KBC Group (OTCPK:KBCSF) Q3 2016 Earnings Conference Call November 17, 2016 4:30 AM ET
Wim Allegaert - IR
Johan Thijs - CEO
Luc Popelier - CFO
Jean-Pierre Lambert - KBW
Tarik El Mejjad - Bank of America
Farquhar Murray - Autonomous
Robin van den Broek - Mediobanca
Nick Davey - Redburn
Bruce Hamilton - Morgan Stanley
Stefan Nedialkov - Citigroup
Benoit Petrarque - Kepler
Pawel Dziedzic - Goldman Sachs
Anton Kryachok - UBS
Albert Ploegh - ING
Ron Heijdenrijk - ABN
Thank you for standing by; and welcome to the KBC results Q3 2016 conference call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Mr. Wim Allegaert. Please go ahead.
Good morning to all of you. Today is Thursday, November 17, 2016, and you are on the KBC conference call for 2016 third-quarter results. We're here in Brussels, in the headquarters of KBC, and we are in the company of Johan Thijs, the Group CEO, as well as Luc Popelier, the Group CFO. They will both comment on our results, and answer questions you might have on KBC.
We will need roughly 30 minutes to guide you through the presentation for the analysts, which was posted this morning on our corporate website, kbc.com; you can find it there. After this, there is, of course, question time until around 10:30 AM. This conference call is taped, and can be replayed for a limited time; until December 2 of this year, actually.
Finally, I'd like to add that Investor Relations and Luc Popelier are organizing a sell-side analysts' meeting in London tomorrow morning, at our offices in the City, Old Broad Street 111. This meeting as usual starts at 08:30 local time; and we would be very pleased to have you over, and we are looking forward to that conversation. We'll make sure there's freshly brewed coffees, and some pastries as well.
Now, it's my pleasure to hand over the floor to Johan Thijs
Thank you very much, Wim. Also from my side, welcome to the announcement of the third-quarter result of KBC Group. I will talk you through the slides, and we will use the usual format. Let's start at page 3, with the key takeaways. Let me summarize a whole page in one single sentence: the KBC Bank insurance machine has been turning on all of its cylinders.
What is far more important, that is that all of those cylinders have been contributing to the result of €629 million in this quarter. If you would summarize it a bit, little bit more in familiar language, and I would say the net interest income has been performing quite well, given the very difficult circumstances. It is flattish now for a series of quarters in a row.
The insurance business, and mainly the non-life insurance, has been performing extremely well, with a growth of 7%, the combined ratio, which is excellent. The fee business has been picking up on the basis of the comparison with the previous quarter. Then, obviously, also quality-wise, the performance of the Bank was very well that expressed in terms of the cost-income ratio, and also, mainly also through the credit-cost ratio, which stands at a very low level, 7 basis points, which is, amongst others, boosted by the release of provisions in Ireland.
As a consequence of the latter, we do also review our guidance for Ireland, where we now state that for the full-year provisioning we expect a total release somewhere in the range of between €10 million and €50 million. As a matter of speaking, if you sum up all those results, and you express it as a return on our equity, we are now performing on the basis of an 18% return on equity after nine months, which I think is a given the circumstance, an extremely good result, and once again proves the quality of KBC Group as a banc assurance Group.
In terms of our capital position as such, again there we have seen in the quarter an improvement of 40 basis points at the fully loaded capital ratio. We are now at 15.3% that compares to the 11.25% SREP 2016 number. Mind you, this is the old number. The new number of 2017 will be disclosed somewhere in the course of December, as soon as we have it. The liquidity ratios also for this Group, for KBC Group this quarter were further strengthened. They both now stand at 123% and 137% respectively, the NFSR and the LCR.
On the back of that profitability, on the back of that very strong capital position, we are, as you know, very confident about the interim dividend, which is further confirmed at €1 per share, and will be paid on November 18; will be paid tomorrow.
Let me now talk you through further details. Traditionally, we also start it, we always start it with the split-up between the Bank and the insurance Company as always more or less on, around the same numbers, it's an 85%/15% split. This time it's a little bit different. It has, depends how you calculate it. There are some one-off taxes and one-off take, non-technical charges on the insurance side.
If you would exclude that it would be more 80/20. If you take the numbers as they have, are on page 6, it's 89/11. So, let's say on average it's 85/15, perfectly in line for what we see in the previous quarter. So, let's not spend too much of time on this Slide, but let's immediately go to Slide 7, talking about the net interest income.
Net interest income has remained flattish, which is translated into minus 6% plus compared to previous quarter, but in a plus 2% [ph] compared to last year's same quarter number. This is, given the circumstances an excellent result and this is also driven by some elements which have been already flagged in previous quarters. It's clear that on the negative side we do see the lower reinvestment yields; we do see the hedging losses kicking in. We can also state that the re-financings in the third quarter for the mortgages in Belgium has dropped. It's still €800 million, but it has dropped, and so, therefore, it has also a little bit of a negative impact on the prepayment fees, which are booked in the quarter. But the hedging losses are now kicking in also for the previously re-financed mortgages at 2014, 2015 and, of course, in 2016.
Next to that, we do also see some pressure on the commercial loan margins, but there I can include also some good news. What we do see is, and it's a bit of a mixed bag, is all in all that the loans on the commercial and on the mortgage business, depending on the country, is, actually, increasing.
The detail is provided in the pack, amongst others, for Belgium, but that is going up. The difference between commercial production and the back book, obviously, in some product lines is a little bit different and, therefore, is a little bit of pressure on the commercial loan margin.
Now, the positive elements contributing to net interest income remained the lower funding cost where we are seeing a decline, which is a positive one, on the term deposit, about €0.5 billion. Also, the usage of TLTRO funding is bringing here some added value.
We do see further increase in volumes, now year numbers stand at 4% on the mortgages. On the total loan business, we see a little bit of a slowdown in the growth at third quarter in Belgium, 0.4%. The question is, is this a sustainable one or is this a slightly quarterly defined decline? But still growth is positive, 4%, on the deposit side. We are currently having on a year basis 3% growth. The negative number for the quarter I just explained, amongst others, by the term deposits.
Further, we do see a positive effect there, because of an enhanced asset and liability management; and we do see a performance increase on the NII in the dealing rooms. In terms of margins, as a consequence of what I just said it's clear that there will be a little bit of a pressure there and that is translated in a 4 basis points decline for the quarter. It is totally clear that some of those elements are still out there for the upcoming quarters. Where I then make abstraction of, let's call it, Mr. Trump effect, which we have seen in the recent days, the question is how sustainable is that? But obviously if not, then we are talking about all the other elements I just mentioned also going forward.
In terms of fee and commission income, on page 8, we see for the third quarter in a row an increase of our fee and commission income, and that is driven by higher management fees. This is also due to the fact that we have seen on part of our assets under management, the CPPI book, a reset date. We had a reset date for €3.7 billion of the assets, of which 1.8 billion were fully cashed out. If you know the ins and outs of the CPPI product, you know that that has a positive effect on the asset management fees on those products.
Next to that, we also saw a better performance of our banking services, mainly in the payment area. And last, but not least, we also saw a bit better performance on the entry fees for the mutual fund business. In terms of the elements, which are influencing more on the negative side the fee and commission business, because of the lower amount of mortgage re-financings in Belgium you obviously, had a bit of a decline there. Also what we saw in the third quarter, but this is mainly driven seasonal, that is that the security related fees are down in Belgium.
A negative effect on the fee and commission income is the fact that the insurance business is performing very well. I'll come back to that number in a second. We have a 7% growth which is obviously translated also in an increase in the commissions to be paid out. That is 3 million more than last quarter. So, the success of that business is bringing down the fee and commission business a bit more. If you would make an abstraction out of that, then our number would not have been 368 but 371.
In terms of assets under management, we are now seeing an increase of 1% on the quarter, 4% on the year, which is driven by a net outflow, which is actually, if you look at the underlying elements and you would exclude double counting, then it would be a slight increase, so a net inflow. But mainly the price effect kicks in with 2% and, therefore, creates the positive effect in the assets under management.
In terms then of the insurance business, I'm on page 9. I already mentioned the strong performance of the non-life business. 7% growth year on year is very well. We do see this number coming back in all the countries. Taking into account, obviously, the size of the portfolio, the numbers look normally a little bit different. Belgium, 4% on the year, 2% on the quarter; Czech Republic, 8% on the year; and then for the whole international markets business unit we do see a whopping 17% growth which is, to say the least, a very nice number.
Now, in terms of growth, everything is very good. In terms of quality, I can confirm again that the quality of the book is excellent. We have a combined ratio standing now for the full year at 94%, which is higher than the 89% of 2015. But there, probably, you remember we said that the 89% was unsustainably low.
Now, the 94%, just for the sake of memory and the sake of completeness, was influenced heavily by the terror attacks in Brussels, the first quarter; and by some windstorms and flooding in the second quarter and, also, probably in the third quarter in Czech Republic. In that respect, 94% is an excellent result. All things being equal, not much of windstorms is something which will be maintained over the fourth quarter as well.
In terms of the split up on the life side, I'm on page 10, between unit-linked and interest guaranteed products, there's a bit of a mixed picture. I would say this is a strong performance, but at first glance it doesn't look like that. Why is that? Life sales is, per definition, seasonal and the third quarter is traditionally a weaker quarter. That means that if you compared it with the second quarter, you see a clear drop in the production, about 20%.
But if you compared it with last year, the same seasonal effect is then clearly carved out. You see an increase of 17% split up and interest guaranteed, 28%, and a more or less stable unit-linked performance of plus 2%. So, in that respect the life business is performing very well and is, combined with the non-life insurance business, a perfect diversification from interest-bearing income in the Group and, therefore, a very important contributor.
By the way, unit-linked sales now contribute for 39% of the total insurance sales. On slide 11, we do have the split up on the more financial elements and more fair value-oriented part of our P&L. In terms of the fair value gains, we do see a quite serious decline, €85 million lower than previous quarter; a plus €23 million uptick from previous year. Let me first explain the €85 million difference between the third quarter and the second quarter of 2016.
This is mainly driven by a negative change in the models, which we use for the market credit and fair value adjustments. This is totaling about €60 million, to be correct, €59 million, out of that €85 million and almost fully explains the difference. Now, the other big driver of that is the change in the ALM derivatives. It was minus 4 in the quarter compared with a plus 13 in the second quarter.
This is due to the further decrease of the interest rate swaps. Therefore, the sum of those two elements is €18 million. Combine it with the €59 million I just mentioned, you have the full explanation of the difference between the second and the third quarter. So, it's kind of model change, which is clearly influencing the biggest chunk of this difference. This completely wipes out the further improvement of our dealing room performance, about €4 million up, which is a great result. That is also fully explaining the difference the third quarter last year and the third quarter this year. This is mainly driven by the performance of the dealing room.
In terms of the gains which we realized on available for sale assets, the huge difference between third quarter and second quarter of 2016 is 100% explained by the one-off, which was included in the second quarter result, after the restructuring of the Visa Group. We realized at that time a one-off gain of €84 million after tax, and that clearly makes a huge difference on that number. If you look at the 2016 number, €26 million is driven almost 50/50 by gains realized on shares and on bonds. A bit more on bonds, €14 million; the remainder is the shares. It's not a huge difference between the second quarter, sorry, third quarter last year/this year. Also, there it's mainly driven by realization on shares.
In terms of the other net income, not that important, it is more or less run rate. The elements which drive the difference are mainly one-offs. We have a one off because of the sale of our Union, our joint venture with Union Bank in Ireland; also, for the sale of a building. Both combined to make the difference of €9 million, almost completely explaining the difference between the two elements.
I would keep it there and immediately switch to the costs, which are on the next page. On the costs side, if you just look at the total number, then it comes down compared to the previous quarter, which I think, given circumstances, as you know in Belgium the wages are indexed, is a quite good result. That is also influenced by the taxes. If you would then, obviously, exclude the tax element, you see costs slightly going up, €80 million on the quarter, a bit more on the year.
How come? This is mainly driven by, despite the fact that the costs have been decreasing, because of FTE cuts in Belgium and in Czech Republic. In Belgium, the total costs dropped also nominally. In Czech Republic, they stayed more or less the same. We had a slight increase of the costs in the countries Slovakia, Hungary and Ireland. That is driven by some elements, which are one off, amongst others, professional fees. Also in Ireland, where we fined for €1.4 million, €1.5 million for infringements on third party-related staff; that is included as well. And also, for some consultancy fees which were included in Ireland because of a review imposed upon us, imposed upon the sector, actually, by the Central Bank of Ireland regarding the mortgage tracker business or the tracker mortgage business, I'm sorry.
The other elements which are clearly kicking in here is the fact that there are some timing differences between the cost bookings in the second and the third quarter. In terms of banking tax, sorry I forgot to mention one thing. The cost income ratio, if you exclude the banking tax and the ALM adjustments, those are the main drivers, then now stands at 57%, which is perfectly in line with previous quarter and, also, perfectly in line in that respect with the last quarter and is an expression of cost maintaining in KBC Group.
Now, the banking taxes, as you know, have been further increased in the second quarter, mainly in Belgium. If you now sum up all those banking taxes and you express them in terms of our OpEx, then you come to the conclusion that €410 million make 11.1% of the full OpEx at KBC Group, which is extremely high. If you would split up that number, taking into account the different business units, then it is about 11% in Belgium which is indeed very, very high. And it is in international markets business unit, where it's mainly driven by Hungary, 18.6% of total OpEx. If you would exclude that, if we would not have, imagine a world where we don't have to pay bank levies, it would be great, but probably realistic. But anyway, if you would exclude those, cost-income ratio would drop to 50%, which is a completely different number.
Anyway, let's come back to reality and let's see how the asset impairments have evolved. In the third quarter, we have only €18 million of impairments on our loans, totaling if you take into account the shares and some other stuff on IT, totaling €28 million which is substantially down compared to previous quarter and is also substantially down compared to previous year.
That low number is mainly driven -- and let's only focus on the impairments on loans, that low number is mainly driven by -- let's summarize it. The good quality of the loan book in all countries: Belgium, Czech Republic, Slovakia and so forth, but also the improving quality of the Irish book. I know that we have been always very careful and very conservative with regards to the Irish book. But what we do see is for several quarters now in a row that we do have releases on the quarter. This time the releases in Ireland, €28 million in total, are linked to the improvement of the book and not linked, or only slightly linked, about €2 million, only slightly linked to the improvement of the housing prices. In the Irish market housing prices which you know, are part of the model used to calculate provisions.
So, it's therefore underpinning the quality of the book in Ireland is substantially improving and that is the reason why we also changed the guidance for Ireland that we do now say that we will expect, at least for the full year, somewhere in between €10 million and €50 million on the provision book.
In terms of the total amount of loans in Belgium, and the Group we booked some one-offs on the larger corporate files. That including brought the total number at €80 million, which is translated into a credit cost of 7 basis points. We all know that going forward, this is unsustainably low. I know we said it last quarter as well, but believe me 7 basis points is very low, too low.
In terms of the improvement of the quality of the book, 7.6% is now the ratio for the impaired loans. This is mainly driven by Ireland, but the evolution over time clearly shows that book is improving, not only in Ireland but also in other countries.
The business units are explained as of page 15. As I traditionally do, I'm not going to dwell upon every detail, page by page. But allow me to summarize it very briefly. Belgium business unit, what you see is an important improvement of the profitability, €43 million extra on the quarter; €56 million on the year, which is an excellent result. This is driven by two things. Mainly, net interest income being flattish, despite the fact that net interest margin came down. This is due to the fact that production has gone up, but commercial margin on the new production also increased. That goes for mortgages and for commercial loans, which is good news. We have been on the margin facing, obviously, the low interest rate environment, which is clearly the case for all of us, and we have been seeing the hedging losses kicking in.
As, a big refinancing was ongoing in 2014 and 2015 and that is clearly kicking in in the NIM of this year. Fee and commission business went up in Belgium. Non-life business performed very well; I already mentioned that. Life business went slightly down, but seasonal, as you know. Credit cost ratio now stands at 9 basis points, very well, even if there were some corporate files there but 9 basis points, extremely low. Costs are well maintained. They brought down the FTEs, they brought down their normal costs. Therefore, it now stands at 56%.
In the Czech Republic, profit was down, mainly driven also by someone off elements. The interest margin was up slightly, with €3 million. They keep their interest margin at the same level, 291 basis points, which is mainly driven by putting up the margins on the commercial production of commercial loans; and also, dropping the margin or increasing the margin but dropping the interest rates on saving accounts. So, volumes are up 3% and 9%, which is quite significant on the retail and on the corporate SME loans. Fee and commission business is not too important in Czech Republic, but slightly down. Life and non-life business was performing very well, also quality wise. And, the credit cost ratio now stands at 7 basis points, which is excellent.
In terms of business unit, international markets and let me stop here for the second a bit longer. International markets business unit has been performing very well. Now, for several quarters in a row, the profitability for the whole entity stands at €106 million for the quarter, €289 million for the year, which is substantially better than last year, and we do see all countries contributing. This is reflected in a lot of elements. The net interest income is clearly going up in the majority of countries: Slovakia, Hungary, Ireland, Bulgaria.
The NIM, net interest margin, is also increasing for the business unit. This is also driven by, amongst others, Ireland and some other business lines in some countries. The non-life business is growing 17% with good quality. The combined ratio stands at 92% which is extremely well and that is true for all countries, so there is no country which is derogating that number. Life business is down, but it's not too important, and it's purely driven by seasonal effects. The costs are going up and that has to do with the fact that business entities are growing in Hungary; for instance, in Slovakia where we see an increase only on the mortgage business of 26%. But the cost income ratio stands at 66%, which is a good number compared to the previous quarter. Then, the credit cost ratio is a negative one, so we have release of provisions of the full business unit, which is due to and Ireland, already mentioned that, but clearly also Hungary where we had a write back of provision for the total of €11 million.
Allow me to keep it here, as far as the business units are concerned. In terms of the Group center, we also saw there we do see there a negative result, which is mainly driven by the traditional stuff. That is the finance of the participations and, also, some costs and timing differences between the second and the third quarter. It has to do with VAT, which were booked in the second quarter in 2016 and was booked in the third quarter 2015; that makes quite a big difference. Also, some invoices which were booked earlier in this year and later in last year makes a big difference between the two years and makes also a big difference between the quarters. But if we would exclude that, then the international -- sorry, the Group center is performing, actually, quite in line with the previous quarters.
Last but not least, impact of all of this on capital on Page 47. We do see the evolution of our capital ratio. It now stands at 15.3% fully loaded. The old SREP was at, fully loaded basis, 11.25%. If you would translate that into a phased approach, then the capital ratio stands at 15.1%. Reflecting the regulatory minimum of 10.25%, it creates a buffer of almost 500 basis points, which is translated on the risk-weighted assets, which we were able to keep stable at €89 billion, so almost €4.5 billion. So, in that respect, indeed, it was a strong performance in the quarter. It has also translated into the leverage ratio which now stands at 6.2% at KBC Group level, 5.3% at the Bank, which is a further confirmation of the strong performance and the solid position KBC has built up over the last few -- last couple of years.
In terms of the total capital ratio, the total capital ratio now stands at, let me flip some pages, 19.5% phased-in, which is obviously the translation of the common equity Tier 1 ratio, but also the fact that we have filled up the AT1 and the Tier 2 buckets. There, we are perfectly already ahead of our total capital target of 17%. Also, if you would look at the same numbers, but done in a fully loaded mode then we stand with a capital ratio of 19.4%, solidly above the capital targets which are imposed upon us. In terms of the liquidity ratio and the funding, the liquidity ratio stands at 123% and the short term on 137%, which are very solid and they are driven by the fact that our funding is very solid. Also, it's attracted by our customers. Currently, we stand at 71% of our funding which is generated through our customers.
Also, if you look at the -- on the next page, Page 51, if you look at the short-term unsecured funding of KBC Bank, then you can see that we were able to drive up our ratio of the coverage of the liquid assets to 337%, which is more than 3 times the required target. In that respect, as a wrap up, I can say that the quarter was having a strong performance. We have been able, in all our countries, to do what we have to do, running all business lines in all countries in a successful manner. It underpins our track record of generating strong performances and it's, clearly, that it boosts for our already very robust capital ratio and liquidity ratio.
Now, that is also something which we do expect, going forward, we will continue whatever it takes to put our customer in the center of our attention. It clearly pays off and that is translated in our quarterly results, but also, we expect this to be translated in the remainder of 2016 and also, clearly, for 2017; that our results will be reflecting that achievement of the past, but also the trust of our customer in KBC. So, you can expect continued stable and solid returns for all business units.
And last, but not least, I already mentioned several times, we do change our guidance for Ireland on the full-year provisions.
I will give now back the floor to Wim, who will guide us through your questions.
Thank you. This sums it up for the first part of the call. Now, the floor is open for questions. As usual, can we ask you to restrict the number of questions to two, to allow a maximum number of people to raise questions? Thank you very much.
Your first question comes from Jean-Pierre Lambert of KBW.
Yes, good morning. Two questions. The first one is we saw an outflow of assets under management, and I was wondering if you saw a further impact of lack of confidence among investors affecting further inflows or outflows.
Second question is the impact of the steepening of the yield curve on NII. Some banks are providing a sensitivity to this parameter in their annual report. I was wondering if you could provide some indication. Thank you.
Thank you for your question, Jean-Pierre. The first question on outflows on assets under management, actually, what we did see is a slight outflow, but this is mainly due to a technical element. If you would look at after adjustment of that technical element has to do with double counting, transforming funded funds into regular funds, then we do see a slight inflow. There is a small but. What we do see is, indeed, a good performance in terms of the asset management business and, to a certain extent as well, on the unit-linked business.
But your second part of your question was related to what about confidence. What we do see today is that confidence -- I'm now talking about the last couple of weeks, that confidence is not, really, increasing. Customers are a little bit hesitant to put further their investments up and to take more risk than what they did in the past.
What I did not say is that they decrease, or that their appetite is decreasing, but what I'm not seeing is a further continuous increase of their risk appetite regarding investments.
As regards the second question, Jean-Pierre, I'm afraid I will have to disappoint you; we don't give guidance at the moment as you've also saw historically. Obviously, with the strong movement in long-term yields, 30-40 basis points up now, I understand that further guidance may be warranted. We'll reflect on this and see whether we can come out with some guidance later on, maybe for the full-year results. We still have to contemplate that, but for the moment, we think it's too early to really start with giving guidance now, because of a few weeks of increasing interest rates.
Thank you very much.
And your next question comes from Tarik El Mejjad of Bank of America.
Tarik El Mejjad
I have a couple of questions please. First of all, on Ireland and NPLs, they were speech from central bank by end of September where it was focused on NPLs in the country and discussions how to, basically, bring down these NPLs. So, is there any at the moment pressure from central bank to accelerate the reduction of nonperforming loans, especially that you have 45% NPLs, one of the highest in the country? And I'm always also surprised by the fact that you're starting booking now these write backs, while the topic might go again into more coverage, a higher coverage.
And second question is on the Pillar 2. You didn't disclose the Pillar 2R, so obviously you will not do it now, but my question is how that will be compared to the present one, compared to the French bank that discloses already? Are we in the same ballpark?
On the same topic, the Pillar 2G maybe you can help us with the thinking how is that calculated. Bank of England takes the drawdown from the stress tests that they've done and then deduct the capital conservation buffer to come with Pillar 2G. ECB said that they are having the same thinking, but if you do this calculation, numbers don't really work. So, can you just help us how you think the Pillar 3G will be set? Thank you.
I will start giving the answer on both questions, and Luc can jump in further detail if necessary. Let me first start with Ireland, your question was reflecting or referring to the speech of the national bank, Central Bank of Ireland, where they were, indeed, questioning what about the NPLs and how we have to deal with that going forward. Now, your question was relating do we have pressure from the Central Bank of Ireland in that respect. The answer is no, not at all. And if you would take it in a broader picture, is a pressure any way on NPLs, I think some countries have been seeing that NPLs are something which you have to manage carefully. Therefore, I think the reaction of the Central Bank of Ireland is quite a logic one. So, no pressure though. How come that our NPL ratio is quite high?
The stress test, the recent EBA stress test learned us quite a lot. We have always been stating that we have been applying, very conservatively, the EBA guidelines in respect of nonperforming loans. Therefore, our nonperforming loans ratio, and also the way how we impair those loans, is quite conservative and, therefore, high. There is a huge difference between, I think, KBC Bank Ireland, and, let's say the NPL ratios of all the other banks. All the other banks not necessarily reflect the Irish bank but also, for instance, Spanish or Italian, or whatever, banks.
That is KCB Bank Ireland is part of a group, which is called KBC, and KBC has no issue whatsoever with its capital position. So, we're not in the urge to leave that conservative position, and that makes a huge difference compared to the other Irish banks. So, therefore, I think, no, there's no pressure. I think also what's going forward we can maintain our conservative stance. The release of the provisions is mainly related to the [Indiscernible] and the quality of the book, and has nothing to do with something else.
In terms of the SREP numbers and the Pillar 1 and Pillar 2, way of treatment, indeed, to the Pillar 2 guidance, and that's at least the ambition of the ECB, European Central Bank. The Pillar 2 guidance and the Pillar 2 requirements are two completely different concepts now. Where the one is more quantitative, the other is more qualitative. One is taking into account, Pillar 2 requirement, the difference between what is not cached in the Pillar 1, and takes into account the impact of elements also learned in the stress.
Now, the Pillar 2 guidance is - at least that is what the ECB is telling us, is, indeed, tailored on the same elements as what the Bank of England is pushing forward. What we are going to do is we do receive our numbers normally, let's say, end of November -- early December, let's say, one of the first two weeks of December, and then we will disclose them. We were a little bit surprise to see, indeed, that some other colleague banks have disclosed their numbers. We had explicit question of the Central Bank of Europe not to disclose the numbers. And we stick to that guidance which we have been given. But if you want to have a bit more color I was not, really, disappointed when I saw the SREP numbers for 2017 of KBC.
Tarik El Mejjad
Will you disclose the Pillar 2 guidance as well in December, or only the requirements?
So far, and that's what I did not really also see with all disclosements of the new SREP numbers. So far, the ECB requests us not to disclose the Pillar 2 guidance. But we told them that we do have difficulty with that position and that we normally would disclose it.
And your next question comes from Farquhar Murray of Autonomous.
Just one question if I may on the Irish provisions. You've seen the first kind of material write back in 3Q 2016, but the guidance you're giving for the full year, essentially, says you're expecting nothing incremental in the fourth quarter. So, I just wondered if you could explain why you're so reluctant to see a trend from what you've seen in the third quarter. And, more generally, what are you expecting in 2017?
Yes, here you perhaps see some conservativeness in that range. The reason is we do see underlying improvements and we don't see any abrupt change in that trend. So, we do see a further continuation of that improvement in the defaulted portfolio. So far, the house price evolution has also been positive. The reason why we're perhaps a bit conservative in the range is that there are -- of course, there's still the corporate loan portfolio, which can sometimes have unexpected consequences, given it's a corporate and real-estate portfolio.
Secondly, with interest rates rising, it can also have a negative effect on, purely mathematically, on the calculation of your class revalue, which is the NPV of the cash which you will collect when you close out those properties. That's purely a technical effect that might, we don't know yet, we will have to see what the effects will be. This could also have some negative effect as well. That's why we perhaps also have some conservativeness in that range.
And your next question comes from Robin van den Broek of Mediobanca.
Robin van den Broek
I just wanted to come back on the whole NII discussion. In the past, you've always said that we'll try to offset margin pressure via volume growth. It seems that that is getting more challenging going forward. So, should we expect NII to drop going forward? And given the fact that mortgage rates for the back book are now basically at the same level of the front book, should we also expect that the prepayments will drop off to zero in the very foreseeable future? And could you give some indication on what term deposits can get for offset going forward? I think you were talking about 800 million of maturing term deposits. And how would that evolve in 2017, for example?
Okay, well yes we believe that, given the current yield environment, although there's some improvement, that it would be a challenge to keep NII stable. We currently believe that it will come slightly down even if we see long-term interest rates moving up a little bit. Obviously, if that further improves we'll have to revise that position. But, currently, we believe it will slightly come down going forward.
With NIM pressures continuing, you saw that the last few quarters, a few basis points per quarter, that will continue as well, offset, of course, partly by that volume growth. The prepayments will normally fall down further -- prepayment fees rather, given that the volumes of prepayments have decreased further. Obviously, with some seasonal effects that have decreased further and, therefore, prepayment fees are going to go down as well. But to zero is probably not in the writing, at the moment.
On the term deposits, we have about around EUR800 million that are maturing in the fourth quarter. For the full year, if we take everything together, about EUR2.5 billion of these long-term deposits and full-year 2017, which are still relatively expensive and will also help support NII.
Robin van den Broek
But presumably the yield on the deposits that are maturing in 2017 is lower than the ones that are expiring in 2016?
Robin van den Broek
Okay, thank you.
And your next question is from Nick Davey of Redburn.
Two questions please, and just one quick follow-up. On the follow up, just so I understood that NII observation you've just made, the guidance there was slightly down, do I understand, is that an observation about overall NII in 2017 and/or 2018? Could you just clarify that statement, please?
Second question --.
To make it concrete, let's say, 2017, NII will slightly come down compared to 2016.
Perfect. Okay, thank you. Second --
Its current position. Again, this is the base scenario we have. Obviously, there is a lot of volatility at the moment with the long-term yields, so if those change, then the position can change as well.
Understood. Thank you. Okay, first question then on capital then, AFS. So, you've got another AFS gain into the CET 1 ratio today. Could you just quantify the cumulative impact from AFS gains into CET 1? I estimate somewhere around 150 basis points in total, just if you could comment on that number, please.
Second question on TLTRO 2, could you just quantify how much you've taken up and what the impact is to NII, or any kind of broad observations you could make about how much you intend to take up, and how much of an impact to the top line that will be. Thank you.
Okay, for the capital gains, at the moment, and of course you have to look only at capital gains on the banking side, given that we are using the Danish compromise the capital gain is around €780 million and that has an effect of 0.9% on the core Tier 1 ratio, so, 90 basis points rounded. Then on the TLTRO, currently, we have drawn around €3.6 billion of TLTRO 2 and, obviously, that will positively impact on a yearly basis around €30 million. On an annualized basis, around €30 million; and for 2016 it will be around €13 million.
Very helpful. Thank you.
And your next question comes from Bruce Hamilton of Morgan Stanley.
A number of my questions have been asked, so maybe just a quick one on your latest thoughts on the Basel progress; obviously, plenty of pushback, most recently from the Bundesbank. But I wondered how you saw that progressing from here, and whether the U.S. elections play a big role in potentially softening impact.
So yes, we have been reading carefully what was indeed announced, was it yesterday or the day before, yesterday from the German side regarding Basel 4. When we were in Washington on the IMF the atmosphere was a little bit different and the week before the IMF, again the atmosphere was different. So, it's changing on and on again.
What I do see now with the statement made by the German side, that is clearly indicating that, at least certain parts of Europe, one is convinced that Basel 4 in its original setting is not something which is going to be helpful and supporting to the economic development in Europe. And, therefore, would be having devastating impact, not only in the European economy, but also on the position of banks. That's clearly translated into the statement made by the German side two days ago. What is our read about that? We'll see. We're not on the side that we can influence that.
We share the vision of the German side that it is not wise to do what is in the original proposals of the Basel Committee. I know what is the opinion on certain sides in the European Commission, it's very clear, and it goes hand in hand with the statement made by the German side a few days ago. We do support that view. But as I just said, we are not on that side of the table takes the decision, so we only argue what we cannot decide. But clearly, we'll wait until they make the final cut.
That's very helpful. Thank you.
And your next question comes from Stefan Nedialkov of Citigroup.
A couple of hopefully very quick questions. Number one, on the TLTRO, you mentioned 3.6 billion has been taken already. What is the capacity that you can go up to? And do you have plans to take more? Secondly, could you just please remind us what's the reset schedule of the CPPI product through the end of the year, and potentially next year as well. And lastly, mortgage risk weights in Belgium. What are they in 3Q and what were they in 2Q? Thank you.
On the TLTRO, we have theoretically still ample capacity, much more than we will ever need. Do we want to take up further TLTRO? And the answer is yes, under current conditions that is, indeed, the case. Given that we intend to use TLTRO to replace the maturing to the refinance, maturing senior bonds and covered bonds, and we will currently not issue any cover bonds that you draw under the TLTRO.
Coming back to your second and your third question about the reset schedule for this year: so the reset schedule is actually always the same, it's January, May, August and November. So, to give you a bit more color on this year, so I mentioned already in the call that we do have had a reset date in August totaling 3.7 billion, of which 1.8 billion was fully cashed out. So by doing so, the position of our CPPI now changed.
We do have, where we had in the second quarter 45% in cash, we do now have 27% in cash. There is an upcoming reset date in November of this year, which totals 4.5 billion, with 2.2 billion fully cashed out. So depends obviously, on the volatility of the markets what that will bring. But if it would reset in normal circumstances, that would bring the 27% down to let's say, 10%-ish in cash. It's a major difference. The reset dates are as I said, for next year the same. The amounts will then obviously, be a little bit different.
In terms of your third partnership, your third question about what about the risk weights for the mortgages after the change the Belgium National Bank announced. You know that they introduced or they will introduce an LTV floor, for mortgages depending on their LTV, 20% or 30% if they LTV is between 80% and 90%, or more than 90%. That will be complementary to the already existing average floor of 10% for residential mortgages, and that latter is irrespective of the LTV.
The National Bank in Belgium on top of that already mentioned a year ago that there would be an additional 5% risk weight add-on for the Belgium mortgage book. That decision is now extended for one year. The two decisions combined would change if Basel -- and that is coming back to an answer I just gave on the Basel question, if Basel would introduce new floors or whatever on that part of our business activity.
Now, what is the impacted, the expected impact for KBC of the decision of our national bank so regardless of Basel IV? We do see, on the basis of the first analysis, that there will be a risk weight impact of about €362 million, which is about 5 to 6 basis points on our CE Tier 1 ratio. That would result that a risk weights would increase to, let's say, a bit more than 10% for the Group, KBC Bank, and CBC Banque, the two banks in Belgium, component.
Thank you very much, guys.
And your next question comes from Benoit Petrarque of Kepler.
Two questions on my side, the first one will be on the IT costs you have been getting for 500 million investment in 2014. We have seen some small amounts recently, especially in Q3 also last year. Could you update up on where you are in the investment plan, how much you still need to invest in IT also for next year? Then the next question would be on NI. I think you mentioned positive effect of enhanced ALM management in the third quarter, could you update us a bit on what you have done here? Then maybe the last question will be on non-life. You mentioned some high re-insurance profit, I was wondering how much it was in the third quarter. Thank you.
Sorry, Benoit, could you repeat the last question, because we didn't understand that quite well, non-life and then?
Yes, on the non-life side, I think you mentioned in Belgium high re-insurance profit. I think the, so, the combined ratio is relatively high, its underlying technical result, but also high re-insurance profit, I guess you have been getting some cash from re-insurance.
The last question perhaps, it just means that we have been reimbursed amounts from insurance companies in the third quarter, which actually are relating to the storms and the flooding in the first half of 2016. That reduced, or improved the sales [ph] re-insurance results.
How much was that?
The total number I don't know by heart, we can give you that offline. I think the delta was around €12 million, but the absolute amount I don't know. But delta in the payments we had to do on the re-insurance was €12 million positive. But I don't know the exact amount that we were reimbursed, no. On the other questions [indiscernible]?
And your next question comes from Pawel Dziedzic of Goldman Sachs.
Hang on, there's, we still have to answer two other questions from Benoit.
Perhaps I will take the other question on NII, the positive effect of ALM management. There are a range of measures that we take; there are no big ones. But, for example, we have increased duration slightly in the third quarter. We've also increased the benchmark volumes, if you have your current account and savings accounts.
We also, we split that into two parts, which is a stable part and a volatile part, and we have reviewed that allocation, which we have the model. Therefore, we do some analysis and we've increased the stable part of those current account and savings accounts. As a result of which, more could be invested on the longer term, therefore also increasing the duration.
Coming back, Benoit, to your question on the IT expenditure, and mainly related to the IT expenditure for a digital transformation. What we announced in 2014 was that we were going to spend €0.5 billion on the transformation of, let's say, the digital front end side.
We don't disclose the detail of where we are today, but what we can say is that out of that €0.5 billion, we're almost two and a half years down the road, so we've spent most substantial part of that, so substantially more than half of that amount is already spent. As you could have seen, and I think we disclosed that earlier, we have been also releasing quite a lot of front end applications in Belgium and the other countries, and that is reflecting that expenditure. KBC continues to transform not only its front end, but also its back end activities, taking into account the digital transformation, which is happening.
That is a continuous effort, and that will also going forward will be a point of attention for us. Next to that, we do manage our legacy activities you need to understand the difference between the digital and, let's call it, the non-digital age.
Just to follow up, if you look at 2017 in terms of investments, will they be the same run rate than what we have seen in 2016, or will that drop a bit?
You're just purely reflecting on the IT side, your question?
What we will do is that whole analysis on where we are with IT, where we are with our IT expenditure taking into account digital transformation, clearly update that for the future. What it means that we will give you some further guidance, in general, on that particular topic going forward. But roughly, without taking what I just said into account, so the digital guidance, you can expect that going forward the expenditure on the IT side for the digital transformation will be in line with what we have seen in the last few years.
Okay, great. Thank you very much.
Benoit, just to give you, because I just been handed over the numbers, the reimbursements we received from re-insurance, that was 15.5 million in the third quarter. In the second quarter, it was only €3.6 million, that's where the delta from 12 million comes from.
Okay, all right. Great, thanks.
And your next question comes from Pawel Dziedzic of Goldman Sachs.
The first question is, actually, a follow-up on your costs. Given your comments on top-line pressure, how do you think about your ability to manage more aggressively cost base going forward? One of your peers in Belgium, of course, have announced intention to reduce workforce and cost base in the country, and we generally see this trend across Benelux more broadly. I know you mentioned that you've done a lot already, that the number of employees is down. We can, obviously, see that consistently, since I think 2007 and you also refer to the fact that you're quite happy with your cost to income. But do you think there is more that you can do going forward?
And then the second question would be on Ireland. I know you made quite a few remarks already, but given that the unit is profitable and the outlook maybe look a little bit brighter, are you any closer to taking the decision about the future of this unit? Would you look into the classification of the operation as a core and what would that entail? Thank you.
Thank you for your questions. Let me start with the first one on cost and cost management, and we clearly refer to also the recent initiatives taken by some peers. First of all, I am not going to comment what peers are doing, that's either your job or their CEO's job. But what we, clearly, are doing in KBC, and that's something which we have been doing over the last four or five years, that is clearly managing our costs in a sustainable way.
That means we do not wait until the moment that we have to interfere drastically. So, the build-down of our, what I call, old school-age activities to the transformation into the digital is the trigger for that, has been happening now over the last four/five years, meaning, intervention in the number of branches, meaning in cutting down on FTEs and so forth. That is what you also saw in the third quarter in Belgium, where we saw the number of FTEs coming down.
This is also something which we do in the other countries, it's the same philosophy. And that is also what we are going to do going forward. This year we'll not see, in the short term, any drastic moves like we have seen by some of our peers. Now, be aware that KBC's cost ratio, if you compare it, for instance, in Belgium with peers, is substantially lower which reflects perfectly what I just said. So, the need for a drastic move is not there.
The second question relating to Ireland, yes indeed, Ireland is continuously improving its position; clearly profitable also in a more sustainable manner. Also, what we have announced in the third quarter where you see there the performance of the underlying book is now improving as well, and contributing in terms of releasing of provisions. Net interest income is improving. Yes, a lot of elements which are out there now confirmed can be used to underpin one of the options. And I always repeat what I said we will clearly give guidance on the future of Ireland on the back of the full-year 2016 numbers, so somewhere early 2017, what we are going to do with Ireland.
And the three options are run it as a true bank which is a profitable one. Those options -- of that option is underpinned by the following quarterly results, and by the recent quarterly results. The other option is, do something in terms of M&A and create a bank insurance group, for instance. A third option if all of this would not come true and would not be an alternative, then we would exit the country. These three options are still there and as I just said, we will get back to you, give you clearly guidance on the back of the full-year 2016 numbers somewhere early 2017.
That's very clear, thank you. If I may follow up maybe on cost, a related question would be on bank taxes. You mentioned that they are very elevated and, in particular, in Belgium. Do you see any scope for reduction there? Or do you see any risk of actually those banking levies going up both in Belgium and in your international operation?
So let me first answer Belgium situation. The Minister of Finance has announced publicly, so in the press that he considers the current level of banking taxes, banking levies to be the absolute maximum for the banks. So, if he sticks to his word, then there is no increase to be foreseen. Is it going to come down? Let's keep fingers crossed. We continuously emphasize, and I'm not the only one doing so in Belgium that those banking taxes are way too high and for KBC it's not an issue, because we are extremely profitable, but for some of our peers its putting really a drag on their performance. So there is pressure but I don't expect them to come down soon.
In terms of the other countries, there are no -- we recently saw, for instance, Slovakia in the insurance business that the government imposed a tax on the sector. But there are no other indications that we can see, on the foreseeable future, any further increases on bank taxes. But I would never, ever exclude that. You know, banks are a favorite target for politicians if it comes to finding new resources of income.
On the other hand, we have to mention that the Hungarian Government is bringing down their bank taxes. This year, they cut it by 50% and the next cut is foreseen for next year. That is also publicly announced by the government, so that's a bit of positive news on that side from the Hungarian Government.
And maybe if I may follow up very briefly on your Czech business, there was some headlines in recent days that Czech Government is thinking about introduction of banking taxes. Have you any view on that or any insight? Do you treat it as a credible threat or rather just press speculation?
Out of respect also for your colleagues, which are still waiting, I will very briefly answer your answer I read the article. I know it was a rumor there. Until now, we have no further indication that it will be a given.
Thank you very much.
Your next question comes from Anton Kryachok of UBS.
Just two questions please on revenues. The first one is on net interest income. I understand you don't provide guidance to rising rate environment, but if you can just help us to understand how you manage interest rate risk in two books. The first one is your government bond portfolio, your liquidity portfolio. Do you tend to swap the book back to the short-term rates, like your Dutch peers do? Or do you tend to have more interest rate risk there on that book?
And secondly on mortgages, given the long-term fixed nature of the Belgian mortgage market. How do you manage the interest rate risk there? Do you tend to lock in the margin for the duration of the life of the product? Or is there a little bit more volatility and therefore rising rates could probably mean higher funding costs for that book and, therefore lower spread? So that's the first question on NII.
The second one on fees, just coming back to the CPPI portfolio, now can you give us an update on the volumes outstanding in that book? And also, whether you have seen your customers rotating into similar high margin products that you have rolled out? Or whether they're just coming back into more plain vanilla savings products? Thank you.
Okay, on NII I'll give you a very short answer and perhaps we can go in more detail, because it's quite technical, tomorrow. But basically we -- the common bond portfolio is partly swapped to the desired durations. These durations are a function of the volumes of current accounts, savings accounts, and so on. So, it's not just kept on our books as a fixed-rate instrument, but swapped to -- partly to the duration.
The mortgages generally speaking, are swapped to floating rate; but there again, some of the current accounts, savings accounts, are reinvested in mortgages. Not everything of these accounts are invested in government bonds. So there as well, we have part of that not swapped. We, actually, basically separate the interest rate management from the assets in which we invest. But looking -- go in more detail tomorrow.
Thank you, sounds good.
And regarding the CPPI exposure, so we already have for a while now a policy of managing the concentration risk in our books in a very explicit way. The CPPI product is one of those focus points. 21.1 billion is still outstanding in the third quarter of '16, which is 1 billion down compared to the second quarter.
Now, the good thing is, and that's the reason why we manage this very actively, that is that 1 billion is just transferred into other products; so more balanced funds -- mainly balanced funds. That has an impact. The volatility on the management fee, therefore, decreases. As you know, the CPPI is depending on the underlying asset allocation. That is now reduced, which means that you don't have the downward swing, but you don't have the upward swing either.
The good news is that what we have seen over the last couple of quarters is that the average managed asset management fee -- sorry, the average management fee, it's obviously an asset management fee, it always is; but an average management fee is now back to, let's call it normal levels, normal levels which could, for instance, stand a comparison with the same quarter, third quarter, 2015.
Thank you. That's very clear.
And your next question comes from Albert Ploegh of ING.
Only a very few questions. Maybe a little bit on the outlook for the loan impairments in the fourth quarter. Normally, [Multiple Speakers].
We have your question, I hear a lot of voices, but nobody who's actually talking to us. Hello?
Especially as the [Multiple Speaker] the run rate been extremely low. I also had one question on the Solvency II ratio of the insurance operations [Multiple speakers].
Apparently, the sound is too weak for that person. So, we'll take that question offline after the call. Happy to do that.
Your last question comes from Ron Heijdenrijk of ABN.
Just one quick question left, maybe actually combining a few comments that were made earlier, on Ireland and on the loan-loss provisions. You said earlier in the comments that you will give full guidance on what to do with Ireland at 4Q results. Farquhar asked about whether or not we started a trend with releasing the loan-loss provisions, which are -- and you also said that the release in Q3 was not driven by house price inflation numbers, but much more about quality improvement in the book. Should we expect comments on your loan-loss provisions and further releases as well? Are you going to reserve that for the fourth quarter, to give guidance on that going forward, 2017/2018? Thank you.
So there is no trend or indication which you could deduct from the release of provisions in the third quarter relating to the future of KBC Bank Ireland. Those two things are completely independent from each other. We judge the new options on the basis of the business model, the possibilities and so forth.
In terms of the loan-loss provisions, yes, we did give guidance. The guidance is in the range of 10 to 50. I think also Luc has already answered on a previous question about this topic, that is, indeed, a quite conservative view. But the guidance which we give is a release in total full year between €10 million and €50 million, as currently we stand at about €32 million for the year.
Sure. Sorry to follow up on that. I do understand that the two things are completely different, but I was just wondering if at the fourth quarter you will also give further guidance for 2017-2018 on this topic?
Yes, indeed, we will give further guidance relating to Ireland in the fourth quarter going forward. But, by the way, I repeat what I said on the future -- the strategic future of Ireland, we will do that on the back of the full-year results, and that will be, indeed, early 2017.
Fully understood. Thank you very much, gentlemen.
So, this sums it up for the call. I'd like to thank you for your attendance and the questions raised. And we do look forward to see you tomorrow at 08:30 AM at KBC at Old Broad Street. Thank you very much, and enjoy the rest of your day.
That does conclude our conference for today. Thank you for participating. You may all disconnect.
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