UmweltBank — Ready to accelerate loan book expansion

UBK is a German specialist bank offering loans to customers executing renewable energy (RE) developments such as solar, wind or hydro projects (c 62.5% of loan portfolio at end-2018), as well as sustainable construction for retail, community and commercial customers (remaining 37.5%). The bank has delivered a solid 2013–18 CAGR in loans to customers as well as customer deposits at 5.9% and 6.3%, respectively. UBK’s offering also includes sustainable capital market and insurance products. Moreover, the bank holds indirect and direct equity interests in a portfolio of solar, wind and sustainable real estate projects with a value of €29.1m as at end-2018.

We are valuing UBK using a P/BV-ROE approach, with an estimated sustainable return on tangible equity of 12.7%, a CAPM-derived cost of equity of 8.9% and a sustainable long-term growth rate of 2.0%. For the purpose of our valuation, we are treating the reserves for general banking risks created pursuant to Section 340g of the German Commercial Code as equity (see the valuation section for a detailed elaboration). Consequently, we currently arrive at a fair value of €13.0 per UBK share, implying 13% upside to the current stock price of €11.50. We have raised our valuation from €11.3 per share in our February note, which is in particular a function of our higher loan book growth expectations.

We believe that UBK’s net interest margin (NIM) is likely to gradually bottom out in FY19e (we assume a 4bp decline vs FY18), as the interest rate on the majority of its loan book is adjusted to reflect the current low-interest environment, while stronger loan book expansion (we expect a 2018–23e CAGR of 7.8%) translates into higher interest income. Amid increased investments in the development and marketing of new products, we expect UBK’s cost income ratio (CIR) to rise to 35.9% in FY19e, but gradually decline subsequently to 34.3% in FY20e and 33.4% in FY21e. Consequently, we expect pre-tax profit of €37.1m in FY19e (broadly stable vs FY18 and in line with management guidance at €37m), followed by a 9% increase in FY20e to €40.3m. We summarise our forecast revisions in Exhibit 1.

Our forecasts for UBK are dependent on a set of assumptions, including the projected path of European central Bank (ECB) rate hikes, as c 90% of UBK’s earnings before administrative costs and taxes are derived from net interest income. We estimate that every 10bp change in UBK’s net interest margin in FY18 would result in a 97bp change in the bank’s ROE (see Exhibit 10). In addition, UBK’s new lending volumes are largely driven by the regulations around renewable energy projects and sustainable construction. Finally, we treat some of the new products UBK plans to introduce as potential additional upside drivers.

UBK is the only German listed bank specialising in financing ‘green’ projects, including renewable energy (RE) sources (in particular solar and wind), as well as sustainable construction. Consequently, the bank is a play on Germany’s ongoing transition towards a low-carbon, resource-efficient economy. On top of its lending business, the bank is also active in the securities business, offering green stocks, environmental funds and green project bonds. A good example of the latter is the completion of the €7.9m bond issue of NATURSTROM confirmed in May 2019. Moreover, the bank is also involved in the distribution of green insurance products. UBK was founded in 1997 and has since provided funding to nearly 23,000 projects, and is currently serving over 113,000 clients (almost exclusively in Germany). As at end-2018, its asset base stood at c €3.7bn. UBK’s free float equals 84.4%, with the remaining 15.6% stake held by GLS Gemeinschaftsbank eG (one of UBK’s competitors) after purchasing it last year from UmweltVermögen Beteiligungs AG, an investment vehicle of UBK’s founder (Horst P. Popp) and his family.

At end 2018, UBK’s credit portfolio (excluding outstanding commitments) stood at €2.4bn and was divided into solar (37%), housing (27%), wind and hydro power (26%), as well as other projects (10%, see Exhibit 2). In comparison to 2017, the share of green construction (currently housing and social and commercial properties) has slightly increased at the expense of wind & hydro and solar power. This is in line with broader market trends, which we discuss later in the report, including bottlenecks in wind projects development, strong expansion of solar capacity and high housing demand in Germany. We estimate that UBK’s loan book has grown at a robust 2013–18 CAGR of 5.9%.

Apart from the lending business, UBK selectively acquires indirect (through its fully owned subsidiary UmweltProjekt AG) and direct equity interests in selected RE and green construction projects. As at end 2018, UBK held interests in several projects, including 48.5MW of wind park capacity, 7.1MWp of solar project capacity, 32,664sqm of residential properties and 6,324sqm of commercial space. In line with earlier intensions, UBK has expanded the equity interest portfolio to €29.1m from €22.4m at end-2016, which was particularly driven by the real estate investments, as well as solar projects. Going forward, UBK intends to acquire stakes in new solar and residential projects.

As discussed in detail in our initiation note, UBK has launched several strategic actions to address key improvement areas, which include net interest margin enhancement, digitalisation, strengthening of existing client relationships and new customer acquisitions.

Firstly, UBK embarked on expanding its product range, with the initial plan to introduce a sustainable consumer credit before the end of 2018. This product would be designed to provide funding of environmentally friendly expenses of retail customers, in particular house renovation to increase energy efficiency, covering for instance heating systems, rooftop PV panels, insulation, etc (and potentially the purchase of an electric car as well). The product launch has now been delayed until end-2019. We understand that one of the reasons behind this was the need to replace the originally selected IT service provider, as the product introduction is supposed to be accompanied by the implementation of a new digital loan processing application. Once launched, we expect that the sustainable consumer loan will provide some additional relief to UBK’s net interest margin, although it will be relatively minor initially (we currently estimate a potential positive impact in FY20e and FY21e of c 1bp and 2bp, respectively).

Moreover, UBK plans to complete a bond issuance by UmweltProjekt AG (its subsidiary holding direct and indirect equity investments as mentioned above) before the end of 2019 to provide external funding and enhance its return on equity. Management has also highlighted that the bank’s team is continuously working on the development of a modern Girokonto (ie current account), which will be accessible through an online banking portal. UBK still expects it to be launched before the end of 2020. Meanwhile, the bank has successfully implemented an online customer onboarding process. It was also able to slightly expand its sustainable investment funds offering towards the end of 2018. Interestingly, UBK has accelerated the timelines of the ecological crowd-funding platform (from end 2020 to 2019) as well as the introduction of further sustainable equity funds (from 2021 to 2019). The latter include the launch of UBK’s own in-house mixed fund this year. We have conservatively not factored in the potential positive impact of these new initiatives yet, but pencilled in the additional costs associated with the new product development and marketing (see the financials section for details).

On the other hand, we do account for the potential increase in UBK’s activity in corporate fixed income securities on the back of solid customer interest. Our net commissions and fee income reflect a few small to mid-sized transactions executed per year (with the NATURSTROM bond issue being the first minor but promising development in this respect). We assume an incremental commission and fee income of c €1.0m in FY19 from the sustainable bond issue.

One of the pillars of UBK’s strategy is further team expansion, in particular with respect to credit experts, IT professionals and securities specialists. The bank’s headcount increased to 172 at end-2018 from 153 at end-2017, with the FTE equivalent at 135.9 and 118.5, respectively.

Germany continues its transition towards low-carbon, sustainable energy generation (the so-called ‘Energiewende’), with 6.6GW of new renewable energy (RE) capacity installed in 2018 (compared to 8.3GW in 2017, see Exhibit 4). We note that the decline in new capacity is largely attributable to wind projects, while new solar additions reached a healthy level in 2018 (as discussed below). As a consequence, total installed capacity increased to 118.3GW from 111.7GW in 2017 (see Exhibit 5) and translated into RE share in total electricity generation in 2018 of 40%. This compares with Germany’s 2030 target of 65% and 2050 target at 80%.

In Germany, wind capacity expansion slowed significantly, with the completion of new onshore projects representing only 2.4GW in 2018 in comparison to 5.3GW in 2017. This is only partially a function of the expansion corridor for onshore wind energy introduced with the Renewable Energy Act (EEG) 2017, as the upper limit of 2.8GW would allow for more capacity to be added. The slowdown in capacity additions continued into 2019, with Q119 seeing new onshore wind capacity at just 134MW – the lowest level since 2000. During the most recent auctions conducted in October 2018 and February 2019, only 54% and 68% of tendered capacity of 670MW and 700MW was allocated, respectively (see Exhibit 6). The lower competition for offered capacity has resulted in an increase in average allocated price to around 6.11–6.26c/kWh in the last three auctions (August 2018, October 2018 and February 2019) compared to c 3.82–5.73c/kWh during earlier tender offers.

The slowdown in wind energy development is due to bottlenecks related to extended regulatory requirements and lengthy project approval timelines (which may now take even more than two years), with local authorities being reluctant to identify new land for wind farms, which results in a deficit of approved regional plans. The German Wind Energy Association (BWE) estimates that 10GW of wind power capacity could be unlocked quickly if licensing requirements were relaxed.

The second hurdle of wind energy development in Germany is associated with the fact that projects that have already received an emission permit are often contested in court by local residents who are against the construction of new wind farms close to their households. According to CleanTechnica, over 750MW of wind farm projects got stuck in legal proceedings as of February 2019. Within the grand coalition’s acceptance/energy transition parliamentary working group, there is an ongoing discussion around increasing the residents’ acceptance through the introduction of minimum distances to residential areas, which would apply to wind turbines. This would however significantly limit the potential wind capacity expansion, with the Federal Environment Agency estimating that a minimum distance of one kilometre would reduce land available for wind farms by 20–50% and limit potential capacity from 80GW to 40–60GW, jeopardising the governmental climate targets. We agree that this would pose a considerable hurdle based on the impact of a similar regulation that was introduced in Poland back in 2016 and has imposed a minimum distance of 10 times the height of the wind turbine (the so-called ‘10H rule’). For illustration purposes, we present the net capacity additions in the Polish wind energy sector in Exhibit 7. Interestingly, the 10H rule has also been introduced in Bavaria in February 2014, effectively reducing the land available for wind farm development close to zero.

Another factor influencing the wind market negatively is the waiver of the preferential terms (ie the lack of requirement to obtain approval under the German Federal Emissions Protection Law), which until recently benefited citizen projects (Bürgerenergiegesellschaften) but has now been suspended until the June 2020 tender. These projects represented the vast majority of accepted bids during the 2017 auctions (95–99% of total allocated capacity) and also represented c 16% of the capacity allocation in the subsequent auctions.

Importantly, the slowdown in wind capacity additions coupled with increased competition globally (including in particular the expansion of Chinese players) has translated into pricing pressures in the wind turbine manufacturing industry. This has led to one of the main players (Senvion) filing for insolvency recently, although we acknowledge that there may have been some company-specific issues as well (eg high leverage). The company’s market share in Europe stood at c 11% in 2017, according to FTI Intelligence. This means that those wind projects in Germany that were supposed to be supplied by Senvion may be delayed until they have identified an alternative wind turbine provider.

On the other hand, we acknowledge the government’s efforts to stimulate further renewable energy capacity growth (in line with its 2030 target of 65% share in total electricity production), as illustrated by the recent grand coalition agreement (leading to the introduction of the so-called Energiesammelgesetz), which has set targets for additional wind and solar capacity of 4GW each over the next three years (on top of new capacity covered under EEG, see Exhibit 8). This will be allocated through special auctions organised throughout 2019–21, with 1GW offered in 2019, 1.4GW in 2020 and 1.6GW in 2021.

Moreover, the agreement covers the introduction of ‘innovation auctions’, which are technology-agnostic (ie where operators of both solar and wind projects will be able to submit bids) with 250MW capacity offered in 2019, 400MW in 2020 and 500MW in 2021. Importantly, in the case of capacity allocated during these auctions, the operator will not receive any compensation when there is excess energy supply on the market and consequently has to consider the capacity of the network when producing energy as well. This is designed as a testing environment for solutions that would encourage more competition in the sector.

While we expect these auctions to facilitate additional solar capacity development in Germany, we are sceptical as to the positive impact of this measure on the wind energy sector, given that existing auctions are already undersubscribed and joint auctions (for both wind and solar projects where 622MW was allocated so far during three auctions since April 2018) remain completely dominated by solar projects. We believe the slow wind projects development is a function of the factors discussed above rather than an insufficient number of auctions or insufficient tendered capacity. Having said that, we believe that given Germany’s ambitious targets with respect to renewable energy generation, there is high pressure on government officials to resolve the current issues and unlock the potential of the wind energy sector.

It is also worth noting that significant progress in Germany’s renewable energy agenda will be dependent on investments in the power grid expansion. In particular, there seems to be a need for ‘power highways’, which would be used to transfer wind energy from northern to southern Germany. In this context, the introduction of a ‘south bonus’ is being considered to incentivise a more even regional distribution of new RE capacity.

While the wind energy business has been struggling recently, new solar capacity reached a solid 2.94GW in 2018, which is up 77% y-o-y compared to 1.66GW completed in 2017. This was ahead of the government’s target with respect to solar capacity expansion at 2.5GW per annum. In 2019, the solar market for larger systems in excess of 750kW continues to be very strong, with the February regular auction heavily oversubscribed (465MW of submitted bids vs 178MW allocated, see Exhibit 9). Moreover, the German Federal Network Agency organised an additional 500MW auction in March, which was oversubscribed as well. Moreover, as already discussed, solar projects have taken over all the capacity during the three joint auctions conducted in April 2018, November 2018 and April 2019 (representing a total allocated capacity of 622MW vs submitted bids at 1,433MW). Despite the above, since the beginning of 2018, average prices during the regular solar auctions were steadily rising from 4.33c/kWh in February 2018 to 4.80c/kWh in February 2019, while being significantly higher during the additional March auction at 6.59c/kWh. Market prospects continue to be encouraging on the back of the recent introduction of additional capacity auctions (as discussed above). Nevertheless, we are aware that shortage of land supply may at some stage become a limiting factor.

Additional support may come from the development of projects outside of EEG within Power Purchase Agreements (PPA), ie long-term purchase agreements that may be used to refinance the construction and operation of a solar plant. This represents an interesting funding option for projects where the 20-year support within EEG is soon to expire, but also for new solar projects. UBK has recently designed a tailored product for new PPA-based projects with a maturity of up to 25 years (independent from the PPA agreement’s time horizon). The funded projects must benefit from a fixed power price set for a period of at least five years in order to be eligible for UBK’s product.

On the other hand, the market for smaller rooftop PV systems with capacity between 40kW and 750kW is likely to experience some negative impact from the recent reduction in the level of feed-in tariff (these systems are not subject to capacity auctions and still benefit from fixed compensation per kWh). This was substantiated by the regulator with the declining cost of purchasing these systems. The tariff has been reduced from 9.87c/kWh as at 1 February 2019 to 9.39c/kWh as at 1 March and 8.90 c/kWh from 1 April.

In the German residential real estate market, high demand combined with supply shortages continues to drive up prices (up 7.4% in 2018 across 126 German cities, according to Deutsche Bank), as well as average rents which were up 5% and 3.5% in 2018 for newly completed and existing homes, respectively (Deutsche Bank). Demographic expansion through immigration and the strong labour market have increased the gap between housing demand and supply, despite the number of completions improving on a yearly basis (from 188,000 in 2013 to 245,000 in 2018). Moreover, the divergence between the number of approved residential projects and the number of completed dwellings is still widening. According to DZ Bank, the key issues include a lack of designated building land, the long-winded planning permission process, speculative investments in building plots and limited spare capacity in the construction sector. As a result, approvals for residential buildings in Germany increased by just 2.0% in 2018. There is no indication that conditions will ease any time soon as building land is becoming more scarce and capacity in the construction sector has been largely exhausted. As a result, social discontent is growing, leading to more frequent and intense protests against housing policies.

This provides additional support for the affordable housing sector in Germany, which is high on UBK’s radar. Moreover, we believe that the above trends highlight the long-term potential of UBK’s green construction lending business – even if the pace of construction across Germany remains somewhat constrained in the short term. This is further driven by regulations aimed at more energy-efficient, sustainable housing such as the Energy Conservation Ordinance introduced from 2016, which requires new buildings to achieve a reduction in primary energy consumption of 25% and an improvement in building insulation of 20% versus certain reference measures defined in the regulation. We acknowledge that Germany is the European leader when it comes to introducing measures to promote energy-efficient buildings, particularly through the German development bank Kreditanstalt für Wiederaufbau (KfW), which is one of UBK’s important funding sources.

UBK’s management board consists of a spokesman and two board members (all of whom are independent):

Jürgen Koppmann (spokesman) joined UBK in July 1996 in the foundation phase as a credit officer. Subsequently, he became head of the project finance department, focusing on renewable energy, heat contracting and ecological farming. Between January 2002 and the end of 2014, he was the board member responsible for credit departments. In 2015 and 2016, he left UBK to found and lead an office for the development of social housing projects. He re-joined the bank in February 2017 to lead the marketing and communication department. He was again appointed as a board member in December 2017, taking ownership of savings and investments, securities and provision, as well as IR and PR. He is also responsible for the market area of the lending business.

Stefan Weber has been with UBK since its incorporation in 1997, initially working on the introduction of an electronic data processing system. In July 1997, he became the head of operations and finance and the IT department. Mr Weber joined the management board in January 2015 with responsibility for construction finance, environmental investments, finance and IT. He also took over the risk control and credit risk functions in May 2015.

Goran Bašić started his career at UBK in the project finance department in 1999, acting as deputy head from 2008, then department head from 2011. He was appointed as a member of the management board in July 2014 and was initially responsible for the back office of the construction, solar and project finance departments. He is now overseeing the administration, HR and project finance functions. Before joining UBK, he spent two years in Sarajevo working for a consulting company headquartered in Frankfurt and setting up a bank specialising in SME lending.

We have identified several sensitivities influencing UBK’s business. These include:

We value UBK using an implied price to tangible book value method based on our estimate of the bank’s sustainable ROE and cost of equity derived from the Capital Asset Pricing Model (CAPM). This is a common valuation method for banks, which allows us to reflect UBK’s specific profitability as well as risk profile. To arrive at the book value of UBK’s tangible equity, we have subtracted the balance sheet value of intangibles from our shareholders’ equity forecast. We calculate the return on tangible equity using net profit after tax, but before allocation of reserves pursuant to Section 340g of the German Commercial Code (reserves for general banking risks). These allocations are subject to income tax and the corresponding reserves form part of UBK’s CET1 capital. Furthermore, the bank only needs to create reserves at a level equal to 10% of income from its trading book generated during the year, which in UBK’s case is normally close to zero. Hence, we believe these allocations should not reduce net profit for valuation purposes. Simultaneously, we have added the balance sheet amount of these reserves to tangible equity.

We forecast UBK’s tangible book value per share at €8.7 at end 2019, compared with €8.2 at end 2018. This represents a c 7% y-o-y increase, which is a function of net profit before allocation to reserves of €25.4m (broadly in line with FY18), an earnings retention rate at 54% of net profit after allocation to reserves and the assumption that c 50% of UBK’s dividend will be paid in shares rather than cash (broadly in line with actual proportions in 2018). We estimate UBK’s sustainable return on tangible equity (after tax but before allocation to reserves) at 12.7%. This return ratio has been adjusted for the proportion of equity capital on UBK’s balance sheet, which is beyond the level needed for UBK to meet its regulatory requirements and secure further business growth (we assumed that CET1 of 9.0% should be sufficient and treated all the remaining equity as excess capital). We have factored in a cost of equity at 8.9% and a long-term growth rate of 2.0%. Based on these assumptions, we have arrived at a fair value per UBK share of €13.0 (see Exhibit 11) compared to our previous valuation of €11.3.

Below we also include UBK’s valuation sensitivity analysis based on cost of equity and sustainable return on tangible equity.

Due to the lack of similar listed sustainable banks that would represent UBK’s close peers, we have combined a set of large and smaller banks from the DACH (Germany, Austria and Switzerland) region. As illustrated in Exhibit 13, UBK is currently trading broadly in line with the market in terms of the ratio of return on equity (ROE FY19e of 10.6%) to its book value multiple (P/BV FY19e of 1.3x). However, we believe the FY19 results are likely to represent a trough in UBK’s return on equity.

UBK’s Total Capital Ratio (TCR) as at end-2018 stood at 14.0%, which provides a certain safety margin versus the regulatory requirement of 12.0% for 2019 based on the Basel III level of 10.5% plus a 1.5% buffer added by the German regulator. This means the bank was able to achieve its earlier target of at least 13.0%. UBK’s capital base was recently strengthened by the issue of a 2.0% unsecured subordinated bond (Green Bond Junior), launched in July 2018. The bank was able to raise €25.1m in proceeds until the end of 2018, with c €13.1m of this amount being the result of the exchange offers to holders of UBK’s profit participation rights (Genussrechte) issued in the period 2003–05 and 2006, which are gradually losing the status of tier 2 capital. The remaining €12m was subscribed to by other retail investors as part of a public offering. The Green Bond Junior issue is scheduled to be concluded in July 2019 and may allow UBK to raise additional tier 2 capital of €15m (we currently assume €5.0m in our forecasts). Importantly, the bank has also raised €20m through the issue of subordinated debt to an institutional investor. Consequently, we estimate that UBK’s current balance sheet has headroom for further loan portfolio growth (ahead of our current projections) in risk-weighted asset terms of c €0.5bn until 2023. This does not account for net profit accumulated or new capital issues. In fact, management reaffirmed its intention to conduct a share issue in the second half of 2019 to further strengthen the tier 1 ratio, which currently stands at 10.7% compared to the 2019 regulatory requirement of 9.6%. UBK hopes the issue will also allow for a reduction of the 1.5% special buffer mentioned above. An additional positive impact of UBK’s capital base comes from scrip dividends, which contributed €3m of new capital in FY18. UBK’s CET1 ratio reached 9.3% vs the regulatory requirement for 2019 of 7.8%.

We expect UBK’s capital ratios to improve further, as our loan book growth expectations (a solid 2018–2023e CAGR of 7.8%) are still below the potential increase implied by current balance sheet headroom. Consequently, we anticipate a broadly stable TCR of 14.0% in FY19e and FY20e, respectively (see Exhibit 14). This does not account for the potential share issue mentioned above. UBK’s tier 1 ratio should reach 10.6% and 10.7% in FY19e and FY20e, respectively. We have excluded the profit participation rights issued in the period 2003–06, which were not exchanged in last year’s offer, from our forecasts starting from end-2020, as these had already been terminated by the bank with the two-year notice period.

UBK was able to grow its customer deposit base in 2018 by a remarkable 8.0%, which is even ahead of the 2013–18 CAGR of 6.3%. It continues to benefit from the sustainable bank image (reinforced by its ‘environmental guarantee’), an effective client hotline, as well as high customer satisfaction. The largest component of UBK’s deposit base represents overnight money (44%), followed by savings accounts (36%), commercial deposits (11%) and temporary deposits (9%). Loans from development banks remained an important funding source for UBK at 77% of total liabilities to banks of c €1.0bn at end-2018 (allowing it to offer loans to customers on preferential terms). We expect continued healthy growth in customer deposits at a mid- to high single-digit growth rate over the coming years (in line with the five-year historical CAGR of 6.3%), which may be further supported by the successful launch of the online customer onboarding process, as well as the introduction of a current account product (planned for 2020).

UBK still uses the Targeted Longer-Term Refinancing Operations II (TLTRO-II) facility (currently standing at €200m), which is a European Central Bank (ECB) measure to boost lending activity in the banking sector and has a negative interest rate of -0.4% (on the condition that the respective bank uses the proceeds to provide funding to the real economy. In March 2019, the ECB announced a new series of quarterly TLTRO, which will start from September 2019 and end in March 2021, with each operation having a two-year maturity. Consequently, we expect that UBK will continue to utilise this facility as a form of cheap funding (we assumed €200m in FY19e). The details of TLTRO-III have not been finalised yet. However, the rate will most likely be indexed to the interest rate on the main refinancing operations, which currently stands at 0.0%. The programme will probably include certain built-in incentives, which may push the effective rate to negative territory (similar to TLTRO-II). Still, these may be less attractive than in the previous programmes given the better shape of the eurozone economy in comparison to prior years (eg the 2011–12 debt crisis). As a result, we have assumed an effective TLTRO-III rate for UBK of -0.2%.

UBK’s customer loan book (excluding commitments) increased by a solid 5.2% y-o-y in FY18 to €2.4bn, with new lending volume at €542m (up 26.3% y-o-y). We appreciate that this was driven equally by renewable energy projects (€280m) and sustainable construction (€262m). Importantly, UBK’s irrevocable lending commitments have increased considerably by 45% y-o-y to €363m in FY18, providing additional income from commitment fees. The strong trend continued into Q119, with €123.4m of new loans advanced, up c 16.4% from €106.0m in Q118. We believe this is an illustration of UBK’s unlocked potential following the strengthening of the capital base in H218 (as discussed above), which now allows the bank to expand its lending business at a faster pace.

In terms of solar projects, UBK advanced c €150m new loans to fund 191MW in FY18 and reached a market share of 11% in added capacity over 250kW (according to the company). This compares with c €93m and 112.8MW in FY17, respectively. It is important to note that volumes were particularly driven by smaller systems up to 750kW, which was assisted by the creation of a specialist team and the further development of a standardised lending process at UBK. As discussed earlier, the feed-in tariff for smaller rooftop PV systems between 40kW and 750kW was recently reduced, which may negatively affect UBK’s lending volumes going forward. However, the bank is addressing this through increasing its focus on ground-mounted PV plants, with further standardisation of the lending process implemented for this product group. We believe these measures, in conjunction with the overall strong development of solar projects and the additional capacity expansion targets set in the ‘Energiesammelgesetz’, should translate into solid solar lending volumes for UBK of c €190m and €210m in FY19e and FY20e, respectively. For FY21e and FY22e, we expect new lending volumes to reach around €240–250m pa. Consequently, we anticipate the bank’s loan book in this segment to grow by a 2018–23 CAGR of c 5.9% (vs our earlier assumptions of c 2% CAGR in 2017–22).

UBK’s new lending volume in the wind segment reached a solid €98m and represents 55.3MW of new capacity (on top of co-funding 38.3MW of existing capacity). This translated into a market share of 2.3% (compared to 1.1% in FY17). We believe this was achieved on the back of projects that participated in the earlier auctions and were able to progress before the onset of the recent permit delays and resistance from local residents. Despite the issues facing the wind energy sector (discussed earlier), we expect 2019 to be a relatively good year for UBK’s lending business in this market segment. This is because of the high number of projects (particularly citizen projects), which received their capacity allocations in the 2017/18 auctions and will now seek funding. These projects must be completed within 54 months of the capacity allocation. Moreover, we understand that UBK focuses on smaller projects which are more likely to receive the necessary approvals more quickly As a result, the bank plans to further expand its market share in the wind market. We assume new lending volumes in UBK’s wind segment of c €86m in FY19 (implying a c 12.5% decline vs FY18). Subsequently, we anticipate that the government will find a solution to resolve the current challenges which, together with the additional capacity expansion targets, should translate into a rebound in new wind capacity in 2020 and 2021. Consequently, we have assumed UBK’s new lending volume in the wind segment at c €92m (up c 7.5% y-o-y) and €107m (+15% y-o-y) in FY20e and FY21e, respectively.

In the green construction segment, UBK’s new lending volumes reached more than €262m in FY18, which represents an impressive increase of 21% y-o-y. This was particularly driven by high-volume sustainable projects which were constructed and rented at cost. The bank thus continues to emphasise building societies and associations, as well as ecological social/affordable housing. This is accompanied by a favourable sentiment towards these projects given the structural housing deficit in Germany. We see further growth in UBK’s lending activity, with our new loan volume assumptions for FY19e and FY20e at 15.0% and 5.0%, respectively. This may seem somewhat conservative, but we are wary of the fact that there are certain bottlenecks in the German construction industry and that we are most likely in a late-cycle environment (which suggests that the risk of a slowdown despite structural drivers remains high).

Importantly, UBK’s loan book expansion is still accompanied by the high credit quality of the portfolio. The ratio of provisions for credit losses to customer loan book stood at a low level of 0.34% in FY18 (and close to the five-year average of 0.31%). Simultaneously, we estimate that UBK’s current non-performing loan (NPL) coverage ratio stands at a solid c 130%.

In the period 2016–18, UBK experienced considerable pressure on its net interest margin resulting from a prolonged period of ultra-low ECB interest rates. This had a somewhat delayed impact on UBK’s interest income from its lending business, as the interest rate on its loans (both in the renewable energy and green construction areas) is usually fixed for a period of 10 years (and subsequently adjusted for market rate movements). As the ECB interest rate cuts were executed over 2008–12, the majority should be factored into UBK’s interest income on its loan portfolio by 2020/21.

Furthermore, the prospective ECB rate hikes should assist UBK’s income on floating rate assets and new sustainable loans. Current ECB forward guidance implies stable interest rates until at least the end of 2019. However, we understand that the reduced maturity of the new TLTRO programme (two-year instead of four-year), coupled with the floating rate interest set-up, may be an indication that the ECB would like to be prepared for interest rate hikes in 2020 or 2021. We include ECB projections for the three-month Euribor released in March 2019, which imply rates of -0.3%, -0.2% and 0.0% in 2019, 2020 and 2021, respectively.

As a result of the above, we believe that UBK’s net interest margin should post only a minor decline in FY19 (down 4bp to 1.45%) and start to gradually recover in subsequent years, with our expectations of a 3bp and 4bp increase in FY20e and FY21e, respectively (see Exhibit 17). This should also be assisted by the launch of the sustainable consumer loan, which is scheduled for FY19. We pencil in a 1bp and 2bp positive impact on UBK’s net interest margin in FY20e and FY21e, respectively. We note that UBK intends to be more active in the corporate fixed income securities space starting from 2019 as a result of increased customer interest. We have factored in a few small to mid-sized transactions per year in our forecasts.

UBK’s cost income ratio (CIR) increased to 32.7% in FY18 from 29.4% in FY17, driven by an increase in personnel expenses (up 14.1% y-o-y to €9.2m) amid headcount expansion from 118.5 to 135.9 in FTE terms, as well as higher banking tax and deposit insurance in conjunction with the growth in customer deposits. We factor in a CIR increase to 35.9% in FY19e due to further headcount growth, as well as marketing and IT-related expenses associated with the introduction of new products and services. As loan book expansion continues and costs related to new product launch moderate, we anticipate a CIR decline to 34.3% and 33.4% in FY20e and FY21e, respectively (see Exhibit 18).

Our forecast revisions are summarised in the table below.