Banco de Sabadell, S.A. (OTCPK:BNDSF) Q2 2023 Earnings Conference Call July 30, 2023 3:00 PM ET
Company Participants
Cesar Gonzalez-Bueno – Chief Executive Officer
Leopoldo Alvear – Chief Financial Officer
Gerardo Artiach Morenes – Investor Relations
Conference Call Participants
Maksym Mishyn – JB Capital
Ignacio Ulargui – BNP Paribas
Carlos Cobo – Société Générale
Sofie Peterzens – J.P. Morgan
Andrea Filtri – Mediobanca
B Borja Ramirez – Citi
Fernando Gil – Bestinver
Carlos Peixoto – Caixabank
Ignacio Cerezo – USB
Britta Schimdt – Autonomous Research
Hugo Cruz – KBW
Gerardo Artiach Morenes
Good morning, and welcome to Banco Sabadell’s Second Quarter 2023 Results Presentation audio webcast. Our CEO, Cesar Gonzalez-Bueno, and our CFO, Leopoldo Alvear, will present the main highlights and details of the commercial and financial performance of the bank in the quarter. The presentation will be followed up by a Q&A session. We have a schedule around one hour for the whole session.
Let me now hand it over to Cesar Gonzalez-Bueno.
Cesar Gonzalez-Bueno
Thank you, Gerardo. Good morning, everyone, and welcome to Sabadell’s results presentation. As we will explain today, the bank is in good shape and keeps performing well. Let’s just start with the key messages in slide four.
First of all, NII grew by 6% in the quarter and our customer margin increased by 16 basis points quarter-on-quarter. Second, asset quality remains stable. Group’s total cost of risk stands at 56 basis points, in line with the first quarter of the year. Third, net profit of the Group reached €564 million in the first six months of the year. TSB continued to deliver positive results and posted a net profit of £105 million.
Fourth, our share buyback program has – was launched in June, once the ECB’s approval was received. So far, as of the 24 July, 19% of the planned €204 million have been repurchased. Finally, our return on tangible equity stands at 10.8%, while our core Tier-1 ration reached 12.87%, increasing by 33 basis points year-to-date.
Let’s talk about volumes. Starting with the quarterly evolution of performing loans, volumes remain quite stable, growing slightly by 0.8% in the quarter and remaining flat considering constant FX. The evolution is positively impacted by the seasonal effect of the social security advance payment in Spain, as well as by positive growth in our other international businesses. On a year-on-year basis, lending volumes declined by 2.7%.
Moving now to customer funds in the right-hand side of the slide, our balance sheet funds remain stable and increased by 0.3% in the quarter, marginally supported by the strength of the sterling pound. On balance sheet funds increased by 0.5% in the quarter, driven by positive net inflows of mutual funds. As a result, total customer funds increased by 0.3% in the quarter.
Slide six; I would like to make a brief comment about our transformation here. As we have explained in the past, we are undertaking a radical transformation in retail banking. In the upper part of the slide, you can see the significant leap forward we have made, and these are just some examples of the activities that have been carried up to date.
For instance, we already are acquiring more than half of our new customers digitally. We didn’t have this option available in 2021. 75% of new customer loans sales take place either digitally or through remote channels, which is almost twice as much as two years ago.
And for those products where the customer demands – requires specialized advice, we have deployed these relationship managers, and mortgages is just an example. Almost 40% of our new mortgages lending is already being originated through these specialized relationship managers.
Our radical transformation in retail banking is accelerating. And most importantly, this transformation is enabling us to keep growing our customer base, that then will be served and is being served with value-added products with our specialists in the network.
Moving on to business banking, we have a solid franchise here, and we are deploying an evolutionary transformation. These are just some examples. We keep focusing on increasing the use of analytics to drive growth in order to increase the profitability of our loan portfolio. As a result, the risk-adjusted return on capital of our loan portfolio has improved significantly from 18% in 2021 to 25% by the end of the first half of 2023.
We also have launched a sector-specific offering for 34 sectors. This has translated in a 53% increase of customer acquisition in these sectors that we understand so well. Finally, as a result of the revamped web and app for business banking customers, the number of logins have increased by 20% over the last two years.
On Slide seven, the review of our commercial activity in Spain. Mortgage origination in Q2 increased by 7% quarter-on-quarter. In the first half of 2023, it decreased by 23% compared to 2022, and this is broadly in-line with the market slowdown.
New consumer loans increased by 9% quarter-on-quarter and by 23% year-on-year. New loans and credit facilities in business banking increased by 44% quarter-on-quarter. But this is mainly driven by the maturity of the three-year-old ICO or ECO granted credit facilities in 2Q, 2023, which were renewed into regular credit facilities. This has no relevant impact on the stock, although it does have a significant impact on re-pricing. Finally, on the lower right-hand side of the slide, working capital financing continued to perform well, posting a 7% increase quarter-on-quarter and 4% year-on-year.
Slide eight, payment-related services continued to perform well for another quarter in terms of both turnover and number of transactions. Cards turnover increased by 9% quarter-on-quarter and by 5% year-on-year, while point-of-sale turnover increased by 18% quarter-on-quarter and 9% year-on-year.
In the lower left-hand side of the slide, net inflows of mutual funds amounted €153 million in Q2, a figure above previous quarters. In the current context of rising interest rates however, we keep offering a wide range of savings and investment products to our customers beyond mutual funds.
In the lower right-hand side of the slide, you can see that the total volume of customer funds in our portfolio of savings and investment products, both on balance and off balance, grew by 5% quarter-on-quarter and by 8% year-on-year. We managed this product portfolio to maintain customer deposits in our balance sheet broadly stable in the quarter, as we have discussed before.
Slide nine, performing loans by segment ex-TSB. Let me start with our business in Spain. Consumer loans grew by 3.5% in the quarter and by 12.3% year-on-year. Sound demand is supported by improving unemployment rate in Spain. On the other hand, the stock of mortgage lending remained slightly subdued in the quarter and decreased by 0.8% quarter-on-quarter. This was mainly due to a lower demand of new mortgages because of the fast increase of interest rates in the last few months.
Loans to SMEs and corporates also remained flattish because of lower demand, as companies are still postponing long-term investments. It decreased by 0.5% in the quarter. Finally, the 19.1% growth of other lending in the quarter is due to social security advance payments of €655 million. This is a temporary effect, it happens every year in June and is reversed in July.
All-in-all, performing loans remained fairly stable in the quarter, increasing by 0.3% quarter-on-quarter. Regarding our international businesses, performing loans grew by 3.1% in the quarter, 1.8% at constant FX. Both Mexico and our foreign branches delivered positive growth in the quarter, while Miami posted a small decrease of its lending book.
Moving on to the U.K. and TSB on slide 10. New mortgage lending volumes at TSB in the second quarter were impacted by the lower activity in the U.K. housing market and origination declined by 5% quarter-on-quarter. Mortgage applications were up 20% in the second quarter versus the first quarter, which is positive news, but they remain below the levels observed prior to the mini-budget episode. In terms of stock, TSB’s mortgage book declined by 1.1% in the quarter, driven by a weak mortgage market.
Moving to customer deposits, they have also decreased in the quarter by similar levels. Total customer deposits decreased by 0.9% in the quarter. Funds are gradually flowing from current accounts to savings accounts, but at a slower pace than the average of the system. In this regard, we have an average deposit amount below £7,000 and 85% of deposit savings accounts have a tenure greater than five years.
Moving on to TSB’s financial performance in slide 11, we see that TSB recorded a net profit of £50 million in the quarter and £105 million in the first half of the year. NII for the first six months grew by 14% year-on-year. Core results in the first half of 2023 increased by 35.6% year-on-year. Good NII performance offset TSB’s decrease of fees and commissions and slight increase of cost, as you can see on the right-hand side of the slide. Let me highlight that despite high inflation, only a marginal increase in cost has been registered.
Finally, net profit as of June posted growth above 70%. This jump, compared to the first six months of 2022, is partly due to the impact of the bank’s levy reversal in first half 2022, as we explained to you in this very same webcast last year. This good performance allowed a return on tangible equity to reach 11%.
In slide 12, I will quickly go through the financials on a group basis, which Leo will explain later in more detail. We recorded a net profit of €359 million in the quarter and €564 million in the first six months of the year, which is a record figure for us. This positive evolution was significantly driven by our core results, calculated as NII plus fees minus total costs.
Core results grew by more than 42% year-on-year on the strength of our NII performance. Return on tangible equity stands at 10.8%, while our core Tier 1 ratio stands at 12.87%, recording a solid increase of 33 basis points in the first half of the year.
Moving to shareholder value creation in Slide 13. At the end of June, after receiving the regulatory authorizations, we launched our first share buyback program. This was one of the main points approved at our general meeting shareholders. The share buyback, together with the increase in profitability of the last few quarters has contributed to shareholders’ value creation.
Tangible book value increased by 6.6% over the last 12 months, including the distribution of a cash dividend of €0.02 per share paid in March. If we consider the full execution of the share buyback program pro forma, value creation rises to 8.5%. Finally, in light of the recurring good evolution of our results, we have improved our return on tangible equity guidance for the year and to remain around 10.5%.
Let me share that we expect the closing of the alliance of our merchant acquiring business with Nexi, which we signed last February, to take place in the first half of 2024. Therefore, our close to 10.5% return on tangible equity guidance for 2023 doesn’t include any capital gain from the deal with Nexi, which will be booked in 2024.
And with this, I will hand it over to Leo, who will cover the Bank’s financials for the quarter in more detail.
Leopoldo Alvear
Thank you, Cesar, and good morning everyone. Now, moving on to the financial results, and starting with slide 15, we show the quarterly and half-year results evolution. So, net profit in Q2 reached €359 million. When added to the first quarter results, half-year profit stands at €564 million. This is 44% higher than last year’s figure. Despite the Spanish banking tax occurred in Q1 of €157 million.
The aforementioned net profit represents a ROTE of 10.8%. Overall, as we can see, the quarter evolution was healthy, which shows the good momentum of the business, with a solid year-on-year performance, which provides a good estimate of the expected evolution for the full year 2023.
Core banking revenues, this is net interest income and fees, grew by 4.6% in the quarter. This is explained by strong NII, which grew by 6.3% Q-on-Q, partially offset by the fee line, which declined minus 1% in the quarter. For the first half, the core banking revenues amount to €3 billion, representing an increase of 19.4% year-on-year.
This evolution was also driven by NII, which increased by 29.2% in the first half of the year, offsetting the 4.4% decline of served-in fees in the same period. Cost inflation accelerated slightly in the quarter, with growth of 2.4% Q-on-Q or 2.7% in the first half of the year. This is in line with our expectation that costs should continue to increase throughout the year, to a total increase of 3.5% at year-end.
The combination of core revenues and costs drove our core results upward by almost 7% in the quarter, and a remarkable 42% in the year so far. This, combined with a stable evolution of cost of risk, drove the aforementioned net profit figures.
It is important to mention that within the numbers of the quarter, the P&L recorded a single resolution fund payment of €76 million, which is usually incurred in Q2 of each year. This marks the end of the SRB’s funds build-up phase, and therefore, going forward, 2024 and onwards, the contribution should be negligible, as we will only have to cover the potential increase in the European deposit base.
We will now go through the different P&L items in more detail. Starting with NII in slide 16, Group NII increased, as mentioned before by 6.3% on the quarterly basis and continued to accelerate in annual terms to north of 29% year-on-year. On the top right-hand side, you can see the drivers that explain the quarterly evolution.
Now, moving from left to right, it has been another quarter where Euribor reprising is coming through, and this will continue to be so over the coming quarters, and according to the forward curve, at least until the second quarter of 2024. Customer NII contributed €60 million. Within it, customer margin added €72 million, underpinned by the fact that a loan book appreciated once again, at higher interest rates, while the cost of deposits remained at contained levels.
The higher ALCO contribution, driven by the reprising of the hedge portion of the portfolio, which accounts to 44%, along with the remuneration coming from the excess liquidity deposited at the ECB, more than offset as expected, a higher wholesale funding cost, producing a combined net profit impact of €8 million.
Finally, the others category, which includes some hedging and other miscellaneous items, have a negative impact of €4 million, while the addition in day count represents an impact of plus €6 million in the quarter. The customer spread increased by 16 basis points to a 2.89% in the quarter, driven by the reprising of the variable rate portfolio, as well as by the higher yield on new originations, and as we just mentioned, by a contained evolution of our customer funds cost. On the other hand, NII grew by 9 basis points in the quarter to 1.88%.
With all this in mind, and with half a year behind us, we revise upwards our guidance and believe that NII in 2023 will grow above 20% on a year-on-year basis. Leaving the fee line and moving on to fees, this posted a decrease of 1% in the quarter and 4.4% on an annual basis. This underperformance was mainly attributable to service and asset management fees. However, credit risk fees remain broadly stable in the quarter and have posted a positive growth in the year.
Service fees remain roughly flourished in the quarter, and these were supported by commissions related to payments and cards where we had a higher activity, Cesar explained at the beginning of the presentation. And on the other hand, they were offset by lower maintenance fees for current accounts. In the year-on-year variation, the underperformance is mostly explained by lower revenues from ForEx transactions.
Within the asset management fees, insurance brokerage fees continues to be impacted by the product mischange, as we are selling regular premium insurance instead of single premium insurance. And this fee stream will recover gradually as we mentioned in last quarter’s result presentation.
Due to this weaker performance in the overall fee line and anticipated a potentially less dynamic credit origination market than initially expected, we revised downward our year-on-year guidance to meet single-digit decline. In any case, it’s important to mention that we expect fees to be higher in second half than they have been in the first half of the year.
Leaving the revenue lines to one side and moving now on to costs, on slide 18, we can see that this quarter total costs presented a growth of 2.4%. In our year-on-year terms, costs grew by 2.7%, well in line with our expectations, as we had anticipated that they would increase gradually throughout the year.
This rate is on track, as explained, with our year-on-year guidance of an annual cost inflation of 3.5%. When we combine the effect of the contained cost increase with the improvement of the revenue sources, as you can see on the right-hand side, the improvement in the efficiency ratio was roughly 6 percentage points in the last year. So at a group level, efficiency ratio now stands at 50.6%, while ex-TSB, it is 44%.
On the following slide, we see the evolution of our core results, which include the core revenues; this is NII plus fees, minus costs. This quarter, core revenues increased by 6.8%, driving the mid-year annual variation to north of 42% at group level. This positive trend, it is driven by wider jobs, as we are seeing NII supported by normalized interest rates, which confidently offsets the declining fees and the before-mentioned limited inflation of costs.
On the right-hand side, you can see the bridge of this year-on-year evolution. The increase of this metric is supported by far by NII, which added a remarkable €513 million. The contention of costs made possible that we only have to deduct €38 million from this line, while fees had a negative impact of €32 million in the year. Now going forward, we expect core revenues to be the main contributor to a continuous growth in core results.
In the next slide, we cover cost of risk and the other P&L items between pre-provision profits and profit before taxes. The group’s total cost of risk declined in the quarter to stand at 56 basis points at the end of the first half, which is slightly better than our year-end guidance. Credit cost of risk stands at 45 basis points at the end of June and remained flattish in the quarter. This instability is related to the fact that delinquency continues to be at low levels.
Taking a look at the breakdown of total provisions on the top right-hand side, starting from left to right, we can see that we booked €187 million of loan loss provisions in the quarter, equivalent to the 45 basis points credit cost of risk that I’ve just mentioned. Next, we booked €12 million for charges and foreclosed assets and €35 million of NPA management costs, which could be considered a run rate.
Lastly, as you can see, we released €2 million in other provisions, which are mainly related to litigation. All-in-all, total cost of risk is performing slightly better than our year-end guidance, fostered by a better-than-expected evolution of our NPAs. And in this context, and taking into account that half a year has already gone by, we improved our total cost of risk guidance from 65 basis points to below 60 basis points. This is total provisions should be around €1 billion for the year.
Moving on, in the next section, I will walk you through as equality, liquidity and solvency. In the first slide of this section, slide 22, we take a look at the group’s non-performing loans, which showed a small decrease in the quarter, bringing the NPL ratio down to 3.5% and indicating that asset quality has remained more resilient than anticipated, with figures for half year looking materially better than those in our budget.
Looking at the exposure and coverage ratios by stages, on the right-hand side it is worth mentioning that our Stage 2 exposure as a percentage of total book has declined by 42 basis points in the quarter or an equivalent decrease of €600 million. While Stage 3 coverage ratio is 40.1% at group level and 43% at ex-TSB level, given that TSB’s loan book is 90% mortgages, a product which obviously entails lower levels of provisions. Finally, it is worth noting that total provisions for the Stage 3 portfolio increased 1 percentage point and stands now at 56%.
Moving on, in terms of foreclosed assets, it is worth noting that the stock continued to decline both quarterly and on an annual basis, and this reduction amounts to 15% on a year-on-year basis. During the last 12 months, 23% of the stock has been sold, with an average premium of 6%, which in my opinion shows that these assets are properly mark-to-market in our balance sheet.
The coverage ratio for this portfolio remained broadly stable at 39%, and 95% of foreclosed assets as you know are finished buildings. Overall, total NPAs, which include both NPLs and foreclosed assets were slightly down year-on-year. Gross and net NPA ratios stand at 4.1% or 1.9%, respectively and total coverage, increased slightly to 53%.
Moving on now to liquidity, in the next slide, the Group once again entered the quarter with a very comfortable liquidity position. Even after having repaid the vast majority of the TLTRO-III facility, including the total amount maturing in 2023. This is reflected in the 47 billion of high-quality liquid assets, as well as in the LCA ratio, which stood at 200% for the Group at the end of June.
The loan-to-deposit ratio entered the quarter at 95%, remaining broadly stable. In terms of the European Central Bank funding, as mentioned, we have repaid another €8.5 billion TLTRO-III this quarter, and as a result €27 billion, equivalent to roughly 84% of the facility have already been repaid. €5 billion remain outstanding with final maturity in March 2024. At the end of the second quarter, the liquidity deposited at the ECB, €21.7 billion, amounts more than four times the outstanding TLTRO balance of €5 billion.
Finally, in the UK, we currently have €4 billion outstanding under TFSME, most of which will mature in the second half of 2025. And to end this slide, I would like to highlight the recent improvement that Fitch Ratings assigned to our rating outlook, which has been revised from stable to positive.
This grade has been assigned on the back of expectations of a structural improvement of Sabadell’s profitability due to higher interest rates, contained credit provisions and improved performance of TSB. With this latest improvement, we now hold a positive outlook for Fitch, S&P and Moody’s.
Turning now to slide 25, we can see our current MREL position. As you can see, Sabadell is already compliant with the requirements that need to be met from 1 January 2024 onwards, which have driven our funding plans in the last few quarters. It is important to highlight that the execution of the funding plan for 2023 has been concentrated in this first half of the year, with a total amount issued of roughly €4.5 billion, and we’ve been issuing senior preferred debt in green format in this quarter. The vast majority of MREL issuances have already been executed.
For the reminder of the year, we only expect one potential senior unsecured debt transaction, as well as to keep being a cover bond issuer. Allow me to remind you that our 81 and Tier 2 buckets are full, and therefore we do not need to top the market on neither of these instruments in the medium term.
Finally, moving to the next slide, and to end my part of the presentation, let me share with you our solvency position. At the end of June, our fully loaded CET1 ratio reached 12.87%, having increased by 33 basis points year-to-date, of which 9 basis points in this quarter.
At the end of June, our fully loaded CET1 ratio reached 12.87%. When we look at the quarter’s evolution in more detail, we can see that organic capital generation was plus 19 basis points after accruing a 50% payout ratio. Fair value reserve adjustments had a minor negative impact of 3 basis points. And finally, RWAs detracted 7 basis points to our CET1 ratio. From a regulatory perspective, the CET1 ratio stood at 12.88% on a facing basis, which implies an MDA buffer of 422 basis points.
Finally, I would like to recall that no regulatory headwinds are expected in the coming quarters, although please note that from July, contra cyclical buffer in the U.K. increases from 1% to 2%, and therefore the requirements for the Group will increase by 20 basis points.
And with this, I hand over to Cesar, who will conclude the presentation today.
Cesar Gonzalez-Bueno
Thank you, Leo. That was very clear. And now to finish our presentation, before starting the Q&A, I would like to recap on our new updated guidance for 2023 in slide 28.
Looking at our financial performance, NII grew in the first six months of the year by more than 29% year-on-year. This makes us more confident that we will outperform our initial guidance, so we are raising our NII growth guidance for the year to above 20%.
Fees decreased by 4.4% in the first half of the year. Applying a present approach, we are revising our year-end guidance downwards from a low single-digit decline to a mid-single-digit decline. We reported a total cost of €1.478 million in the first half of the year, which means we are comfortably on track to meet our year-end target of below €3 billion. We have now adjusted our guidance to a more precise guidance from the previous close to 4% growth to close to 3.5% growth.
Total cost of risk stood at 56 basis points on the first half of the year, and our guidance has been improved from less than 65 basis points to less than 60 basis points by year-end. All this has brought our return on tangible equity up to 10.8% year-to-date, which is already above our initial year-end profitability guidance.
The return on tangible equity guidance for the year has now been increased to close to 10.5%. As I said before, this close to 10.5% return on tangible equity guidance does not include any capital gain from the alliance in our merchant acquiring business with Nexi, which we expect to book in the first half of 2024.
Finally, let me highlight that our transformation keeps moving forward and delivering results. This will keep contributing to improve our return on tangible equity further in 2024.
And with this, I will hand over to Gerardo to kick off our Q&A session. Thank you.
Question-and-Answer Session
Gerardo Artiach Morenes
Thank you, Cesar. We will now begin the Q&A session. [Operator Instructions] Operator, could you please open the line for the first question?
Operator
The first question is coming from Maksym Mishyn from JB Capital. Please go ahead [Operator Instructions]
Maksym Mishyn
Hi, good morning. Thank you for the presentation and taking our questions. I have three. The first one is on the outlook for the loan book growth. I was wondering if you could just share a little bit more color for what you expect first segment in the second half of 2023 in Spain.
And then the second question is on customer spreads. They seem to be evolving better than expected for all the sector. I was wondering if you could guide us on what we should expect as a new normalized customer spread in the medium term for Sabadell.
And then the last one is on capital. I was wondering if you expect any headwinds at the regulatory level in the second half of the year. And I was wondering if you could guide us on what we should think of as comfortable level for Sabadell and what kind of ways to deploy capital could you consider in the future? Thanks
Cesar Gonzalez-Bueno
Thank you very much. I’ll take the first one, leave the second two, which are too easy for me, to Leo. The second half of 2023 and volumes. I think overall we are seeing that there’s been a deleveraging from the different players, both in retail and in enterprises.
This is just normal, because when you see interest rates rise, people tend to reduce their positions both on their asset and on their liability side. We are seeing some deleveraging, for example in mortgages. People are – especially the ones who have variable mortgages, are finding the ways to repay their mortgages at a more accelerated rate. At the same time, commercially, we remain very driven. So we continue to attract new clients. We continue to deploy our commercial activity with a high level of engagement.
So overall, I think in terms of our expectation, I would say that we are kind of flattish for the rest of the year with two factors. One, that we increase our commercial activity and continue to capture new clients. And at the same time, we will continue to see some level of deleveraging from our customers.
On the spread?
Leopoldo Alvear
On the spread, we’re aiming for somewhere around 3% for year-end and what we believe is that deals will keep on improving as I mentioned before, because of the asset re-pricing through the course of 2024. So we expect at this stage, still not in the budgeting phase, which will come through in the second part of this year, but what we believe right now, looking at the curves and how things are going, it’s that customer margins should keep on improving through the course of 2024.
And the final one was in capital. We have no regulatory headwinds coming through, aside from BASEL IV down in 2025, but that should not be very material for us, because it’s basically only operational risk. And once the ratio has been set at 1.0, we don’t expect a very big or very material impact coming from this headwind. And no others down the road in the foreseeable future.
Gerardo Artiach Morenes
Thanks a lot. Let’s please move on to the next question.
Operator
Next question is coming from Ignacio Ulargui from BNP Paribas. Please go ahead [Operator Instructions]
Gerardo Artiach Morenes
Ignacio, are you there? We cannot hear you.
Operator
Ignacio, please remember to press star six to submit your question.
Ignacio Ulargui
Can you hear me now?
Cesar Gonzalez-Bueno
Loud and clear.
Ignacio Ulargui
Okay, thanks very much. Sorry for that. Thanks for taking my questions. I have two questions. One on following up a bit on the question about capital before. If you could just give us a bit of a range on what we expect for BASEL IV, it will be very useful just to get a bit of a feeling of whether we are talking of 20, 30 basis points or a bigger magnitude.
And the second question, it’s on the structural hedge and how do you see it evolving in the U.K. given the evolution of deposits? So, do you see that the current framework that you have, the current structural hedge, can be rolled forward in the same magnitude or given that current counts are going down, that will probably have to shrink a bit. Just to get a bit of a sense of how do you see TSB, NII going forward? Thank you.
Leopoldo Alvear
So, the first one, BASEL IV, I think it can be around those levels. It will depend on the final RWAs that we have at that stage. It’s difficult to give you a precise number right now, because it will depend very much on how we look like in 2025. But I think it will be, I don’t know, in the levels that you mentioned. So as I said, I don’t think it’s a material, a very material impact coming through.
As per the structural hedge and the NIAI on TSB, okay, what we’re seeing is that the peak of NII was probably seen in Q1. So in the coming two quarters, I think we’re going to have some pressure coming from the re-pricing of deposits for the sector, not for TSB, if you wish. And most likely, the most likely scenario, and this will also depend on the availability to produce and to originate more or less volumes of mortgages. But demand, it’s subdued right now, despite the fact that we have increased applications in this quarter by 20%. There are still not very high applications, which are basically a very good proxy for the originations in the following quarter.
So what we see is that probably NII will come down in the coming two quarters, in 2023. In other words, the structural hedge will not be able to cope with the re-pricing of deposits. Just remember that deposits are re-priced much faster than the structural hedge because the structural hedge is a five-year caterpillar, and therefore only 20% re-prices each year.
Now, looking at 2024, we are a little bit more optimistic because the starting point would be to re-price this 20% of the structural hedge. And while the back book is around 1.3, the front book is close to, which is the five-year swap, it’s close to 5%. So there’s over north of 350 basis points to re-price. So this could give us as much as £130 million, £150 million, and this is the buffer that we have in 2024, in order to have a more, I don’t know, positive view on NII for 2024.
Cesar Gonzalez-Bueno
I think that’s very clear, Leo, and I think the only thing I would add is that we are confident that TSB will provide higher contribution to Group in 2024 than in 2023.
Gerardo Artiach Morenes
Thank you. Operator, let’s please move on to the next caller.
Operator
Next question is coming from Carlos Cobo from Société Générale. Please go ahead [Operator Instructions]
Carlos Cobo
Hello! Hope you can hear me well now. My question is about NII guidance. I mean, you push it higher, more optimistic, but I remember your base case for your rival was around 3%. I was wondering if you can update what’s the new risk scenario. And also comparing with some peers, even when you’re becoming more optimistic on NII, it sounds a bit conservative versus some peers guiding between 35%, 40% and even above 45% total increase in NII.
So I was wondering if you can elaborate on what in your opinion is driving that weaker performance in total NII. Is it high deposit beta? Is it the U.K. or how do you compare yourself with domestic peers? Thank you.
And also, if you could – sorry, if you could touch on what’s your view on the normalized customer spread on normal deposit beta, and what’s the proportion of term deposits for the total deposits that you think you’re going to stabilize at? Thank you.
Leopoldo Alvear
So, okay, let me try to guide you through this. So yes, clearly, we budgeted on an arriver in the region of 3%, and it’s clearly above those numbers. So, that is one of the reasons why we’re guiding for a better evolution of NII this year.
So, it’s certainly – I think, there’s basically two things that move our guidance upwards. On the one hand its rates, that’s for certain. And on the second one, it’s that we are a little bit below what we budgeted in terms of deposit beta in all geographies, but especially in Spain. So these two factors will allow us to increase this guidance to this north of 20% as mentioned.
As per the potential conservatism of this figure, I think it’s worth taking into account that all banks have different structures in their balance sheet, you know. And especially in the loan books and these drives basically to a speed of re-appreciation of their assets.
In our case, we have more fixed mortgages than others. Therefore, the representation of our asset side is slower than others. And these drives that NII, in our case, will grow north of 20% this year. But on the other hand, we are a little bit more optimistic for 2024, because we have for example, €8 billion of loans which did not reprise this year and will reprise next year. These are basically fixed loans from an SME franchise, which are now with an average duration of two, three years and did not reprice neither in 2022 and 2023, but will reprice in 2024.
So, as I said, every bank has a different scheme of fixed and floating loans. And this drives the speed at which they can reprise. In our case, the good news is that we foresee a few quarters where we will keep on increasing our commercial margin and therefore our NII well through 2024.
As per the normalized customer spread, as I tried to explain before, we are seeing that deposit beta is going to keep on progressing, both in 2023 and in 2024. In my opinion it’s difficult to predict which is going to be the number for the deposit beta at the end of 2024. Impossible for me to say it right now, because as I said, we have not started budgeting. But I’m getting more and more of the feeling that what we’re going to see in this cycle is that term deposits will not represent 50% of the total deposits, as was the case in previous cycles you know. And this idea is driven by the fact that, on the one hand, banks have a very solid liquidity position. In the previous cycles, loan-to-depots could have been as much as 160%, 180%. And today we are all well below 100%.
And it’s also driven by the fact that we are offering alternative products to our clients. So the yielding on savings do not end with term deposits. And therefore, we are offering guaranteed mutual funds, structured deposits, savings insurance, commercial paper, etc., etc., etc. So my view is that the end game for the mix between current accounts and savings will be lower than in other cycles, despite the fact that as I mentioned at the beginning, deposit beta will keep on increasing.
Now, despite this, we still see commercial margin expanding in 2024. Difficult to predict the precise number now, because as I said, we haven’t budgeted. But year-end should be around 3%, and in 2024 it should be north of that figure.
Gerardo Artiach Morenes
Thank you. Let’s please move on to the next question.
Operator
Next question is coming from Sofie Peterzens from J.P. Morgan. Please go ahead [Operator Instructions]
Sofie Peterzens
Yes, hi. This is Sofie from J.P. Morgan. Thanks a lot for taking my question. I’m sorry to go back to the deposit beta and NII, but could you just elaborate what your deposit beta as of now is? That would be just helpful. And also, you said that the customer margin will improve, but does it also mean that the NII will continue to grow quarter-and-quarter throughout ‘23? So that would be my first question.
And then the second question, your capital position is very solid with close to 12.9%. You have done almost 20% of your share buyback. How should we think about further share buybacks? How do you think about kind of inorganic growth? And if you could just talk a little bit about how you see kind of capital deployment going forward and what your thoughts here are. That’s everything. Thank you.
Leopoldo Alvear
Okay, shall I take the first one? So basically, with regards to the deposit beta at the end of Q2 at the Group level, we have a cost of deposits, an overall cost of deposits of 78 basis points. This is around 18% of – this would imply 18% of deposit beta, depending on the different interest rates in the different geographies. This 18% is 19% in TSB and is 10% in Spain, okay. While it is higher, for example, in our Mexico franchise and higher also in Miami, for example.
But as I said, all these numbers are well within budget. As a matter of fact, they are below budget. So I think things are going well. We are being able to offer our clients alternative products to term deposits, and therefore the beta is growing slower than what we budgeted.
I’m sorry, your second question. Yes, we believe that for certain NII should grow in the coming two quarters. And probably into – well, without probably, we are certain that it will grow also in 2024.
Cesar Gonzalez-Bueno
Yes, on capital and potential inorganic growth. I think it’s clear that we will continue to generate capital organically. We have generated nine basis points in the last quarter and 33 basis points in year-to-date and this trend should continue. But our capital levels are now in line with peers, so – and as Leo mentioned before, we don’t see any regulatory headwind this year. We are accruing currently 50% of payout over our net profits. And this payout on the back of higher return on tangibles equity implies higher shareholder remuneration.
Today, just as an example, the 50% payout would be equivalent to a dividend yield north of 9%. But at this point in time, any decision on shareholder remuneration will only take place later towards the end of the year. And it is the sole responsibility of the Board of Directors.
In terms of dates, I think we can say that they should be in principle similar to last year. So an interim dividend could be announced in the third quarter paid in December and final shareholder remuneration should be announced in the year-end results paid in April and any potential share buyback executed once regulatory approval is obtained.
And as you know, share buyback is into its fourth week of execution and we have purchased around 19%. In terms of strategy, I think we’re very satisfied with what we’ve done in terms of keeping a fixed perimeter and concentrating in the performance of our franchises. We are focused on increasing profitability organically and as I have shared, we have multiple projects that are helping to achieve these objectives. So no change in our perimeter of geographies and businesses. We have a clear roadmap in terms of increasing profitability in all of them.
We have improved in the last 10 quarters our return on tangible equity from zero to above 10%. But of course, as it is our duty as managers, we will evaluate if any opportunity arises, we will evaluate it. But in our current strategy, as I said, we are focused on the current perimeter as it stands.
Gerardo Artiach Morenes
Thank you. Let’s please move on to the next question.
Operator
Next question is coming from Andrea Filtri from Mediobanca. Please go ahead [Operator Instructions].
Andrea Filtri
Thank you for taking my question. The first is asking for more details on NII. You’ve given the aggregate deposit beta. Could you actually split it for customer types, so households, SMEs and large corporates, both in Spain and in TSB, please? And where do you see it in your 2024 expectations of a further growth in profitability? And what rates curve are you using behind that? If you could also, in 2024 – that’s my second question, detail your expectations on volumes, fees, cost and cost of risk, just to give us an idea what sort of scenario you have in mind in your growth in profitability for that year. Thank you.
Leopoldo Alvear
Okay, shall I take them? So I think we’ve given quite a lot of detail on deposit beta, but nevertheless, as I said, in Spain. For the first half, we have a deposit beta of second quarter 10%, first half is 8% in Spain. And this implies a fairly low beta on the retail part of things, well below budget. Higher beta around 20% or so in private banking, in line with budget, and then SMEs and corporates are obviously well below private banking also. So as I said, the overall number is 8% and this is well within our budgeted figures that we made at the beginning of the year.
As for the second question on 2024, the curve upon which I’ve made my assumptions is the forward curve right now. So basically, the rates stop raising by year end, and then they are stable for a while, and then they start to come down, but not very rapidly. Forward curve, basically.
And as for the rest, I would like to highlight that we haven’t budgeted, and therefore I don’t have the numbers, you know the precise numbers for 2024. Nevertheless, what we’re seeing right now, we believe that NII will grow. We don’t see how it wouldn’t grow in 2024, unless things change dramatically on the curves.
Fees, I guess after the changing mix of the insurance products this year should be fairly stable or growing. Costs should have an inflation, well, similar or below the one that we have in 2023. In other words, we will have wider jaws, okay. So the core results will be higher, if you wish.
And finally, in terms of the lower part of the P&L, well, there is – I have less visibility right now, because we’re still six months from budgeting, but we’re seeing zero, zero movement in terms of asset quality. So if I would have to say something right now, basically, I would believe that provision should be more or less in the level where we expect them to be for 2023, but we need to budget.
And then there’s one very important additional item, and it’s that this year is the last year where we are building up both the SRB fund and the deposit guarantee fund in Spain. Therefore next year, we expect basically no contributions for neither of these funds, because from now on, banks will only have to contribute depending on the evolution of total deposits. And I don’t expect total deposits for the system, neither in Europe nor in Spain, to grow materially next year.
Therefore, we’re talking about a big impact next year, just by bringing down both, the contribution to the four, which was €75 million this year or the contribution to the deposit guarantee fund in Spain, which last year was around €120 million, and this is what we’re expecting for this year. Neither of the two will probably be in our P&Ls next year.
Andrea Filtri
Thank you very much Leo.
Leopoldo Alvear
Thank you.
Gerardo Artiach Morenes
Thank you. Operator, let’s please move on to the next caller.
Operator
Next question is coming from B Borja Ramirez from Citi. Please go ahead [Operator Instructions]
B Borja Ramirez
Hello, good morning. Can you hear me?
Cesar Gonzalez-Bueno
Yes.
B Borja Ramirez
Perfect. Thank you for taking my questions. I have two quick questions. Firstly, on Mexico, if you could please update on the strategy. And then the second question is on the U.K., if you could please provide details on the risk appetite. And lastly, if I may ask, could you provide the retail deposit balances, the average retail deposit balance for Spain and the U.K.? Thank you.
Cesar Gonzalez-Bueno
So, on Mexico, I think the evolution of the return on tangible equity in Mexico has been quite spectacular in the last two years. And it’s proving very, very solid. But nevertheless, I think when we looked at Mexico, we realized that we were missing a little bit the retail part, because the cost of funding is mainly driven by retail. So we are exploring at this current point in time. We’re just exploring and no decision has been made. But it’s progressing – Mexico is progressing well.
Leopoldo Alvear
Sorry, on the UK, we have not changed the risk appetite. We said from the beginning of the year that for probably all our territories, at least U.K. and Spain, this was a year to focus on margin and not to focus on volumes, because the demand for volumes is subdued, if you wish. And therefore, if you want to increase your market share within a pie, which is not growing, this can prove to be a fairly bad decision going forward.
So, what we are focusing in both geographies, Spain and the U.K., it’s to protect our margins. And obviously, within margins, I include cost of risk. So, we’re not changing our risk appetite at all in the U.K. Remember that 90% of our loans are mortgages. Mortgage is a product in the U.K., which has a fairly low cost of risk, because the loan to value of these mortgages is very low in the case of TSB and this is in the region of 40%.
As per the average deposit balances in the U.K., we include this number in the presentation, £7,000. And in Spain, I would say it’s around €20,000, something like that. And in retail in Spain, it will be, I don’t know, much less, half that figure, probably €10,000 or so.
Gerardo Artiach Morenes
Thank you, Leo. Operator, let’s please move on to the next questions.
Operator
Next question is coming from Fernando Gil from Bestinver. Please go ahead [Operator Instructions].
Fernando Gil
Thank you very much. Can you hear me?
Cesar Gonzalez-Bueno
Yes, go ahead, Fernando.
Fernando Gil
Okay, thank you. Just a question on capital structure and ratings. I see that your capital structure on ratings regarding 81 buckets is a little bit, I would say, high. I wonder, given the fact that you can simply approval of the share buyback quite quickly in three months. I wonder if, and how you see the regulator when regarding potential tender offers of these ratings that I think should improve your capital structure and [inaudible] going forward. And related to that, if you can comment a little bit on the stress of results, just give a little bit of context to what we saw at the time.
Cesar Gonzalez-Bueno
I’m sorry, Fernando. I am sorry, but the line is a little bit faint, and I’m not able to understand you very well.
Fernando Gil
Now better?
Cesar Gonzalez-Bueno
I think so.
Fernando Gil
Okay, sorry. So first is on capital structure and how you see your bucket in 81’s, because to me it’s a little bit high, and how you see the regulator potentially thinking about tenders on these vehicles, given the fact that you have had a quick approval on the share buyback. And second, if you can comment a little bit on the stress test coming out on Friday, it will be okay. Thank you.
Leopoldo Alvear
Okay, thank you, Fernando. And sorry, we just couldn’t hear you before, this one was clear. The 81, well no, I think we’re going to – we’re not thinking of doing any kind of tender on the 81’s. We’re happy with the numbers that we have right now. As per the second question regarding the stress test, well as you know, this will be published tomorrow in the afternoon, after the market is closed. Therefore, we cannot share any of the numbers with the market.
In any case, I think the assumptions were harder in this adverse scenario than in previous cycles. But in general, I would expect European banks to show more resilience. Why? Because we start the scenario or the process with higher capital levels. We have lower amount of non-performing assets. And very important, especially I would say, in the case of the Southern European banks, especially in the Spanish banks, much greater capacity to generate income with a positive interest rate environment, as opposed to the negative interest rate environment that we had in the previous stress test. So if I would have to guess, I would believe that the depletion numbers should be lower.
Gerardo Artiach Morenes
Thank you. Let’s please move on to the next call.
Operator
Next question is coming from Carlos Peixoto from Caixabank. Please go ahead [Operator Instructions]
Carlos Peixoto
Hi, good morning. Thank you for taking my questions. So actually, most of my questions have already been answered, but I just wanted to make a follow-up…
Cesar Gonzalez-Bueno
Sorry Carlos, excuse me, we can’t hear you very well. Can you get closer to the mic please?
Carlos Peixoto
Is it better now?
Cesar Gonzalez-Bueno
I think it is.
Carlos Peixoto
Better now?
Cesar Gonzalez-Bueno
Yes.
Carlos Peixoto
Okay, sorry about that. So as I was saying, a couple of questions here. The first one is a follow-up on the cost of risk. I’m sorry, because I believe I didn’t understand. You expect cost of risk for next year in this first assessment of course, to be more or less stable or was it a slight improvement? Sorry about that.
The second question was a more detailed question regarding ICO loans defaults. And well, a couple of weeks ago, maybe a month ago, there was this ruling from a Spanish court regarding the ICO loan and the way that an ICO loan had been granted. I was just wondering here whether you see here risks regarding the effectiveness of the state guarantee in ICO loans, whether you see there this as a potential legal risk going forward, and what type of impacts could it have. Thank you very much.
Leopoldo Alvear
Sure. So the first one, cost of risk for 2024. As I said, it’s impossible for me to give you a precise number now because we haven’t budgeted. So what I was saying before is that given the current environment of NPA generation, which is pretty stable and better than what we expected last year, I am becoming a little bit more optimistic on this.
So when we budgeted, we thought NPLs were going to grow on the basis of inflation and interest rates. The truth is that inflation is coming down and wages are going up. So the affordability of clients has remained stable or improved from last year actually. And therefore, we see no movement in terms of delinquencies, not even in early delinquencies. These numbers, as you can imagine, I’m watching them very, very closely.
And there is no first indications of delinquency going up and therefore we expect NPAs to be broadly stable. And if I would have to guess right now, I don’t think cost of risk will grow next year. Whether it can go down, allow me to get through my budgeting process and have a little bit more visibility by year end. But at least I would say it should be roughly stable.
Cesar Gonzalez-Bueno
On ICO loans, I don’t think we have any concern from any legal issue of any sort.
Leopoldo Alvear
No, not at all. I don’t think so. As a matter of fact, there was something at the CNMV a few months ago, and that was basically surpassed. And we have not seen any increase in delinquency in these loans. I mean, when I look at the delinquency loans of ICO loans, obviously, I compare them with the total amount drawn, because this is a wind down book. And therefore, the final picture of this book will be 100% NPLs, because it will be the loans that have not been repaid. But when you take into account the delinquencies on the total amount drawn, it’s very, very, very stable.
It’s important to note that ICO loans were mostly granted to companies in sectors which were the most affected during COVID. This is hospitality, tourism, or services. And precisely those services – sorry, those sectors are the ones that are booming right now. And that’s why probably the outcome of delinquency on ICO loans in general is being much lower than what we all could have expected.
Gerardo Artiach Morenes
Thank you. We have three more callers. If you don’t mind, we’ll try to squeeze them. So let’s please move on to the next one.
Operator
Next question is coming from Ignacio Cerezo from USB. Please go ahead [Operator Instructions]
Ignacio Cerezo
Hi, good morning, and thank you for taking my questions. Two quick follow-ups. One, I’m sorry if I missed it, actually. I think there has been a release of litigation provisions in the quarter. So if you can give us some color on what is that and prospects basically of that lining to next year. And the second one is if you can give us some sensitivity to 100 basis points rate cut in both TSB and ex-TSB. Thank you.
Leopoldo Alvear
So on the first one, there has been some release on some litigations, especially in TSB. The good news, in my opinion, in this line is that we have seen no new issues being raised in the last probably three years or whatever, no 2.5 years. So basically, we are providing for the details of things that were already on the table. This is mortgage expenses, floors on mortgages, real-estate developers or credit cards if you wish. So basically, I would imagine that this line should go down next year as it has been the case this year. If, again, no new issues are raised, which is not the case today.
As per the sensitivity, well, this is very difficult to predict. In order to see the regulatory sensitivity that we publish in our annual accounts for a rate, probable rate increase of 100 basis points and we have around 16% increase of NII in the second year, because not everything reprises in the first year. So in two years, you would reprise 16% NII.
And for a decrease, it would be fairly similar. So it’s very parallel.
Gerardo Artiach Morenes
Thank you, Leo. Operator, let’s please move on to the next call. I will ask you to make brief questions, please, to try to adapt to the other two callers.
Operator
The next question is coming from Britta Schimdt from Autonomous Research. Please go ahead [Operator Instructions].
Britta Schimdt
Yes, hi there. Two quick questions, and I’m not sure if they’ve been asked before, but the ROTE improvement in 2024, would that also be the case without any Nexi gain? And then secondly, the outlook for other expenses in 2024, you point to the SRM charge decline, but you also expect the deposit insurance charge to decline in Spain. And what would the overall amount be you expect for next year in that line? Thank you.
Cesar Gonzalez-Bueno
So on the return on tangible equity and you will give more color Leo, but on the return on tangible equity for 2024, it should grow on the back of customer NII, ex-TSB, higher loan yield, which will more than cover the increase in deposit costs. Also, some non-customer NII from ALCO wholesale and liquidity, marginally positive. And TSB, flat NII, that’s what we expect versus ‘23, because of the structural hedge that will offset pressure on volumes and margins.
So if I understood your question, is it without any extraordinary results, the improvement in return on tangible equity in 2024? The answer is yes.
Leopoldo Alvear
That’s correct. And as per the contribution to the funds that I mentioned, SRB is finished. It’s already been built up. And our understanding is that that is the same case for deposit guarantee scheme after the contribution that we will make, the banks will make this year. So both numbers should go down. I don’t know if to zero, but to something fairly negligible, because from now onwards, we will only contribute for the difference on the total deposit base, both in Europe or in Spain, and we don’t expect those to grow next year.
As per how much is that, the SRB contribution has been €74 million this year, and for the deposit guarantee scheme, we are expecting something around €120 million. So we could be talking about €200 million before tax figure for next year release.
And as per the return on tangible, as mentioned by Cesar, we’re not including here the potential capital gain that we can make once we sign and finish the joint venture with Nexi on our merchant business, which will come through in Q1 next year, hopefully.
Gerardo Artiach Morenes
Thank you, Leo. Thank you, Cesar. We have one final question. Operator, could you please give access to this last call?
Operator
Last question is coming from Hugo Cruz from KBW. Please, go ahead [Operator Instructions]
Hugo Cruz
Hi, thank you for the time. Just two quick questions. First, your cost of risk guidance for this year, which I think you said around €1 billion, how much does that split between loan loss provisions and other provisions? And this is a good market, I think. Are you thinking about accelerating the cleanup of foreclosed assets and NPAs? And the second question on trading income, it’s quite volatile always every quarter. I wonder if you could give any guidance for the rest of the year. Thank you.
Leopoldo Alvear
So on the first one, I would say that out of the less than 60 basis points provisions, in the first quarter, credit cost of risk amounted to 45 basis points, and total cost of risk amounted to 56 basis points. So I would assume that that’s going to be the split going forward for year-end, being total cost of risk below 60 basis points. So this amounts to a total number of €1 billion, and you can make the numbers with this 45 and 60 for both credit or total cost of risk.
As per the NPAs, we are reducing NPA. I mean, the good news is that we have a very stable market, if you wish. So we’re not seeing, as I said before, any kind of delinquencies raising, and therefore we expect a more or less stable market throughout the course of what’s left in the year.
And finally, as per trading, well, there are some positive contributions are coming from the positive performance related to interest rate swap with our customers. This is volatile, so it’s very difficult to give you a precise number, and they’re not recurrent. So I would expect a lower contribution in the coming quarters, perhaps in a rate of, I don’t know, €10 million, €15 million per quarter. But this is very difficult to predict because it’s extremely volatile, and it depends on the movement of interest rates.
Gerardo Artiach Morenes
Thank you, and thank you all for your questions. Thank you, Cesar and Leo for your answers. We now wrap up the Q&A session. As always, the full IR team is available for any further questions that you could have.
Once again, thank you all for your participation and for joining us today. For those going on holiday soon, have a good break.
Cesar Gonzalez-Bueno
Thank you all.
Leopoldo Alvear
Thank you very much.
