ProCredit Holding — Annualised ROE ex-Ukraine of 9.5% in H122

PCB reported a net profit of €9.4m in Q222 (€20.7m in Q221), as the 24.1% y-o-y increase in operating income to €82.5m (excluding provisions for credit losses) was offset by higher loss allowances at €21.7m (versus a minor positive P&L impact of €0.9m from loss allowances in Q221). The vast majority (c €21.2m in Q222) of these provisions are related to PCB’s operations in Ukraine (the company also booked €35.3m in loss allowances in Q122). Excluding ProCredit Bank Ukraine, PCB’s net profit would have been €42.0m in H122 (up 64% y-o-y, with a positive contribution from all local banks), implying an annualised ROE of 9.5% (close to PCB’s reaffirmed mid-term target of 10%) versus 6.5% for PCB excluding Ukraine in H121.

PCB’s NII increased by a solid 20% to €64.7m in Q222, driven by a combination of higher NIM (3.1% in Q222 versus 2.9% in Q221) and continued robust loan book growth of 4.4% q-o-q in Q222, bringing the growth between end-2021 and end-June 2022 to 6.2% (4.7% if adjusted for foreign exchange (fx) changes) and y-o-y growth to 11.3%. Meanwhile, net fee and commission income rose by 12.7% y-o-y to €13.7m in Q222, assisted by the continued increase in the client base and in volumes (most notably in the transaction and credit card business).

PCB’s NIM benefitted from stable lending margins, an increase in base rates across several of the company’s countries of operations and a higher share of sight deposits and FlexSave deposits (up 2.1pp y-o-y to 71%). Overall, in Q222 customer deposits increased by 4.1% q-o-q and 14.3% y-o-y. All loan categories contributed to the loan portfolio growth, but the major driver was working capital loans with maturities of up to three years (c 52% of Q222 growth, according to our calculations) as clients funded their additional working capital requirements arising from high inflation and supply chain bottlenecks (which encouraged SMEs to build up larger inventories). Green loans were up c 4.4% in Q222, with their share in the total loan book broadly unchanged versus the end-March 2022 figure of 19.1% (close to PCB’s mid-term target of 20%).

Growth in Eastern Europe was largely due to fx effects, but we note that this was in part due to the Ukrainian hryvnia (UAH) being pegged to US dollar since the start of the Russian invasion, coupled with the US dollar appreciation versus the euro. Here, we note that the Ukrainian Central Bank devalued the hryvnia by 25% versus the US dollar in July 2022. Some additional positive fx impact in Q222 came from the appreciation of the Georgian lari. Almost all new loans in Ukraine in Q222 (€69m) were loans to agricultural clients utilising state and European Bank for Reconstruction and Development guarantees.

PCB made further progress on its efforts to bringing its CIR below 60%, in line with its mid-term target. The company’s CIR reached 61.0% in Q222, down 3pp y-o-y, as growth in its operating income outpaced the 11.7% y-o-y rise in personnel expenses to €23.6m and broadly in line with the 24.8% y-o-y increase in administrative expenses to €26.7m. We note that the latter includes €2.9m of one-off legal, advisory and audit fees related to the war in Ukraine, adjusted for which the growth in administrative expenses was 11.2% y-o-y in Q222. Moreover, PCB’s net other operating income in Q222 contained a €1.9m extraordinary income from derivatives and a €0.8m negative impact related to a full write-down of goodwill in Ukraine. Adjusted for all the above one-off items, PCB’s CIR stood at 58.3% in Q222, according to our calculations. Finally, PCB’s net other operating income in the second quarter of the year included seasonally higher deposit insurance contributions, amounting to €1.5m.

PCB’s high annualised cost of risk of 188bp in H122 (and 141bp annualised in Q222 alone) primarily reflects stage transfers within the Ukrainian portfolio, with Stage 2 loans representing approximately 35% of the local loan book and Stage 3 (credit-impaired) loans 4.8% at end-June 2022 (resulting in the group share of credit-impaired loans increasing to 2.6% vs 2.3% at end-March 2022 and end-2021). Despite the nationwide credit moratorium currently in place, PCB classifies loans with no repayments (neither interest nor principal) as credit impaired. At present, over 70% of Ukrainian customers make their planned interest payments, while more than 20% also make their planned principal repayments.

As a result, 10% of the Ukrainian loan portfolio was covered by provisions at end-June 2022 (excluding guarantees and collateral), with the Stage 3 loans coverage ratio now standing at 55.6%. PCB’s provisioning at end-June 2022 includes €30.1m of management overlays, of which €13.7m is attributable to a higher loss given default (LGD) assumption in Ukraine (PCB extrapolated the LGD of its Donetsk portfolio in 2014–15 to the entire portfolio in Ukraine). The remaining €16.4m accounts for potential macro headwinds outside of Ukraine. Management highlighted that PCB’s cumulative cost of risk related to Ukraine was at the upper end of the provisioning level of local peers (12.2% annualised cost of risk in H122 based on local regulatory reporting versus 6.2–14.6% for a set of undisclosed comparable companies). Excluding Ukraine, the cost of risk was marginal at €0.8m or 3bp in Q222 and the share of credit-impaired loans declined slightly.

The group’s capital base remained solid with a CET-1 ratio of 13.7% at end-June 2022 (14.1% at end-2021), well above the regulatory requirement of 8.2%. The increase from 13.4% at end-March 2022 was largely due to the recognition of Q421 profits and the reversal of dividend accruals related to 2021 earnings (the general meeting of shareholders accepted PCB’s proposal not to distribute a dividend for 2021 in response to the outbreak of the war). The CET-1 ratio at end-June 2022 does not reflect Q222 profits or the adjustment to the official hryvnia exchange rate (see above), though management expects the latter will have a minimal negative impact (3bp). PCB’s leverage ratio was 9.7% at end-June 2022.

ProCredit Bank Ukraine’s CET-1 ratio at end-June 2022 was 4pp above the regulatory requirement (which we understand is 7.0% at present). As discussed in our previous note, while the credit losses of the Ukrainian bank may at some stage lead to a decline in its CET-1 ratio below the regulatory requirement, we note that the National Bank of Ukraine stated that in these instances it will allow banks to continue to operate so they can gradually rebuild their capital buffers. PCB considers the risk of a default by ProCredit Bank Ukraine is low. Still, it recently proposed to its lenders a change in the cross-default clauses of its bearer bonds, registered bonds, promissory notes and a senior loan of an aggregate value of €289.5m. If agreed, the change would exclude ProCredit Bank Ukraine from the list of PCB’s material subsidiaries (from 1 July 2022 for two years), whose default is subject to special termination rights to investors. In exchange for agreeing to this exclusion, investors would receive a fee of 50bp pa. We understand that investors have until 22 August to accept the offer and subsequently the company will likely update the market with this respect. Fitch recently highlighted that the change in debt terms would have no impact on PCB’s credit rating (its Long-Term Issuer Credit Rating is BBB with a stable outlook). Moreover, Fitch believes that even a failure to receive consent would not result in a material increase of default risk for PCB.

Minor changes to our PCB forecasts include higher loss allowances for the Eastern Europe segment in FY22e (€85.9m vs €75.7m previously), largely offset by lower credit loss provisions in South Eastern Europe (€5.2m vs €10.0m previously) and some slight upward revisions to our group net interest income and net fee and commission income forecasts. Management continues to expect a significant decrease in PCB’s ROE in 2022 versus the prior year (we forecast an ROE at 2.7% in FY22e vs 9.7% in FY21). It is now guiding to a CIR of 60–63% in 2022 (vs 64.4% in 2021), based on the strong efficiency improvements in H122 (we have factored in 63.0% vs 63.6% previously). Moreover, PCB expects the group loan book to increase at a high-single digit percentage rate in FY22 (after adjusting for currency effects), compared with our estimate of 8.6% (including a positive fx impact at c 0.7pp). We note that management intends to prioritise the growth in customer deposit and enhancing its NIM over loan book growth on the near term. Finally, management anticipates a CET-1 and leverage ratio of around 13.0% and 9.0% in FY22e, respectively. Our CET-1 forecast for FY22e is somewhat higher at 13.5% (14.1% at end-2021).

Management confirmed its mid-term guidance of a c 10% ROE (which we expect to be reached in c FY24–25e) and a CIR below 60% (we assume that PCB will gradually approach the 60% mark between now and FY26e). In terms of loan book growth, the company expects an annual loan portfolio growth rate in the mid- to upper-single digit percentage range. We have conservatively factored in 3.0% growth in FY23e (due to the recessionary environment) followed by 9.1% in FY24e and c 10% in FY25e and FY26e.

Regression lines based on FY22e and FY23e P/BV and ROE indicators for PCB’s peers imply a P/BV (for PCB’s sustainable return on tangible equity of 10%) at 0.71x (see Exhibits 3 and 4), which is slightly ahead of the 0.66x in our previous note. As a result, we have assumed a fair value multiple of 0.74x (0.72x previously), which is the average of the 0.77x multiple derived from our capital asset pricing model and the regression analysis (see our previous note for details). This implies a fair value per PCB share of €10.60 (versus the current share price of €3.48). Here we acknowledge that the peer group is quite scattered across the P/BV-ROE map, making the regression line less reliable. We believe this may be due to a number of non-financial factors, such as political risk perceived by investors.