EBKOF - Erste Group: Expect An 8% Dividend With A 40-50% Payout Ratio

2023-10-19 10:30:00 ET

Summary

• Erste Group's earnings remain robust, with pre-tax profit increasing to 2.44B EUR and net income of 1.49B EUR.
• The bank's coverage ratios for loans in Stage 2 and 3 have increased, indicating a good grip on potential risks.
• Erste Group's CET1 ratio is at a historic high of 14.9%, exceeding regulatory requirements and providing excess capital for share repurchases and dividends.

Introduction

In an article about Erste Group ( EBKDY ) ( EBKOF ) that was published in January 2022 , I highlighted the bank as an interesting option to gain exposure to Eastern Europe. Indeed, the Austrian bank has exposure to several Eastern European and Central European countries.

Erste's primary listing is on the Vienna Stock Exchange where it's trading with EBS as its ticker symbol. Considering the average daily volume in Austria is approximately half a million shares per day, making it the most liquid listing to trade in the company's shares (and options).

As Erste trades in Euros and reports its financial results in EUR, I will obviously use the Euro as the base currency throughout this article.

The bank’s earnings remain robust

As I'm mainly interested in the bank’s capital position, I will be brief on the bank’s operating performance.

Thanks to the increasing interest rates on the financial markets, the net interest income increased by approximately a quarter while the net fee and commission income increased by approximately 5%. A very strong result and although the overhead expenses increased by more than 10% (the personnel expenses increased by a double digit percentage while the other administrative expenses increased by approximately 3%), the bank’s pre-tax profit increased to 2.44B EUR.

After deducting the taxes and the net income attributable to non-controlling interests, the net income was 1.49B EUR of which 50M EUR was attributable to the owners of AT1 capital. The net income attributable to the common shareholders was 1.44B EUR resulting in a diluted EPS of 3.36 EUR per share.

I was concerned about the loan in Stage 2 and Stage 3. How has this evolved?

When my previous article was published, I was a bit worried about the relatively high percentage of the loan book that was classified as Stage 2 (where the repayment potential is more doubtful). While that's not necessarily a big issue – you can expect the loans in for instance Romania to carry a higher average risk, it was something I'm keeping an eye on.

As of the end of June, the total coverage ratio of the loans in Stage 2 and 3 increased. As you can see below, the total percentage of loans remained stable, but the coverage ratios came in at 51.9% for the Stage 3 assets and about 47% for the Stage 2 assets. The latter is a 130 bp increase compared to the end of the first quarter.

The coverage ratio is quite decent, especially knowing the non-performing loan percentage decreased to a historic low and the bank confirmed there were "no significant increases in hard defaults." So while the bank’s exposure to Stage 2 loans remains pretty high, it has a good grip on the potential risks there and as you can see below, the NPL coverage ratio exceeds 100% in most of its markets.

Additionally, Erste’s CET1 capital ratio also has reached the highest level ever. As you can see below, the CET1 ratio stood at 14.9% at the end of June and this clearly confirms the bank’s strong focus on strengthening its balance sheet as there has been a continuous improvement since the Global Financial Crisis.

And although the total amount of risk-weighted assets continues to increase as well (up by almost 7% on a YoY basis), the total amount of CET1 capital increased at an even faster pace: while – in absolute amounts – the RWA increased by 9.5B EUR, the total amount of CET1 capital increased by 2.4B EUR and that boosted the CET1 ratio.

The minimum required capital ratio currently stands at 11% or 12% (depending on if you exclude or include the Pillar 2 Guidance), and with a capital ratio of 14.9% the bank is comfortably exceeding those minimum requirements. Additionally, Erste uses an internal target of 13.5% which means that based on the 147.7B EUR in RWA, there's about 2.1B EUR in CET1 capital exceeding the internal target. On top of having a more strict target than the regulatory requirements, Erste only considers the capital exceeding the 14% CET1 ratio to be "excess capital." Based on the H1 results, there is about 1.3B EUR in "excess" capital beyond the 14% CET1 ratio. This means there’s plenty of firepower to complete the planned 300M EUR share buyback which would allow the bank to repurchase 8-9 million shares or 2% of the total share count. Additionally, I don’t see any issues with the plans to pay a dividend of 2.7 EUR per share as the payout ratio of 40-50% will be respected. The standard dividend withholding tax in Austria is 27.5% .

The strong capital ratio and earnings profile were the reason why Fitch confirmed Erste Group’s capital ratio at A with a stable outlook. Fitch does expect a "moderate upward trend" in the bank’s impaired loans ratio but the improved earnings profile on the back of higher interest rates should help to compensate that risk for a large percentage.

Investment thesis

Erste Group offers an interesting exposure to some Eastern European countries but that very same exposure is likely also what’s holding the stock back. Erste is trading at just 5.5-6 times this year's earnings and although the dividend payout ratio is just 40-50%, the dividend yield will exceed 8% based on the current share price.

I currently have no position in Erste Group as I wasn’t quite comfortable with the relatively high amount of loans in Stage 2 but in the past two years, Erste has shown it's committed to its balance sheet strength and with a CET1 ratio of almost 15% (and likely exceeding 15% by the end of this year), I'm getting increasingly comfortable and may initiate a small initial long position in the near future, while realizing the earnings may be under pressure next year due to higher loan loss provisions.

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