Equity 15 May 2015, 10:53am

Hungary OTP posts small surprise profit for Q1

Portfolio

Contrary to expectations, Hungary’s OTP Bank did not incur losses in the first quarter of 2015, which partly owes to lower-than-expected operating expenses and partly to the fact that adjustment items worsened results less drastically than projected. The bank’s Russian and Ukrainian operations continue to struggle. Their combined loss amounted to HUF 21 bn in January-March. The Bulgarian arm, however, delivered record profit; this is the group’s gem. On the whole, the bank has split into two. The Russian and Ukrainian subsidiaries and the Central and Eastern European operations are on two totally different paths. The former “group" is persistently in the red, whereas we see promising signs at the latter.

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Two-speed bank.

OTP does not incur loss in Q1

Analysts forecasted HUF 3.6 billion loss for OTP for the first quarter, whereas Hungary’s largest bank by assets reported nearly HUF 2 bn profit for the period. The difference stems from the fact that operating expenses turned out to be more than HUF 4 bn lower than projected and adjustment items were nearly HUF 3 bn below the market’s call. Provisioning was HUF 3.5 bn over the expected sum.

So it was party adjustment items that caused a difference between the actual Q1 figures and the forecasts. The special tax on financial institutions totalled HUF 28.75 bn instead of the expected HUF 29.3 bn; the effect of acquisitions was HUF 1.5 billion against the market’s call for HUF 1.1 bn; the actual and expected one-off impact of regulatory changes related to consumer contracts in Hungary (after tax) totalled HUF 7.4 bn which was hardly taken into consideration by the analysts. Also, the revaluation of reverse mortgage portfolio of OTP Life Annuity Ltd. caused a HUF -5.5 bn impact, which the market did not expect. This occurred on the back of regulatory changes.

The group’s total income dropped 10% year on year to HUF 189.5 bn in Q1. Net interest income and fee and commission income dropped 12% and 11%, respectively. Operating expenses, though, decreased by only 8% compared to Q114, as a result of which OTP’s operating profit went down 12% to HUF 95 bn.

Total risk costs amounted to HUF 64.5 bn, against HUF 69 bn a year earlier and HUF 77 bn in the fourth quarter of 2014. The bank’s consolidated after-tax profit dropped 20% to HUF 28.3 bn. Taking into consideration all the adjustment items worth HUF 26.4 bn, OTP posted after-tax profit of HUF 1.9 bn, which is 67% lower than in the base period.

Two-speed bank

It was plain to see already last year that OTP’s operations may be divided into two sections of markedly different dynamics. One is the Russia and Ukrainian subsidiaries where the operating environment deteriorated significantly, and the other is the CEE operations where the operating environment improved and OTP is profitable (well it posted only symbolic profits except for the Hungarian (Core) and Bulgarian operations).

This is clearly reflected in the Q1 figures too. OTP Russia posted HUF 11.5 bn negative result and the Ukrainian unit incurred losses of HUF 10.2 bn. All other operations posted profits.

With respect to the two underperforming members of the group OTP’s management expects gradually normalising operating environment in 2015 and lower overall losses compared to the previous year. However, weak macroeconomic outlook will remain valid through 2015: according to OTP’s forecast, the economic contraction in Ukraine might be higher than 7% and the average inflation will hover around 40%. In Russia the GDP will shrink by around 4%, whereas the headline inflation after a high level at the beginning of the year will decelerate to 10%, according to OTP estimates. Management expects losses of the two subsidiaries to be less severe this year than in 2014. In CEE, OTP projects economic output growth on all of its markets except Serbia. The biggest improvement in terms of the economy and the regulatory environment is projected for Hungary.

Those we are proud of

There is unfairly little talk about OTP’s Bulgarian operation, while this “average Joe" is delivering sizeable profits, unlike former star player OTP Russia. We need to highlight DSK Bank specifically now, because it has posted a never-before-seen HUF 17.6 bn profit in the first quarter, which represents a 56% improvement over the base period.

Besides the rise in revenues this is attributable to the fact that unlike in the previous quarters the Bulgarian unit did not generate provisions. In fact, on the risk cost line there was actually a provision release, also linked to some corporate exposures and its coverage has also dropped somewhat. Net interest income jumped by 15% yr/yr to over HUF 22 bn, mainly due to lower funding costs, and as interest expenses on deposits almost halved yr/yr fee and commission income soared by 19% to HUF 5.4 bn. The Bulgarian unit operates extremely effectively. While revenues leaped operating costs were kept in check and the cost/income ratio was only 32.4% in Q1.

Losses in Russia and Ukraine

At OTP Bank Russia there are no signs of stabilisation. Total revenues (in RUB terms) dipped by 41% yr/yr; operating income plummeted 48% and the cost/income ratio jumped to 51.7%.

The decline in revenues may be attributed partly to deliberate action, as due to the market turbulences, cash loan disbursement was suspended from the middle of December and restarted only in the middle of February with stricter conditions and lower approval rate. The ratio of non-performing loans (90+ days past due loans/gross customer loans) rose to over 19%, partly due to which provisions for possible loan losses amounted to HUF 27 bn. The bank incurred HUF 11.5 bn after-tax loss in the first quarter. The negative result also contains the operating costs related to the operation of the new online bank (Touch Bank), which amounted to HUF 731 million (after tax) in Q1.

OTP Bank Ukraine had a negative result of HUF 10 bn in Q1, partly over HUF 26.5 bn provisions. Portfolio quality deteriorated further and by the end of March more than half of the bank’s loan portfolio were in the DPD90+ category. New disbursements in corporate and cash lending were suspended temporarily in March. After endorsing a new lending strategy, cautious lending with stricter underwriting criteria was resumed in Q2 in these two segments. The unit closed 25 branches during the quarter.

Outlook

The Central and Eastern European (CEE) region enjoys an improving operating environment. Due to strengthening household consumption and better export performance the GDP is forecasted to further grow in all countries, but Serbia.
The average economic output in OTP’s CEE markets is expected to increase by 2.3% which exceeds both the European Union average and that of the Eurozone.
The operating environment which includes not just the macroeconomic, but the regulatory conditions, too is expected to improve the most in Hungary. With the settlement of FX and HUF consumer loans there is a good chance that household loan demand will gear up. Not only the improving financial condition of customers supports that belief, but the dynamic rebound of the local property sector already seen through increasing transaction numbers and higher housing prices.
With respect to the two underperforming members of the Group, in case of Ukraine and Russia OTP’s management expects gradually normalizing operating environment in 2015 and lower overall losses compared to the previous year. However, weak macroeconomic outlook will remain valid through 2015: according to our forecast in Ukraine the economic contraction might be higher than 7% and the average inflation will hover around 40%. In Russia the GDP will shrink by around 4%, whereas the headline inflation after a high level at the beginning of the year will decelerate to 10%.
In 2014 within annual administrative expenses OTP Group’s contribution into the National Deposit Insurance Fund (OBA) represented HUF 2.7 billion, HUF 0.6 billion into the Resolution Fund established in 2014 and another HUF 0.3 billion into Beva, i.e. in total those contributions represented HUF 3.6 billion.
For 2015 those items are expected to change as follows: contribution into OBA: HUF 3.8 billion, contribution into the Resolution Fund: HUF 2.3 billion and HUF 0.4 billion into Beva coupled with another HUF 0.4 additional contribution already stipulated and approved by the Beva. In total OTP Group’s obligation will increase to HUF 7 billion (booked mainly at OTP Core).
On the top of that an additional contribution obligation in form of advance payment might arise towards the special Quaestor fund, its volume is to be calculated from the total sum of Quaestor clients’ claims (yet unknown) multiplied by the share of Beva members’ 2014 annual contribution (26.6% in case of OTP). However, according to Act No. XXXIX of 2015 there will be a separate act stipulating that that part of the advance payments into the special Quaestor fund will be deductible from tax that do not recover during the operation of the special Quaestor fund.