Caixabank SA

MAD:CABK

Earnings Call Analysis

Strong Quarter with Upgraded Guidance

CaixaBank reported impressive results for Q2 2024, with net income jumping over 30% to EUR 1.67 billion year-on-year. This growth was buoyed by a 7.5% year-on-year increase in service revenues and a notable 20% rise in Net Interest Income (NII), primarily due to strong deposit volumes. The bank has upgraded its FY 2024 NII guidance to high single-digit growth. The bank's Non-Performing Loan (NPL) ratio improved to 2.67%, and it reaffirmed its guidance for cost-of-risk at 30 basis points annually. CaixaBank also expects Return on Tangible Equity (RoTE) to exceed 17% for the year.

Strong Q2 Performance and Upgraded Guidance

CaixaBank reported a strong Q2 performance, with net income reaching €1.67 billion, up over 30% compared to the same period last year. This increase was primarily fueled by higher net interest income (NII) supported by rising deposit volumes and improved liquidity. As a result, the bank has upgraded its fiscal year '24 NII guidance to high single-digit growth.

Diverse Revenue Streams

Revenues from services saw impressive growth, up by 7.5% year-on-year. Wealth management revenues and protection insurance showed double-digit growth, a clear indicator of robust underlying trends and positive market effects. Banking fees have also shown signs of recovery, contributing to the bank's optimistic outlook for continued revenue growth.

Cost Management and Profitability

CaixaBank continues to manage its costs effectively, reiterating its guidance to keep cost growth under 5% for the year. The cost-to-income ratio has breached the 40% mark, now standing at 39%, thanks to strong revenue contributions. With a comfortable NPL coverage ratio of 70%, the bank's cost of risk is down to an annualized 23 basis points, consistent with a ca. 30 basis points target for the year.

Capital Strength and Shareholder Returns

The robust capital generation continued, achieving a CET1 ratio of 12.22% despite deducting for a substantial share buyback program. In line with its enhanced profitability, CaixaBank has confirmed its plan to distribute €12 billion to shareholders over three years, with €7.4 billion already executed and €1.3 billion announced, including a €500 million share buyback【4:0†source】.

Positive Outlook on NPL and Liquidity

Non-performing loans (NPL) were actively managed down to €10.5 billion, achieving a historically low NPL ratio of 2.67%. The liquidity position is strong, with more than €200 billion in liquidity sources and a liquidity coverage ratio of 218%【4:2†source】. The bank expects NPLs to remain around current levels for the rest of the year.

Guidance and Financial Targets

As a result of the improved performance and outlook, the bank has upgraded its return on tangible equity (RoTE) guidance to above 17%. The upcoming Investor Day in Madrid this November will further elaborate on these positive projections and strategic directions【4:13†source】.

Sustainability Achievements

CaixaBank surpassed its three-year sustainable finance target, reaching €67 billion by June, ahead of the €64 billion goal set for December. This highlights the bank's commitment to sustainability across environmental, social, and governance dimensions【4:7†source】【4:19†source】.

Earnings Call Transcript 2024-Q2

[Marta Noguer, executive]

Good morning, and welcome to CaixaBank results presentation for the second quarter of 2024. As usual, we are joined today by our CEO, Gonzalo Gortazar, and our CFO, Javier Pano. A reminder in terms of logistics, we plan to spend about 30 minutes with the presentation and about 50 minutes to 1 hour with the Q&A. The Q&A is live, and you should have received instructions by e-mail on how to participate.

Let me end by saying that my team and I will be at your full disposal after the call. And without further ado, Gonzalo, the floor is yours.

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Marta, and good morning, everybody. I would start with the highlights. I was going to say, have a good holiday, but you probably still have a few days at least before that. But in any case, I said it in advance.

For us, we closed this first half of the year with, as you've seen, this is like very strong operating momentum. And I would say this is the thing that I would like to highlight the most. Activity levels are very good to the extent that they suggest that we've reached an inflection point in terms of activity.

Obviously, we need to see how things go in the next quarters to confirm that. But the good news we had on the economy yesterday, the figures that we're seeing, particularly this quarter, the reasons why we're seeing them in terms of activity are suggesting and certainly are creating a good sense of what is in store for us in terms of business volumes in the next quarters and years.

You can see here loan growth. And there's both the new lending, up 10.7% if you compare this year versus the first half of last year. And the loan book up 2.2%. There is some impact there of seasonal aspects that we'll discuss. But it is, in any case, very robust relative to the past performance, including the fact that mortgages are now the stock. Mortgages have grown in the second quarter. And obviously, in terms of new mortgage production, as you can see, that is up 43%.

It's even, I would say, more remarkable when you look at the customer fund side. And here you have 5.9% growth in this first half of the year. Most of it, as you can see, is in the quarter. And obviously, there's, again, some seasonality, but still very robust figures for just half of year.

Net inflows into wealth products up 25%. Protection insurance, in terms of premia, up close to 11%. These are figures that we haven't seen for very, very long, I have to say. And I would say this is certainly the most remarkable part of the second quarter. There's obviously profitability that has worked very well, associated to both better management of all NII-related matters, but also fees generally associated to activity. And you have there NII and wealth and protection revenues. NII, 20% up. Wealth and protection revenues, 12% up. Cost of risk in line, and hence, net income up 25%.

That is leading us to upgrade our expectation for return on tangible equity this year to be above 17% at the end of the second quarter. And looking at the last 12 months, as you know, we are always looking at the last 12 months rather than the quarter annualized, because it would be much higher. But if we look at the last 12 months, which then includes tax on banks, et cetera, is 17% or 16.9%. And obviously, the upgrade in guidance for NII with that high single-digit growth from the mid single-digit that we had after the first quarter.

Capital is still very robust, and hence, we can be confident that we will complete our commitment to deliver that EUR 12 billion in this 3-year period. So a very good quarter financially. And I want to take the opportunity to remind you that beyond our good financial results, we continue to have a position as a different bank. That's what we want to think of us, being different in terms of our commitments to financial inclusion, which continues.

And basically, our ability to bank in over 3,000 towns in Spain, microcredit activity through MicroBank, various social housing solutions that we offer into our clients and our volunteering activities, long list of social commitment, which makes us different and obviously, the relationship with the Caixa Foundation.

This particular quarter, I'm proud to see that we have actually exceeded our 3-year target for sustainable finance. We had a 3-year target published of reaching EUR 64 billion. That would be the target by December this year. Actually, in January -- sorry, in June this year already, we're at EUR 67 billion. So we have exceeded that 3-year target, which makes us obviously very happy and proud of what we're doing in this part of the business.

But I just want to remind you, these things are still very much a unique characteristic of what we are. And we'll continue to position the bank from a sustainability perspective on the social, on the environmental, and obviously also on governance as a reference in ESG in Europe.

Talking about the economy. I mentioned before the robust economy. We had these numbers of 0.8% growth just in the second quarter for Spanish GDP yesterday. We actually embedded estimating these numbers, the 2.4% for the whole year, had a 0.5% growth in the second quarter. That 0.5% is now 0.8%. So obviously, I am convinced that they have already said. So our research team will be upgrading this GDP estimate for 2024 at least in the coming weeks.

But in any case, these are very good levels in Spain, also in Portugal, and certainly better than the eurozone, which is obviously, in any case, doing better than what it did last year. PMIs are a clear example of the status of the economy. You see the data there. But also looking to more current data, actual labor market evolution and tourism are 2 pretty good examples.

I'd like to highlight on the right-hand side the household saving rate, which is close to 14% at this moment. It's actually obviously very high compared to historical levels. And obviously, if we have that kind of savings rate, that's going to have good implications for us, particularly in the evolution of customer funds, which we have seen, as I mentioned in this quarter, as pretty impressive.

Investment is something that is relevant to highlight. In the figures from yesterday, we saw CapEx or the fixed capital formation, above the 0.8% for the economy, and clearly much higher than we had seen it recently. It's actually happened at the same time that we have seen a better appetite for lending from our clients.

So it doesn't seem to me that it is a coincidence. And hopefully, that means that we can see also not just the liability side of the balance sheet and the up balance sheet, because savings rate is high, but also the asset side of our balance sheet also growing as loan demand picks up over the next quarters and years.

Numbers for new lending production, you see them, it was per half on half is 10.7%, as I mentioned before. And in this quarter, it was obviously even higher. Margins are good. The loan -- the front book yield is growing, still growing, 11 basis points. And you can see, if you go segment by segment, very strong growth in mortgages, but pretty good levels in consumer lending. And also in business lending. So it's across the board, something that we haven't seen with this visibility for quite some time.

In terms of stock of loans. The performing loan book, and Javier will mention, we have obviously managed the NPLs downwards during the quarter. If we just look at the performing loan book, it's up 2.2% year-to-date. And as you can see, it's basically all this quarter with business lending up 2.3% year-on-year, consumer up 4.4% and residential mortgages, although declining year-to-date, already showing an increase in the quarter-on-quarter. And on the right side, the bottom of this page, you see that evolution of residential mortgages, how is the stock of residential mortgage loans doing, and it clearly is showing the right trends, no?

So pretty good performance on the asset side. And on customer fund side, I said it was very good performance with that increase, 4.9% just in the quarter. We do have some seasonal impact here, somewhere around, I would say, EUR 10 billion, EUR 12 billion, possibly that are more seasonal, but even if you adjust for that, you see a very strong growth rate across the board, certainly in wealth management, but also on balance sheet deposits. And as you can see, year-to-date, we're gaining 30% basically, and round numbers in both off balance sheet wealth management and on balance sheet deposits.

So this is one of our key strengths. We don't like to say it's the most important strength that we have, but certainly it's one of the most, our ability to gather customer funds, it's our history, and it seems that we're doing at our best, certainly year-to-date. And my expectation is that we can continue to do reasonably well.

Wealth management. Very quickly, you see the figure for net inflows up 26%, 1/3 is savings insurance, 2/3 is pension and mutual funds, actually mostly mutual funds. And again, market share gains in each of these segments, mutual pension and savings insurance, this is, I think, I see we're back to where we were before the large integration that we did 3 years ago, recovering our cruise speed and nicely gaining market share as we go.

Protection insurance. MyBox continues to be a superstar for us, balanced production between life risk and non-life, and within non-life health, home and auto. Total premia up 10.9%, gaining market share, you see in the bottom left, particularly on life risk, is almost one percentage point year-on-year. And as you know, we still have good potential, clients, former banking clients have increased the penetration of these products in a big way from 10.8% to 15%, still behind the 20% for our other clients. So good penetration potential, and certainly for the entire country as we are well below the Eurozone.

When we look at BPI, obviously BPI will be presenting results or is presenting results today, and you have all the full detail, but just to highlight. Net income with a 44% increase, return on tangible equity above 20%, and cost income below 39%, the same figures as we have for the group. And again, excellent asset quality indicators, and most important, BPI continues to grow and gain market share, you see there some of the numbers. This needs to be a gradual process. In retail banking, you don't gain market share at much faster rates than this. And if you do it, sometimes it's because you are not thinking through all of the consequences of that growth. But this steady growth and gains in market share have characterized BPI since we took over. And I think we are going to see much more in the future. Good growth, good profitability, sound asset quality, and sort of all the characteristics to continue giving us good news.

Net income, not a surprise, mostly is a result of increasing revenues with costs and impairments reducing the extent of the improvement, but still a 25% improvement and a major gain in efficiency.

And to finish up with my part. Capital, again, shareholder remuneration is critical for us. You have here the numbers of our EUR 12 billion target. Remember, it used to be EUR 9 billion, but we upgraded that some time ago, as the conditions and our performance was much better than what we were initially expecting. Here we have EUR 7.4 billion that have been executed. Another EUR 1.3 billion have been announced, so that includes the EUR 500 million share buyback, which we are starting today.

And the interim dividend, which at a minimum, if we were to choose the bottom of the range that we gave of 30% to 40% of the profits up to June, at the minimum would be EUR 800 million. So that's the EUR 1.3 billion announced. The interim dividend will be confirmed at what level, it is in, when we present the third quarter results. And then there's another EUR 3.3 billion pending, which obviously will be a combination of the ordinary dividend payout and some extra extraordinary or special distribution to be announced in due course.

So higher profitability, good activity levels. Growth is gradually, but it is coming back. And obviously a very capital-rich P&L and evolution, which makes us, I think, quite satisfied with what we have delivered so far this year.

And I will let, obviously, now Javier to get into the review of P&L and balance sheet. Thank you.

[Javier Pano Riera, executive]

Okay. Thank you. As usual, from my side, additional details on the P&L and the balance sheet. Well, here you may see something you already know very well.

Net income EUR 1.67 billion for the second quarter. This is up by slightly over 30% compared to the second quarter last year. I could say that our key revenue P&L lines are doing really well. I would remark on NII that is up quarter-on-quarter with support basically from deposit volumes and that this is resulting into higher average liquidity this quarter. We come to the details in the following slide.

Also on revenues from services, we have had a strong quarter, as you may see, up by 7.5% year-on-year, 4.7% quarter-on-quarter with management, with sustained growth, protection insurance with really strong commercial dynamism. And finally, banking fees showing signs of recovery in the quarter, both in recurrent and in non-recurrent banking fees that are up on a quarter-on-quarter basis.

On other revenues, I would basically mention that this year, this quarter, we no longer have the contribution to the single resolution fund, hence, we have on other revenues clearly an improvement compared to last year. Further down the P&L, on cost, not much to comment. Everything is in line with our expectations and planning to meet our guidance.

Loan loss charges in a quarter with compared to the recent quarters with lower loan loss charges, but also on track to meet our guidance, everything evolving in line. And finally, other provisions that are mainly reflecting higher provisioning levels for legal contingencies, something that we already highlighted in the previous quarter.

With that, let me go into the details for NII. Upper left, you may see the evolution year-to-date, up by slightly over 20%. And in the usual quarterly bridge in the center, we are highlighting here precisely the contribution of higher liquidity from a widening of the commercial gap, which is contributing specifically by EUR 39 million in this second quarter.

Below, bottom left, you may see the evolution of the customer spread, 358 basis points. It's the same level we had at the beginning of the year. And then in the center, yields, the bad book deal of the loan book, 459 basis points, down by 3 basis points, already somehow impacted by lower market rates. Also, you may see the evolution of the cost of our client funds, considering ex-hedges and foreign exchange, at 81 basis points. This is up by 6 basis points, but this is less than the 10 basis points on the previous quarter.

And precisely on that front, you have on the right, additional information. Here, we are disclosing the [indiscernible] of interest-bearing deposits over total deposit balances. This is end of period, so this is by the month of June, and this is standing at 22.9%. This is an increase of 1.5 percentage points, but basically on the back of the very strong inflows we have had during the quarter.

At the same time, we are disclosing the yield of those same interest-bearing deposits, and you may see that it's already trending down, now at 2.91%, and the peak being, by the end of last year, at 3.06%. With all that, but basically on the back of those strong inflows, basically on deposits, and a better tone in volumes in general, we are upgrading our fiscal year '24 NII guidance to high single-digit growth.

Let's move now to the other key revenue line, which is revenues from services. As I said before, it's gaining traction this second quarter. On the left, you may see the evolution year-to-date, up by 4.4%. This is a combination, remember, of wealth management revenues, protection insurance, plus banking fees. You may see that protection insurance and wealth management are growing at double-digits year-to-date.

On wealth management, we have already said, no strong inflows, also positive market tailwinds, the market-to-market effects are clearly positive this year. And on protection insurance, strong organic trends, but I would like to mention also that we have had a positive one-off this second quarter out of Portugal.

On banking fees, although negative year-to-date, we are seeing that on a quarterly basis, banking fees are resuming growth on higher CIV and transactional activity, as you may see, up by 1.5% year-on-year and 6% quarter-on-quarter. We are reiterating our guidance for revenues from services, and remember, low single-digit growth for this year.

I move to costs. First, I would like to remark is that we are reiterating our guidance, remember, for costs to grow by less than 5%, although we are going to be very probably, at the upper bound of this guidance for this year. And on this slide, I would basically remark the very good evolution of our cost-to-income ratio, breaching the 40% mark, already at 39%, and as you may see on the bridge on the right, basically with a strong contribution from revenues.

Cost-of-risk. I already said, is a quarter with slightly lower loan-loss charges compared to recent quarters. Actually, it's an annualized cost-of-risk of 23 basis points. We are reiterating our guidance for cost-of-risk for the year, circa 30. We are keeping a very comfortable NPL coverage ratio at 70%. We have assigned this quarter EUR 273 million of the unassigned collective provisions, but we still have EUR 550 million left.

Moving now to the P&L and continuing -- sorry, to the balance sheet and continuing with NPLs. Here are a few comments on the stock that is down by EUR 300 million to EUR 10.5 billion, and this is despite the full alignment this second quarter to the new definition of default. Remember that this was something that we had pending, with some impact during the first quarter, but the final impact already fully in the second quarter.

But this is more than offset by active management. We have been, basically with some NPL portfolio disposals this second quarter, but basically very underlying -- very supportive underlying organic trends in terms of new NPL formation. As a consequence of all that, we are ending the quarter with an NPL ratio at 2.67%, which is basically the low we have been in recent times. You have also the breakdown by segments, and as you may see, there is not any single segment that is far from the average, so no issues in any particular segment. We are improving our views on NPLs for the year, and now we are expecting to remain around current levels throughout the rest of the year.

Liquidity. Here an even more ample liquidity position, on the back of precisely that good performance in terms of deposit volumes, a liquidity cover ratio at 2.18%. Also the rest of the liquidity metrics, really comfortable ones, more than EUR 200 billion of liquidity sources, specifically EUR 214 billion. We keep our deposit funding basically at very comfortable levels, close to that 80-20 between retail and wholesale, although with some increase in wholesale precisely on the back of the strong inflows, many of those being seasonal, impacting our wholesale deposits.

On capital, it's a quarter of really strong organic capital generation, but before that let me highlight that we are already fully deducting the EUR 400 million, EUR 500 million share buyback. This is minus 22 basis points on our CET1 ratio. From there we have 66 positive from organic capital generation, minus 46 basis points from dividend accrual and coupons, and then finally it's a quarter with no material impacts from markets or other. So with that we are ending the quarter with a CET1 ratio of 12.22% and an MDA buffer at very comfortable levels, 343 basis points.

On the right you may see the evolution of the increased shareholder value we are delivering on tangible book value basis, up by more than 10%, once including obviously the dividends paid, a tangible book value per share that is ending the quarter at EUR 4.15, and that reminder, this interim dividend expected to be paid in November of at least EUR 800 million, the final and formal decision to be taken by the board in the month of October.

And here you have a summary of our guidance and financial targets. We are highlighting what has changed, that is basically all improvements, NII upgraded to high single-digit growth for the year. NPLs expected to remain around second quarter levels for the rest of the year. And as a consequence of these better views and upgrades on guidance, we are also improving our view for RoTE to deliver better than 17%.

And finally, just a reminder, we are planning to hold our Investor Day in Madrid, November the 19th, so please save the date and we will be very happy to see you there. So thank you very much. And ready for questions.

[Marta Noguer, executive]

Yes. So operator, can you please let the first question in?

[Operator]

Thank you. The first question is from Antonio Reale of Bank of America.

[Antonio Reale, analyst]

Hello, good morning. It's Antonio from Bank of America. I have a couple of questions, please. The first one, we're half the way through what seems to be another good year and we've seen some banks starting to plan for future years. I'm conscious you have a business plan later this year. But how much of your profitability you can defer to next year across your key P&L line items? I mean, for example, I've seen you haven't changed your cost of risk guidance despite the better trend. So what appetite do you have to frontload charges, top up more coverage, or even consider cost savings in order to protect future profitability?

My second question is similar, but applies to NII. Can you talk about the key assumptions behind your new NII guidance, please? I ask you this because, of course, you've grown your deposits by over EUR 20 billion in one quarter. Now, I understand this is analogy effect, I think you mentioned EUR 10 billion to EUR 12 billion, that's still a big number.

Then on Slide 28, you've increased your hedges by another EUR 7 billion or so, and this should be a boost to your NII, probably more meaningful than what your guidance implies. So I'm trying to understand and put things together, how much of this is split between '24 and '25 in the context of your new guidance?

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Antonio. Let me try to answer the first question, and obviously Javier is much better equipped to answer the second one. Obviously future profitability is very important, we're having a very good year. There's a sense a bit of deja vu vis-a-vis in last year when everybody was saying, okay, 2023 is going to be great, but how about 2024? You can see 2024 has become better than 2023, clearly. We understand, obviously, the need to look beyond this year, and obviously rates are going to have an impact in future profitability, but it's only one part.

When I looked at the environment, when I look at the level of activity, when I look at what we're doing in our core businesses in insurance and wealth management in general, I am actually very optimistic. So I see no need, and certainly also we do not like to sort of manage profitability between years. It's something that is not in our strategy to do so. But it means that we're fairly confident about the future, and we see plenty of opportunity. So no, there's nothing that we have, certainly, in mind of that sort.

[Javier Pano Riera, executive]

Okay. Antonio, thank you. Well, on NII, there are obviously several questions related to that. Well, basically, the improvement on guidance is based more on volumes than on rates, because actually for 2024, what happens to rates has a limited impact. But in any case, what we have had or at least for rates priced for 2024, the evolution, at least up to the end of June, has been a positive one. So it's -- basically, the driver is deposits.

So you saw, as you already mentioned, quite a strong increase. It's approximately like EUR 20 billion in the quarter, of which approximately half of that may be considered seasonal. But our experience from other years is that, okay, then the payback during the third and the fourth quarter is not exactly that fewer. So at the end of the day, the average balances into next quarters usually are more positive than at least our initial expectations. So that is a key driver here. Basically, it's about what we are improving in number of clients.

So after some time with some friction after the merger with Bankia, we are now growing in terms of number of clients. So this is obviously a positive effect into deposits. And already Gonzalo mentioned, but we are observing that the savings ratio in Spain is higher than our initial expectations. It's at double-digits. It was clearly below double-digits before the pandemic.

And this is a new development that for sure is very positive for us because we are very good at deposit gathering with a strong transactionality with clients. And this is what is happening, so that we are observing that our transactional balances are improving. And, well, that's definitely very positive news going forward.

You could see that there is a slight increase on interest-bearing deposits to 22.9% when you look only to client, deposits from clients and we have deposits from other kinds that we are not considering here, but it's 22.9%. But at the same time, let's say that the back book yield of that part that is interest-bearing is already trending down.

So at the end of the day, when you have strong inflows, so it's very difficult to avoid that percentage of interest-bearing deposits is increasing because in several cases you have like corporates, SMEs that already have a current account with a yield that is already agreed with the bank. Those balances increase. So it's something that actually you cannot fully control.

But in any case, we think that we are really on track to meet -- I remember the previous quarter mentioning that we were envisaging an average cost of our client deposits, circa 80 basis points, once you exclude hedges and foreign exchange, and we reiterate that view. So I think that we are going to be there. So we are of the view that we have a lot of visibility, so now the pace of increases into interest-bearing deposits is going to be declining progressively.

And then you have to keep in mind that we have approximately circa 45% of our interest-bearing deposits that are fully indexed. So the replacing is automatic. So as a consequence, with lower rates, we will have automatically the visibility there.

So on the loan book, although it has a lower impact on NII, the fact that it's evolving well, it's always a positive. Consumer lending also doing well, growing over 4% year-to-date. This is a high-yielding portfolio. So that's good news, and obviously it's also a contribution to NII.

You mentioned hedges. Yes. We are keen to continue taking any market opportunity we consider makes sense to increase hedging in order to limit the sensitivity of NII. Keep in mind that this is like a moving target, because the balance sheet is not static. So as the balance sheet changes, the mix, the volumes, you have to adapt. We have added EUR 7 billion approximately with an average maturity between 3 and 4 years. And we will continue looking at -- on ways to have the sensitivity of our NII within those ranges that we consider appropriate that, for the moment, is with that circa 5% sensitivity to a parallel move on the yield curve.

And you had like a question for 2025 or related question. I mentioned on the previous quarter that on NII for 2025, that we saw that the market consensus was a little bit too low. Well, not a little bit. We were considering that there was clear upside. It was back then at EUR 9.7 billion. Now it's at EUR 10.2 billion. We continue thinking that at EUR 10.2 billion there is still some upside. And it's probably increasingly more based on volumes than on rates. Let's see where rates settle. But we are more a bit on the volume front and think that, going forward, this is a key driver for our NII. I think that I have touched several things, but probably were connected to your question, broadly speaking.

[Marta Noguer, executive]

Operator, next question, please.

[Operator]

The next question is from Sofie Peterzens of JPMorgan.

[Sofie Peterzens, analyst]

Yes, hello. This is Sofie from JPMorgan. Thanks a lot for taking my question. So a little bit related to the previous question. We saw that there was 3 basis points decline in lending rates quarter-on-quarter. Could you maybe just elaborate a little bit on how we should think about the lending rate compression going forward and kind of what the key drivers are? And also, related to this, on the volume side, you gain market share, but so did some of your peers. Could you maybe just comment from whom you're gaining market share?

And then my second question would be that your core equity Tier 1 was 12.2% end of the second quarter. Do you still target EUR 3.3 billion of additional shareholder remuneration? How do you ensure that you have enough core equity Tier 1 due to pay this EUR 3.3 billion to shareholders because if you assume EUR 800 million or EUR 1 billion share buyback, that would be like 30, 40 basis points of core equity Tier 1? And maybe related to this, if you could just remind us what your capital tailwinds and headwinds going forward are?

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Sofie. If I may start, we are doing well in terms of activity and gaining market share. I don't think this is particularly focused on gaining market share out of one particular competitor. Obviously, all competitors are doing reasonably well in the market, but our numbers in terms of activity, particularly in the customer front side, really outperform all of them by a significant margin. And I think this is about what we are. And maybe in the last 3 years with integration, pandemic, and an increase in interest rates, this thing has sort of been diluted a bit.

But if you look at our history, our ability to grow faster than our competition has always been there on an organic basis. And I think that DNA is still with us. And hence, I wouldn't point to any particular competitor as the one that we are taking market share from indeed. In terms of capital, well, Javier can elaborate. But obviously, the EUR 3.3 billion includes a large part dividend, which, as you know, we are accruing at 60%.

So it's in the numbers plus the profitability that we'll have in the second half, and we are generating core equity Tier 1 pace that is beyond the consumption from these sources. So from these 2 sort of buckets will come the excess capital that we need to generate to pay this EUR 3.3 billion. Obviously, we are in June, 6 months away from this end of 2024. We wouldn't be reinforcing our guidance if we had doubts about our ability to get there. But Javier, there were some further questions on…

[Javier Pano Riera, executive]

Yes. You had an initial question on the lending rate. And well, that had to come down a few basis points. Well, here, it's obviously already repricing that is starting to take place. And lower rivalries is already having some impact. Also, you need to take into account that as you increase new mortgage production, and mortgage yields are fixed, basically, we are making like 2/3 at fixed, and the yield curve is inverted. So you are pricing mortgages at a lower yield than, let's say, the average of the loan book. And this is also having a small impact.

So I think that we have to get used to the fact that, to some extent, the inverted yield curve plus negative re-pricings will start having an impact. I think that this is completely normal and expected. But here is precisely to the previous question, when I was mentioning that volumes are increasingly having -- well, the weight of volumes is having an increased importance in trying to forecast future evolution on NII. And on that front, we are happy to see that our, let's say, traditional deposit gathering capability or factory is at full steam. And we are doing really well on that, and we are quite a bit on the future evolution.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Maksym Mishyn of JB Capital.

[Maksym Mishyn, analyst]

Thank you very much for the presentation and taking our questions. I have a couple. The first one is a follow-up on the loan book. Could you please give us a little bit of more detail on the corporate loan book and the new production? What kind of maturities do you see more demand from? Is it mostly short-term financing, or do you also see longer-term financing demand? And then, do you expect the phase-out of ECO loans to cause a cliff impact at your loan book at some stage?

The second question is on the fee revenue line. Could you please share more detail on the one-offs, the ones from BPI you mentioned during the presentation? And what prevents you from becoming more positive on the outlook for 2024? And lastly, on capital, several banks have improved their expectations on the impact of Basel IV, and I was wondering if you still expect a neutral impact on your capital?

[Gonzalo Gortázar Rotaeche, executive]

In terms of loan book growth on the business side, and corporates, working capital growth has been slower than longer-term funding. So that's the answer. There's more long-term here, and it's only one quarter. But perception is that there's something more structural than just a pickup and lending that we had associated to, at some point, for instance, inflation and working capital. Working capital lending this year, month by month, is below the levels of last year. And obviously, that's not true for the rest of the book.

So it's a good feeling there. And with respect to ECO, we are not expecting any cliff effect at all. There's already a good amount of the ECO loans that have been repaid. And frankly, at this stage, I think this is just not a thesis, but a reality that these were, both in terms of volumes and in terms of asset quality, this is being managed properly, without any cliff effect. And capital and others.

[Javier Pano Riera, executive]

Yes. Hello, Max. Well, actually, if I may add, actually ECOs, the maturity of ECOs is accretive in terms of yield, because the yield, the back book yield of ECOs is lower than current, let's say, new origination for SMEs. So well, the one-off on fees, this has to do with a legacy live risk portfolio in BPI that was basically originated well before we took control of BPI. And actually, there is an agreement with the third party that was underwriting the risk to early terminate that portfolio. And as a consequence of that, there is EUR 16 million positive 1-6 in this quarter. And the impact, let's say, the running impact going forward is so long-term that is actually not material. So that's the one-off that is on protection and protection revenues.

And well, you mentioned about the future evolution in general. Well, we are positive. So on fees, we are happy to see that on banking fees, we are in a better -- we have a better tone. You may remember me by commenting the headwind we were having on current account maintenance fees. Well, on that front, it looks like we have settled at a level more or less stable. So that's a positive. And well, then it's about transactional fees, et cetera. The second quarter has been really strong.

The third quarter is more seasonal, so you cannot extrapolate what happens in the second quarter to the third. And the fourth quarter, we are positive. But let's see if the good tone we have had in the second quarter is at the same level exactly or not. So we'll see. We stick with this guidance for, let's say, other key revenues, that is protection plus wealth plus banking fees on low single-digits, probably at the upper bound of that. But we stick with that guidance.

And on Basel IV, no changes. So no impacts, not at implementation, not on phasing. When I say no impacts, it's not exactly zero, but this is maybe dependent on the final figures, the final balance sheet we have, et cetera. It may be a few basis points, positive or even negative. But in any case, you can consider it's completely non-material.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Ignacio Ulargui of BNP Paribas Exane.

[Ignacio Ulargui, analyst]

Thanks very much for the presentation and for taking my questions. I have 2 questions, if I may. I mean, one is on having a bit of a sense of how do you see the profitability levels of this new business in the context of a stronger lending demand that you were flagging before. I mean, do you see it accretive to your current [ RRT ] targets? It's worth investing that money, that capital.

And the second question is, how should we think about wholesale funding cost in the context of lower rates? I understand that you have most of your wholesale funding swapped. I just wanted to get a bit of a sense on how do you see that part of the NII going forward?

[Gonzalo Gortázar Rotaeche, executive]

On the first question, we definitely see the growth is going to be accretive to the current situation. So volumes are going to be important. And we have obviously a large platform. And on a marginal basis, what we are going to be adding in terms of growth is obviously going to have the associated funding costs. But basically, with our platform, we can put more activity. We're going to be more profitable.

I think this is one of the better news we have, is obviously when we look at the next plan and the next 3 years, we'll have time to discuss it in November. But this is going to be a very different environment with growth incorporated. And this growth is going to obviously make it a more attractive proposition for us to take initiatives and obviously also a more profitable institution.

So we are clearly looking at growth. It doesn't mean that we will grow at all costs. We are always and will continue to be very disciplined. I'm talking about, by the way, only organic growth, obviously. But we see plenty of pockets. We have, I think, the best platform, certainly the largest, a very competitive one with that cost income below 40%. All our eyes centered on sort of winning in Spain and Portugal. And it's going to be a good environment to deliver shareholder value, no question. That's certainly what we're looking forward to. And Javier?

[Javier Pano Riera, executive]

Yes. Well, happy [Foreign Language]. By the way. So yes, you are right. So we have our wholesale funding fully swapped into floating, basically to a 6-month arrival. So you can consider that all that stock is going to trend down in terms of costs according to the yield curve. And well, there are so many issuances, so many fixings that it's almost like a constant repricing now downwards, no? It was upwards and now it's downwards. Also, well, I take the opportunity to mention that as we are increasing hedges on core deposits, also you will start seeing savings on that front going forward, no? And just to remember a question that I think that was you made the previous quarter, that also the ALCO portfolio, that is quite a low-yielding legacy book that is maturing. And any maturity, even if not reinvested, is in fixed income, is yielding much more in cash, no? So all that, obviously, is a tailwind for NII going forward, but this is basically considered when I make my comments about 2025. Obviously, all that is taken into account.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Francisco Riquel of Alantra.

[Francisco Riquel, analyst]

Yes, hello. The percentage of the so-called indexed deposits has gone up from 40% to 45%, the total remunerated deposits quarter-on-quarter, if you can explain this jump. I understand that most of the inflows in deposits come from wholesale deposits probably in this quarter or if you are remunerating more on the current accounts. And then I also see that the time deposits in Spain are up 12% quarter-on-quarter, so if you think that the higher for longer interest rate environment will increase the demand from clients for time deposits and if this could eventually derail your deposit beta assumptions going forward.

And my second question is about asset quality. I see that you have reduced the overlay provisions, despite the sound asset quality trends. So if you can comment on the allocation of these overlay provisions, what segments are required -- requiring more provisions at this point in the cycle?

[Gonzalo Gortázar Rotaeche, executive]

Thank you, [ Paco ]. Let me try to answer the first question or at least part of it, and Javier, you can take any comments from there and answer on the overlays. I would say looking at the macro picture in Spain, there's more liquidity around Javier and I mentioned the same rate at 14%. What we generally are seeing is that our clients have more cash with them, and hence, they have higher deposits with us. When these clients are corporates, obviously, they are going to put that money in remunerated time deposits or not time deposits, but very often also remunerated current accounts. And that is what drives that increase in index from 40% to 45% is just there's more cash around.

And again, this is, I think, a structural we're talking about a higher saving rate, close to 14%, and this is obviously reflected in -- across the market, certainly for our retail clients is one factor. And I guess, in terms of the evolution of time deposits and EBITDA, we ask Javier as for consistency…

[Javier Pano Riera, executive]

Yes. Well, I was checking, hello, Paco. I think we said more than 40%. So now we are getting closer to 45%. And this is why we said circa 45 and it's what Gonzalo is saying. So I tried to mention that in -- on, I think it was on my first answer, that actually there is more liquidity around. And in many cases, we are the bank of choice. So okay, we have the inflows and hence, the increase in the percentage.

The increase on time deposits, so the -- my short answer is no. So this has not any change to detail our views in terms of EBITDA or views on cost of deposits. You need to take into account also that there was at the very beginning of the rate cycle, retail clients were investing also into treasury bills. We're investing into what were called targeted yield fixed income funds. All that is maturing, well, the balance of treasury bills in the hands of retail is still quite significant. But the targeted funds are maturing.

And well, in some -- we are not rolling over those products. And so in some cases, those balances flow into the balance sheet. And in several cases, you need to offer like a time deposit in order to keep those balances. But keep in mind, don't focus too much on that because time deposits do have a margin. So it's better to make a time deposit with a margin of 100 basis points, they're not making it at all. So obviously, we need to deal with this carefully, but it's -- keep in mind that deposits do have a margin. So this is my comment.

And on overlays, we have assigned EUR 270 million. And I would say that basically, this has to do with -- well, there are several things, but have 2 main impacts. The main one is the Bankia PPA. Remember that when we are disclosing those unassigned provisions is the mix of Bankia PPA plus, let's say, legacy or formerly COVID related reserves. And the Bankia PPA is actually ended, okay? So by design at inception was already expected to at some point to finish, and this has been the case. So this has been the case the second quarter.

And also, I already mentioned that we have finished the full alignment to the new definition of default. When we flag that situation, we said, okay, the impact on P&L of that is not going to be material. So we have used a small part of those overlays to absorb the small impact we had on provisions due to the new definition of default. This has been the driver.

So it's not anything related, I would say, to any specific industry sector segment. But those things that, let's say, the runoff of the Bankia PPA, that is actually almost ended, and that adjustment to the new definition of default.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Alvaro Serrano of Morgan Stanley.

[Alvaro de Tejada, analyst]

I guess there's a couple of follow-up questions on some of your answers. I heard you mentioned that the NII, you still see upside to NII next year for the consensus and most of all, your sense is that some on the volume side. I just want to get a sense of direction, you're clearly more optimistic on volume growth. You're currently growing the loan book at 2%, the run rate of 5% deposits. Can it get better than that in 2025, would be my first question?

And second question related to the strong growth, and you do seem to be taking market share. So any comments on spreads, in particular, on the loan side and what pricing is that volume being done under -- where I'm coming from is basically to what extent that loan growth or volume growth in general can offset the 5% rate sensitivity you got for 100 basis points? Obviously, trying to think about NII from here.

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Alvaro, I will start, and Javier can complement. In terms of volumes, beyond whatever we can have in a given quarter, we're certainly bullish and optimistic about 2025 versus 2024. Clearly, what we're seeing is -- what we were expecting is it seems to be taking place a bit earlier. Remember that our guidance for this year in terms of volumes of lending was kind of flattish. And clearly, at this stage, we're beating that certainly in consumer lending with that 4%, 4.4% in just 6 months. And on the business front as well as mortgages has been much less of a track than what we expected. So this is taking place earlier. This is good news. But in any case, we see this as a trend. And certainly, we expect that 2025 should be better.

On the lending side, again, are the reduction in leverage, the deleveraging process on the business front and the mortgage front is coming to an end. That's our view, and that we're going to see long gradually convert into at least nominal GDP growth in the future. And this quarter, if anything, this kind of hunch that we had and filling already last quarter is becoming more real. And on the customer fund side, I think this is -- again, this is very much a macro thing associated to the saving rate. But what we're expecting for the next years is much more liquidity. Obviously, we need to make sure that there's no sort of external shock or something that derails the current macro trends. But it's pretty powerful. So I am optimistic.

Again, looking at this quarter, you need to adjust for the seasonality in terms of the growth of customer funds. But once you do that, still a fairly good growth rate. And we -- I don't see a reason why some quarters may be higher or lower, but as a trend, we don't see that moving in the right direction. It's about time, I would say. It's been a long wait for activity to improve, certainly on the asset side. It's been 15 years now. And on the lending side, obviously, there's a strong competition, but the business we do is good business, no?

[Javier Pano Riera, executive]

Yes. Indeed. Hello, Alvaro. Well, basically, the situation is -- has not changed compared to previous quarters. It continues to be more mortgage [ SIM ] and being extremely competitive. The whole thing is that we are in our share or the weight of fixed rate mortgage to maturity in the new production is increasing, which I think is positive because, well, at the end of the day, it's positive for us because it helps stabilize our sensitivities as you, I think you suggested, but also from a credit quality point of view through the cycle, it's always positive.

So I think that that's fine, but extremely competitive as it has been. So basically, when you compare Spain to other jurisdictions, you have much more competition on the asset side and I would say that due to this excess liquidity, in general, you have lower pressure on yields on liability side. So you have probably this kind of difference compared to other jurisdictions and we see this clearly, for example, in Portugal.

Although, I take the opportunity to say that the situation in Portugal also on the deposit front is much calmer than just a few quarters ago and already from book yields trending down, being able to reprice according to the yield curve, et cetera. So extremely competitive on the asset side as it has been, but nothing different. It's good to see that we have a better tone on SMEs this second quarter and as a result of that, if there is more demand, ultimately maybe also a positive in terms of margins.

We saw on the macro figures yesterday that CapEx in the economy, from a macro point of view, looks that is improving a little bit. It was already our expectation. That remember that individuals leading the way in terms of loan demand in the first half of the year and the second half probably SMEs to some extent doing better. And that's the case. So we don't expect the landscape in terms of margins and competition to change and this is what we are incorporating in our projections.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Andrea Filtri of Mediobanca.

[Andrea Filtri, analyst]

For me, just a follow-up question on the answer you have given on the overlay provisions allocation. We have seen a study by the ECB attempting to standardize the assessment and charge of overlay provisions. What are your expectations as a finalization of that work? And alongside that, the work is being done on levered loans. Is the ECB busy in searching for more angles to tighten the bolts, in your view?

[Gonzalo Gortázar Rotaeche, executive]

I would say, one of the ECB's missions in life is to look at risks and warn everybody of what things can go wrong. That's what they need to do and they will continue to do that in whatever environment and they are right to do it. So are they on that mission of identifying risk and making sure that everyone has prepared for that and have well reflected those risks? Absolutely. But that is no different from what the ECB did a year ago or 5 years ago. They obviously focus on different risks at different moments in time.

In terms of our own position, we have a very strong position. If you look at, and I'm sure you have these numbers. But again, coverage level for the Spanish book, and I look at our competitors, listed competitors, and obviously we compare, we're at the very top of that league table. And that means that we have been very prudent, but also that we have a very high level of provisions and our provisions incorporate, obviously, traditional risks and they're based on, obviously, probability of default, which is through the cycle, and loss-given default, which incorporates the worst moments in the cycle as well.

And obviously, they reflect a lot of risks that we had in the past. We have pandemic and we have had the war and we have the big financial crisis and you name it. And now we have different risks and we obviously continue to incorporate them in the way we account and when I look around, we are very well provided for. We also have very low non-performing loan ratio. Again, if not the lowest, the second lowest in -- and certainly the lowest among the top four banks in Spain, which reflects the fact that we have been very prudent. We have managed that portfolio sometimes at a cost.

So in any of these sort of environments and concerns that the ECB would have, I think we are certainly well prepared. And on lever lending, we are fortunately, for these purposes, we have a very small book. So we are not going to be a target or particularly impacted by this discussion where other large competitors have been more active in that market. We continue to have a very prudent approach to risk underwriting and we do lever lending, of course we do, but we do it to a much lower proportion than other peers of similar size.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Ignacio Cerezo of UBS.

[Ignacio Cerezo Olmos, analyst]

I've got 2, I'm sorry for coming back into the lending growth, but specifically on the mortgages, I mean, what kind of visibility or evidence do you have that the pickup we're seeing in terms of demand is, or has traction on legs from here? I mean, is there a risk that banks are being reasonably aggressive on the pricing when rates are starting to go down and then demand rides up, say in 6 months or so?

And the second question is, if you can give us your view on where CET1 is probably going to end this year? And the discussion around whether you are subject to potentially having to increase the go-to capital level for extraordinary capital distribution. You're stepping to the 12% for the time being, but is there a risk actually into the business demand that you need to use a higher number?

[Gonzalo Gortázar Rotaeche, executive]

Okay. Ignacio [Foreign Language] I will now [Foreign Language]. Sorry for that, just saying. I have a son that is also Ignacio, so I should have remembered at the beginning. But anyhow, going to your point, mortgage visibility, I think the structural demand is there. You know that the Bank of Spain has said there's demand for 600,000 new housing units, and obviously there's a concern to what extent there's going to be enough supply. The creation of new households is around 240,000 to 250,000 per year, and new housing construction is picking up, but it's below that level.

There is immigration, and obviously that's very structural. There's growth in population in Spain. It's about 1%, 1.2% because of immigration. And obviously there's some changes in the nature of society and new households being created that are smaller. The need for housing, the demand is there. Obviously, we have a big economic crisis that will slow down for a while, and we have people like we've seen in the past looking for other solutions. But in the current environment, I think there's a good level of demand that is already there.

And what we need is to accelerate the supply of new housing. And in terms of the lending, to be honest, obviously rates are coming down. If we see a change in rates for whatever inflation doesn't get under control and rates come back up, I think that will have an impact on demand. Obviously, it will have a positive impact for us on NII, but in any case that's a fairly unlikely scenario.

So looking at what rates are doing, they are sort of coming down, giving predictability, where obviously if we used to have a fixed rate sort of mortgage policy where we were actively advising clients to take fixed rate mortgages before the jump in interest rates. Now we have an even better reason to tell clients to listen to what happened three years ago. Do you want to have that risk or not?

Most of them would say no. And we have actually a very high market share in fixed-rate mortgages, which given our extraordinary sort of long-term deposit funding from retail clients is very well matched and gives us the ability to lend on mortgages long-term. And in fact, it reduces our sensitivity to decreasing rates by lending fixed rates.

So the answer is definitely we see that. And obviously, the numbers, the pipeline we have for the third quarter suggests that the force of the mortgage market is going to stay. But beyond given quarter numbers or 6 months, as you correctly say, it could be sort of something that gets reverted. To be honest, I don't see why if we don't have a sudden change of economic circumstances or again interest rate environment.

So yes, we're reasonably bullish there. But again, look at consumer lending is doing very well. And we have also seen very good levels of business as discussed before. So when you look at it in aggregate, I think it's a legitimate cost to think that there might be an inflection point that is, my personal view, in terms of long demand after a sort of 15-year cycle with ups and downs, but 15 years of de-leveraging. We'll see. At least what I expect is that de-leveraging to change very clearly its pace. On capital, Javier, do you want to comment?

[Javier Pano Riera, executive]

Well, we have this contracyclical buffer that you know is very probably coming. We mentioned last quarter that so the one fully implemented the impact for our requirements would be like 75 basis points. And what we have been saying is that, okay, we need to take a decision on that. Obviously, something we will elaborate precisely on November 19th. But you should not think that we are going to have the need to pass all that additional requirement to, let's say, our internal targets, because the starting point is a situation where you have an ample MDA buffer, where we have a situation with strong profitability, with strong coverage in general.

So there are not like short-term risks. You never know, because black swans may happen. But theoretically, we're in a position where we can absorb part of that impact. So a final decision is not taken. So we are not able to share with you today. But obviously, in November, we will do so. But that's the message. And it's the same message we had the previous quarter here in Nacho.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Marta Sanchez Romero of Citi.

[Marta Romero, analyst]

My first question is a couple of follow-ups on your deposit. When I look at the average balance in Spain, I see a very impressive performance in the quarter, EUR 6.5 billion new deposits, so that's 2% quarter-on-quarter. Is there any extraordinary there, such as inflows from public sector, next generation funds? So what are you thinking about in the second half of the year in terms of growth in average volumes in deposits for Spain? And related to this, if you could share the balance of public sector deposits that you have and how, again, on average volumes are stripping out the seasonal effects.

And my second question is on capital. Thank you very much, Javier, for your attempt to trying to explain and give us peace of mind. But I think it's -- and I understand you've got the Capital Markets Day -- but I'm not sure if you're being very helpful. So if I look at the average MDA buffer implied in European banks' capital targets, we're talking about something like 240, 250 basis points. That would be kind of what you would have on your current 12% fully loaded currency ratio. So why do you feel like you need to be running your bank with a higher MDA buffer?

[Gonzalo Gortázar Rotaeche, executive]

Sure. If I may, and again, Javier can add as he sees appropriate. The increase in average customer funds is genuine. There's no one-offs or any genuine positive consequence of the environment, which again is more liquid and our activity. The other point in terms of capital, you are right, we feel very comfortable with our MDA buffer and we still have to have a discussion. And as we need to look at what's in for the next 3 years and sort of have a lot of -- well, obviously we'll be very focused on what comes out in terms of financial targets.

But behind that, there's a lot of what are the things we need to do to continue creating value for the longer term. There's a lot of discussions that we're going through internally and that we have to get through and pass the board. And obviously, in all that context, we will take a decision on various financial targets. And given that there has been a change, it's logical to at this point say, well, we cannot prejudice or have an early conclusion on this topic. And it will need to be discussed in the context of the full next 3-year plan.

But I agree, we feel as, obviously, we feel as comfortable as before. We're not particularly supportive of this change in terms of the countercyclical buffer in the case of the Spanish economy. Clearly, the fundamentals are not there, but there is this positive neutral thesis. So it's kind of a temporary buffer that the ECB is asking people to say, well, well, there are good times you have this temporary buffer that you run out.

When there are bad times, we kind of have to complete our thinking about that topic. But fundamentally, we agree, we have a great business model and certainly good ample room in terms of our capital targets. We'll, again, complete this discussion internally and come back to you with that point. But in the context of what's happening over a 3-year period, hence, what is going to be, obviously, we're going to generate a lot of profits and a lot of capital.

What part of that capital is going to be dedicated to growth? Because risk-weighted assets are going to grow, obviously, much faster. What we say about activity is true. What is going to be dedicated to the kind of ordinary payout? And then what is remaining and do we use it to build a temporary buffer? Or do we use it again all to give to shareholders? This is something that we need to wait. We don't have a firm view. What is pretty clear is, as Javier said, whatever it is, I do not think we're going to sort of reflect this change in full in our targets. I would say that would be -- I would be very surprised if we end up in that side of the discussion.

[Javier Pano Riera, executive]

You had a few questions on deposits. Well, first thing, because I don't remember if we have already commented this at the call or not, our view is that our deposits will grow, let's say, for the year, like mid single-digits. Remember that I mentioned that we have that seasonality in the second quarter, this, let's say, extra payroll that is like EUR 10 billion, but then the payback of those balances, according to past experience, is not 100%.

So average balances generally tend to be more positive than before. So that's our view. But honestly, here we are a little bit, I would not say uncharted territory, but the evolution is, generally speaking, surprising us a little bit positively, but surprising us to some extent. So let's see how it evolves. But we are quite positive and quite a bit on our deposit-gathering capabilities, as you know well. There are no extraordinaries beyond that, so I would say that beyond that is the normal course of business, so nothing.

You asked the question about the amount of the public sector, which is circa EUR 20 billion by the end of the quarter. And probably I was thinking about adding some additional information, talking about interest-bearing deposits. Obviously, the percentage is not distributed evenly across different segments, and precisely the public sector is the highest one. So we have close to 70% of our public sector interest-bearing deposits that are interest-bearing deposits at a cost, and the major part of those indexed.

[Marta Noguer, executive]

Thank you. Next question, please.

[Operator]

The next question is from Britta Schmidt of Autonomous Research.

[Britta Schmidt, analyst]

Three quick ones for me. The first one is coming back to the cost of risk. I'm just trying to figure out what the underlying cost of risk would be without the overlays, but I also need to exclude the new definition of default. So could you give us that impact or maybe comment on where the underlying provisions would stand? Are they around 40 basis points or maybe even a little bit less this year?

The second one would be on the other provisions. I think last quarter we discussed the run rate here for this year. I think you guided it to EUR 300 million from EUR 250 million. It looks to be running a little bit ahead of that. So could you give us some insight as to what's driving that? Are there any other legal costs that are coming? And when we should expect to reduce to a lower run rate?

And the last one is on IRRBB. I think Basel proposed some tightening of the stress test there. Some of the geographic rate stress tests increased. You've always been a little bit high on the supervisory outlier test. Is there a need for you to do a little bit more there in terms of decreasing the sensitivity?

[Gonzalo Gortázar Rotaeche, executive]

On cost of risk, obviously there's a lot of elements going into the detail that affect cost of risk in a given quarter. We've been with that circa 30 basis points for a while. And we have actually, in the last-- look at the last 12 months, we have seen the impact of higher rates, which has had an impact in terms of some deterioration of our mortgage portfolio, which is now coming to an end because the process is reversing. So I will not take, because it's complex and Javier may or may not try and get into all the detail.

But what I would say is I will not take certainly our activity this quarter, this far half of the year, as a sign that our cost of risk on an inherent basis is going to be higher. Just because we're running this out, keeping it lower. We are actually pretty upbeat in cost of risk, because as I said, the large sort of potential impact and actual impact of some of these increasing rates have been offset.

The transition to the new definition of default has been completed, and we are actually much better. We're at 2.7% non-performing loan ratio. We're bringing down our target for the end of the year. So we certainly have more caution in cost of risk than we had or thought at the beginning of the year. And if anything -- if I may, I know that you want as many details as possible, and that's obviously your job, and I respect that.

But it's also important in the message that we want to convey on cost of risk is one of actual better developments than what we were expecting, and I think you should be quite comfortable. We do not see a problem or deterioration on that front. We quite to the opposite could see upside rather than downside.

One comment on the mortgage, on the other expenses, we have had obviously an increasing claims from mortgage set-up costs that we flagged already in the first quarter, and during the second quarter we've seen a continuation of that, but actually clearly a trend that is running down in June, July, and with the numbers that we have. And here, I'm getting into Javier's territory, but with the numbers that we are seeing, actually we are comfortable with our former guidance. And I don't know, Javier, if you want to add any detail, and that's also the third question on IRRBB.

[Javier Pano Riera, executive]

Exactly, no, no, you are obviously right. That's the feeling we have, that guidance we have given on that front is still valid, because that decay in the pace of new claims and lawsuits, so I think that yes. On IRRBB, yes, there is for 2026, or there is some time from now, an increase of the stress on rates, basically on economic value. And well, first thing here, keep in mind that all those impacts are subject to some kind of modeling assumptions, basically for non-maturity deposits, and so you cannot read across the industry that everyone is modeling the same.

In our case, precisely because of our nature and history, we are of the feeling that the duration of our non-maturity deposits is probably longer than the average of the industry, for the good reasons. And well, basically here we have the evolution of our sensitivity on that front is being gradually impacted organically, as we keep originating mortgages at fixed rates that are basically offsetting part of that long duration on deposits.

And then, as you may see, as we are increasing hedging activities, and recently basically via derivatives, but eventually we can use again the fixed income portfolio. So with all that, with, let's say, natural evolution plus actions taken in terms of hedging, obviously we are going to be within parameters for sure.

[Marta Noguer, executive]

Thank you, Gonzalo, and thank you, Javier. That's all we have time for today. So the IR team will follow-up with anyone who was left in the queue. And with that, just it's been a pleasure hosting you one more quarter. Thank you for watching. Have a wonderful summer, and bye-bye.