality underlying book performance is really, really strong. So it's likely the only way that we will end up with a small charge for the year is by implementing some form of post-model adjustment for let's say, the net disposable income effect. So really, you're going to be talking about weaker borrowers in the personal space potentially in the mortgage space as well on a small PMA to take account for that. But you've got to remember that the throughout '21 and '22, all of our legacy nonperforming exposures were effectively resolved. So typically, when you come into an environment like this with higher rates, re-defaults of NPEs is your main risk. But we did manage to resolve most of those pre-COVID NPEs before or throughout this year as we go into 2023.
Okay. Given that we are past the hour at this stage, we have run out of time, I think, but the IR team are very, very happy to take any further questions you might have on this release this morning. Can I thank you all for your attendance and we look forward to speaking with you again in 5 weeks' time.
This concludes today's conference call. You may now disconnect.
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