Year-end report 2018
Strengthened business and navigating through regulatory changes
October – December 2018
- Total operating income increased 19 per cent to SEK 766 million (643).
- Items affecting comparability before tax totalled SEK –24 million and are attributable to restructurings and costs related to a business acquisition in Italy.
- Profit before tax increased 69 per cent to SEK 186 million (110).
- Profit before tax excluding items affecting comparability totalled SEK 210 million, a year-on-year increase of 24 per cent.
- Diluted earnings per share amounted to SEK 1.59 (0.92).
- Return on equity excluding items affecting comparability was 18 per cent.
- Return on equity was 16 per cent (11).
- Carrying value of acquired loan portfolios totalled SEK 20,605 million (14,766).
- The total capital ratio was 14.14 per cent (17.71) and the CET1 capital ratio was 9.66 per cent (11.70).
Figures in brackets refer to the fourth quarter of 2017 for profit comparisons and to 31 December 2017 closing balance for balance sheet items.
Events during the quarter
- Hoist Finance is evaluating alternatives in response to the FSA’s new interpretation of the capital adequacy regulation for risk weights for non-performing loans, and is adopting measures for continued growth.
- Strong volume growth with portfolio acquisitions of SEK 2,246 million, with the first Greek portfolio of non-performing consumer loans and SME loans followed by continued growth focused on Italy and Great Britain.
- Increased digitalization and improved operational efficiency.
- Hoist Finance signed an agreement to lease and subsequently acquire operations in Italian credit management companies Maran S.p.A and R&S S.r.I (the ”Maran Group”) in a multi-stage process under compulsory administrative proceedings in accordance with Italian insolvency law.
- The European Parliament and the Council of the European Union has comprised, as published 3 January 2019, that non-performing loans will likely start to be affected by NPL regulation from 2021. Hoist Finance has identified mitigating actions with ongoing implementation.
- Revised financial targets.
- Hoist Finance has entered into an agreement to acquire assets held by Polish debt management and collection company GetBack.
Strengthened business and navigating through regulatory changes
Hoist Finance has delivered a solid financial performance in 2018. We have achieved strong growth in portfolio acquisitions and are broadening our product and geographic spread. We have implemented a new operating model and are making progress towards becoming more effective and efficient. Our market has become materially more attractive over the year as yields are rising and new regulation is encouraging supply. As a bank operating in the secondary market, this same regulation has presented us with some challenges in the short term. We are committed to implementing mitigating actions in the coming year to reduce the impact of these challenges.
Beneficial market dynamics intact
Following the financial crisis more than 10 years ago, the level of Non-
Performing Loans (NPLs) in banks is still very high. The regulators have taken various initiatives and introduced new regulations to push banks to divest their NPLs to make their balance sheets healthier. These regulations are stricter than before and aim to ensure real risk transfer. Driven by the regulatory and accounting changes, as well as the commercial benefits of selling NPLs, the secondary market for acquiring NPLs is developing in a very positive way. The regulators also recognize the need for a well-functioning secondary market as an important and relevant part of the financial value chain.
While regulation itself has been an important factor explaining the growth of the Credit Management Services (CMS) industry, recent years’ supply of cost-efficient funding through the high yield bond market has increased demand, competition and margin pressure. In 2018 the CMS industry experienced increased cost of funding and lower access to new financing to finance growth. With no signs of any material improvement in the funding market, the industry is now focusing on reducing leverage, finding alternative sources of funding (e.g. co-investment or asset management structures), and improving operational efficiency.
Strengthening our business
The winners in the industry will be those companies that have the best operations and the lowest cost of capital. In 2018, Hoist Finance took numerous steps to improve performance and operations. We implemented a new operating model across all markets, which is more agile, with fewer management layers. The model is completely standardised, harmonised across markets and it allows for rapid knowledge transfer. We are implementing new company-wide digital solutions that make performance management, analytics and customer interaction easier and more cost efficient. Through site consolidation and the use of centers of expertise and shared service centers we are committed to bringing down our costs and improving our performance.
Our growth in 2018 has been the highest ever, more than the portfolio investments in 2017 and 2016 combined. Broadly speaking, the NPL markets consists of unsecured and secured assets for retail, small and medium sized companies and larger corporates. While the NPLs within the unsecured consumer segment are only around 11 per cent of the total NPL market, this has traditionally been Hoist Finance’s core business. To address a larger portion of the NPL market, and even acquire performing loans, has been a very important strategic priority for Hoist Finance. Our ambition is still to grow within the historic core, and also to expand further into the secured consumer segment which is more than twice the size of the unsecured segments. Last year, 59 per cent of portfolio investments were in unsecured consumer NPLs, 27 per cent in secured NPLs and 14 per cent in performing loans.
Hoist Finance has been regulated as a bank since 1996 and this has served us well. The access to low cost funding through bank deposits represents a clear cost advantage, and our regulated status has also proved its value in many commercial situations. Over the years, many regulatory changes have been implemented for European banks, and Hoist Finance has always, and will at all times, fully comply with regulations.
Regulatory changes have recently been put in place to reduce the risks on European banks’ balance sheets. For the CMS market as a whole, this is positive. But it also entails unintended negative consequences for Hoist Finance, as we operate in the secondary market with a banking license.
The revised interpretations of required risk weights for purchased unsecured NPLs of 150 per cent do not reflect any change in risk of the underlying assets. However, we have fully implemented these new risk weightings and, we continue to have a CET1 ratio above regulatory requirements and within our stated Board risk appetite for a buffer over regulatory requirements as at 31 December 2018.
Unrelated to this change in risk weights, the European Parliament and the Council of the European Union is expected to publish a new legislation by early Q2 2019, which will impact the timeline over which banks are required to provide for new formation of NPLs (NPL Backstop). The NPL Backstop will regulate how the book value for future unsecured NPLs should be treated in capital adequacy calculations. For unsecured debt that is originated after implementation of this regulation and then defaults, the NPL Backstop will require these NPLs to be provided for in a bank’s capital adequacy after the end of year three following default.
This regulation only applies to future unsecured NPLs and does not have an impact on Hoist Finance’s existing portfolios at the time of entry into force. The unsecured debt that we acquire from banks, has typically been in default for three to five years before being sold. Whilst this period may shorten following the new rules, this regulation will not have an adverse effect on Hoist Finance’s capital ratios for the next two to three years. Longer term, and without mitigating actions, the NPL Backstop will become more challenging for Hoist Finance as the requirement to write-down the value of unsecured NPLs to zero for capital adequacy by end of year three after default will materially impact the required capital for future unsecured NPL purchases. The effect of the NPL Backstop is counterintuitive and has unintended negative consequences for companies operating in the secondary unsecured NPL market with a banking license.
In response to these regulatory changes we are now reviewing various market-standard mechanisms, processes and products such as: introducing more sophisticated risk models (IRB), securitisation, and various alternative investment fund structures leveraging third-party capital.
By introducing more sophisticated risk modelling, Hoist Finance will seek to move from the standardised method of calculating Risk Weighted Assets (RWA) to an Internal Rating-Based model (IRB). With IRB, validated and approved, our own internal risk modelling methodology would apply, effectively reducing our applied risk weights from the standardised 150 per cent. To get an IRB model approved typically takes at least two to three years.
By securitising NPLs through market standard processes, Hoist Finance may be able to achieve significant risk transfer, enabling a reduction in RWAs, reduced effect of NPL Backstop and thereby strengthen the CET1 ratio. Securitisation is a well proven concept for performing loans, and in recent years, also for NPLs, for example in the Italian market. We are now exploring our options for NPL securitisation and will update the market on our progress.
In order to keep optionality with the overall aim of optimising our capital efficiency and maximising return on capital for our shareholders, we also continue to consider other risk mitigation measures, such as establishing fund structures, in order to leverage third party capital.
Working with regulators is a core competence for Hoist Finance, and the business model has been pressure-tested over time and through multiple changes to regulation. While adjusting to these changes comes at a cost, our firm belief is that by adjusting to the new requirements Hoist Finance will preserve the competitive strengths we have.
Updated Financial targets
As a consequence of the new regulatory requirements, our financial targets have been revised. These revised financial targets represent our ‘base case’, assuming no positive effects from mitigating actions. However, through our mitigating actions we are targeting reduced risk weights, improved capital ratios, increased capacity for further growth and consequently improved operational leverage.
As a result of the changes to our RWAs which we announced in December, our CET1 ratio is 9.66 per cent for 31 December 2018. Without implementing mitigating actions, this constrains our near term capital flexibility and our expected purchasing volume for 2019. We now expect portfolio investments totalling approximately SEK 5 billion in 2019, broadly in line with the average purchasing volume for Hoist Finance over the last 3 years. We expect purchasing volumes to grow thereafter.
In the ‘base case’, our CET1 ratio target and dividend policy remain unchanged per our announcement in December. CET1 ratio target is 1.75– 3.75 per cent over regulatory requirement and, as stated, dividends will not be paid for 2018 and 2019. Longer term dividend policy is 25–30 per cent of net profits per annum. Our commitment to operational improvement, gives us confidence that despite slower top line growth, we will still achieve our cost/income ratio target of 65 per cent by 2021. Our new 15 per cent RoE target is a reduction but still well in excess of our cost of capital. We believe our new 10 per cent EPS CAGR target remains attractive.
In summary, Hoist Finance operates in a growing and profitable market, and our operating model is becoming much more efficient. While the new regulations are challenging, we are encouraged by the fact that there are several different countermeasures available to ensure a continued profitable development for Hoist Finance.
Hoist Finance AB (publ)
Hoist Finance AB (publ) (the “Company” or the “Parent”) is the parent company of the Hoist Finance group of companies (“Hoist Finance”). The company is a regulated credit market company. Hence, Hoist Finance produces financial statements in accordance with the Swedish Annual Accounts Act for Credit Institutions and Securities Companies.
The information in this interim report has been published by Hoist Finance AB (publ) pursuant to the EU Market Abuse Regulation. This information was submitted by Julia Ehrhardt for publication on 12 February 2019 at 8:30 AM CET.
For further information please contact:
Acting Group Head of Investor Relations
Tel: 46 (0)70 591 73 11
About Hoist Finance
Hoist Finance is a trusted debt restructuring partner to international banks and financial institutions. We are specialised in serving banks in handling non-performing loans, and supporting individuals in becoming debt free. Through expertise and rigorous compliance we earn the banks’ trust. Through respect, honesty and fairness we earn the trust of our customers. For further information, please visit hoistfinance.com.