OTP Group: first half 2022 result

Consolidated earnings: close to HUF 251 billion 1H adjusted profit after tax (2Q: HUF 162 billion), q-o-q improving NIM, significant decrease in risk costs, stable portfolio quality, ytd 8% increase in performing loan volumes (FX adjusted, without the Russian and Ukrainian volumes).

Considering OTP’s exposures to Russia and Ukraine at the end of 2Q 2022, it is important to note that while volumes didn’t change in RUB/UAH terms or even declined, due to the depreciation of HUF their weight within the Group increased q-o-q. Accordingly:

• the combined weight of Ukrainian and Russian assets out of total consolidated assets comprised 8%;
• the combined weight of net loans in Ukraine and Russia comprised 7.8%;
• the volume of gross intragroup funding towards Ukraine comprised HUF 83 billion and HUF 85 billion towards Russia;
• under an unexpected and extremely negative scenario of deconsolidating the Ukrainian entity and writing down the outstanding gross intragroup funding as well, the effect for the consolidated CET1 ratio would be -1 bp, whereas in the case of Russia the impact would be -128 bps (as for the latter the significant change is explained mainly by the material q-o-q appreciation of RUB against HUF).

In both cases OTP management applies a „going concern” approach, however in Russia the management is considering all potential options that do not meaningfully reduce shareholder value, and can have a positive effect on shareholders’ perception including the potential sale of the Russian operation at an acceptable price.

In 1H 2022 the total volume of adjustment items amounted to -HUF 208 billion of which -HUF 86 billion occurred in 2Q. Within the latter the major items were as follows:

• -HUF 68 billion (after tax) windfall tax announced by the Government on 4 June and payable temporarily in 2022 and 2023. The due amount for 2022 was booked in 2Q in one sum;
• -HUF 10 billion (after tax) as a result of the extension until 31 December 2022 of the cap on
• the Hungarian variable rate mortgages (the 3 months BUBOR rate was frozen at 2.02% effective on 27 October 2021, whereas its current level is around 12%). The rate cap was originally effective for the first six months of 2022 and its negative impact was booked in 4Q 2021 within OTP Core’s risk costs;
• -HUF 3.4 billion effect of acquisitions (after tax). Most of this amount was related to the acquisition and integration processes in Slovenia, Serbia, Bulgaria and Croatia;
• -HUF 2.5 billion (after tax) related to the liquidation of Sberbank Hungary. This item consists of two legs: firstly, in 2Q the Hungarian Group members were obliged to pay HUF 28.5 billion extraordinary contribution to the National Deposit Insurance offset by the expected recovery from the already completed sale of Sberbank’s assets. Based on the available information the Bank expects 100% recovery on its extraordinary contribution into the NDIF. However, due to the uncertainty about the timing of the realization of this recovery, this claim was boked at its expected net present value, thus a 9.57% discount was applied;
• -HUF 1.8 billion related to the extension of the Hungarian payment moratorium until 31 December 2022 (after tax).

The first half consolidated adjusted profit after tax comprised HUF 250.8 billion, +2% y-o-y. Thus the adjusted 1H ROE stood at 17.0% (without the semi-annual results of the Russian and Ukrainian subsidiaries the 1H adjusted ROE would be 23.2%).

Apart from some major negative one-offs (windfall tax in Hungary, goodwill impairment in Russia) the 1H profit after tax was shaped mainly by risk cost developments and increasing core banking revenue supported by the still dynamic business activity. OTP Group posted HUF 42.7 billion profit after tax in 1H (2Q: HUF 76 billion).

Against the significant losses suffered by the Ukrainian and Russian operations in 1Q (-HUF 34 billion and -HUF 24 billion, respectively), in 2Q bottom line earnings turned into positive at both entities. The q-o-q improvement in both case can be explained by substantially lower risk costs; besides, in Russia the deferred tax assets written off in 1Q were written back in 2Q, as a result of this reversal the consolidated effective tax rate declined significantly (1Q 2022: 24.9%, 2Q: 7.6%, 1H 2022: 14.6%).

At OTP Core, in the first six months altogether HUF 18.7 billion positive risk cost emerged. Within that, the positive amount of provision for impairment on loan losses was HUF 29.9 billion, including HUF 17.1 billion in the first quarter. One of the main reasons was the revision of the highly conservative assumptions previously used in the impairment models: as the uncertainty about the pandemic and the moratorium abated, provisions were released.

At OTP Core, the half-year operating profit surged by 44%, as total income grew much faster than operating expenses. The improvement in net interest income could be attributed to increasing business activity: the deposit inflows provided a stable financing source for both the sustained lending growth and the continued expansion of liquid assets. Despite the rising interest rate environment4, the semi-annual net interest margin stagnated at 2.8%, partly because most retail loans have fixed interest rate for at least five years, thus the interest on these loans does not change during the fixed interest rate period, even if reference interest rates rise. Moreover, securities’ average interest rate level rose only modestly in the second quarter, because long-term Hungarian government bonds, which make up a large part of the securities portfolio, have fixed interest rates until maturity, and this portfolio is repricing slowly, along with the maturing amounts that can be reinvested at higher yield levels.

At OTP Core, net fees and commissions surged by 21% in the first six months, mainly supported by stronger revenues from deposit, transaction, and card-related fees, while income from securities’ sales declined.

Other net non-interest income dropped by 11% q-o-q mainly due to the weaker OTP Core.

1H operating expenses grew by 15% y-o-y in HUF terms and by 11% on an FX-adjusted basis. As a result, the consolidated cost-to-income ratio declined to 47.3% (48% without the Russian and Ukrainian operations). Within the three major expense items personal costs grew by 8% q-o-q, amortization by 15% and administrative expenses by 10%, respectively.

In 1H 2022 the total volume of credit risk costs reached -HUF 74 billion (2Q: -HUF 16 billion), whereas without the Russian and Ukrainian operations the semi-annual figure would be +HUF 27 billion. As a result the 1H credit risk cost rate stood at 0.86% (2Q: 0.36%). In 2Q other risk costs grew by HUF 1 billion q-o-q mainly due impairments made for government securities at OTP Core.

The FX-adjusted consolidated performing (Stage 1+2) loan volumes increased by 3% q-o-q,

following a 2% increase in 1Q. As a result, the organic loan volume growth was close to 6% (HUF 994 billion) in the first six months. Without the Ukrainian and Russian volumes, the consolidated loan portfolio advanced by 8% ytd. The loan volumes grew by 15% y-o-y.

Due to the Russian-Ukrainian conflict the loan portfolio kept further eroding in those two countries: ytd there was a 18% and 6% decline (-11% and 10% q-o-q), respectively. The fastest q-o-q performing loan growth was posted at OTP Core (+6% q-o-q), but the Romanian, Slovenian, Serbian, Bulgarian and Croatian portfolio advanced in a meaningful way, too.

As for the major segments, the performing mortgage and consumer volumes increased by 3% and 1% q-oq, whereas large corporate volumes expanded by 4%. SME loans demonstrated the fastest quarterly expansion at 7% q-o-q. While the performing consumer loan volumes declined in 1Q at OTP Core, 2Q already witnessed a bounce-back with the book increasing by 5% q-o-q; the SME and corporate portfolio grew even faster (+9% q-o-q each).

The FX-adjusted deposits grew by 2% q-o-q, as a result for the first six months volumes expanded by 5% (+HUF 1,201 billion). Both in Ukraine and Russia deposit volumes grew by 3% q-o-q, as a result the deposit book in those two countries increased by 5% and 15% ytd, respectively. The consolidated net loan-to-deposit ratio grew by 1 pp q-o-q, to 76%.

Total liquidity reserves of OTP Bank remained steadily and substantially above the safety level. As of 30 June 2022 the gross liquidity buffer was around EUR 5.55 billion equivalent. The level of these buffers is significantly higher than the maturing debt within one year and the reserves required to manage possible liquidity shocks.

The Stage 3 ratio under IFRS 9 was 5.3% at the end of 1Q, underpinning a marginal q-o-q increase. Apart from Russia and Ukraine in all other Group members there was a q-o-q decrease in the Stage 3 ratio. The consolidated Stage 2 ratio stood at 11.7% at the end of 2Q. The own coverage of Stage 3 exposures was 65.4%. At the end of 2Q 2022 it was only Hungary with significant volumes participating in the payment moratorium, but even there the participation rate was minimal: at OTP Core 3.7% of gross loan volumes were under the moratorium, whereas at Merkantil Group the rate was 1.4%.