Caixabank SA

MAD:CABK

Earnings Call Analysis

Company Delivers Stable Outlook and Growth

The company's financial outlook remains positive with expectations for at least 10 billion EUR in 2023, aiming for stability at 2023 levels. Their cost of risk is on track, maintaining strong liquidity reserves at 200 billion EUR, accompanied by a solid CET1 ratio closing the quarter at 12% and a notable increase in tangible book value per share to 4 EUR. Bankia's integration is advancing gradually, meeting initial expectations without anticipating significant year-on-year increases. Customer deposit structure improvements have resulted in a lower deposit beta than expected, instilling confidence in future earnings potential. With a thorough approach toward integrating products, management foresees a steady journey toward their targets.

Solid Performance with Enhanced Profitability

CaixaBank's third quarter of 2023 results reflect a substantial upsurge in profitability. Net income has soared by 48% year-on-year, reaching an impressive 70% increase in the third quarter which equals EUR 1.5 billion. This surge in net income can be attributed to a 'new normal' of normalized interest rates, a strong base for future business expansion. The CEO announced exceeding their 2024 targets, with the return on tangible equity (RoTE) at 14% outpacing the anticipated 12% or more, and a cost-income ratio of 42.6%, better than the 46% adjusted target. The bank demonstrates robust balance sheet fundamentals and projects enhancing their capital distribution capacity, forecasting to transcend the initial EUR 9 million estimate for distribution.

Increasing Shareholder Returns and Strong Capital Position

CaixaBank is committed to enhancing shareholder value. Already in the process of a EUR 500 million share buyback, the bank aims for a cash dividend payout at the higher end of their 60% target range. The financial health of the bank is evident from their capital generation outlook, which is expected to significantly outperform the initial EUR 9 million projection for available capital distribution. Furthermore, a commitment to sustainable profitability is solidified with a robust coverage ratio at 76% and stable non-performing loan (NPL) levels. On liquidity, CaixaBank maintains strong reserves and excels in comparative benchmarking across the Eurozone, revealing a competitive edge in this domain.

Promising Outlook on NII and Controlled Cost of Risk

The bank has improved its guidance on net interest income (NII), expecting it to be at or above EUR 10 billion in 2023. This revision is supported by continued low deposit cost beta, with retail beta around 5% and corporate/public sector beta near 30%. Prudent loan provisioning policies contribute to managing cost of risk favorably. The CEO also confirms guidance for the upcoming year, anticipating a net interest income of at least EUR 10 billion, capital expenditures below EUR 500 million, and a cost of risk contained at roughly 25 basis points.

No Impact Expected from Basel IV and Strategic Capital Utilization

Management believes that Basel IV regulations will not negatively affect the bank's capital. The strategy on capital utilizes synergies from the integration with Bankia, particularly in insurance, long-term savings, and consumer lending. The ongoing EUR 500 million share buyback reflects the bank’s confidence in its capital adequacy, reporting a Common Equity Tier 1 (CET1) ratio of 12.2% after a growth of 70 basis points in the quarter.

Commitment to Efficient Operations and Cost Improvements

CaixaBank emphasizes operational efficiency, with an improved cost-income ratio and aims for positive 'jaws' – the rate at which revenue growth outpaces expense growth. Additionally, CaixaBank is reaping the benefits of strategic moves, such as deleveraging in low-density assets and managing loan book compositions, which align with their prudent capital generation plans. The bank maintains a conservative outlook on potential risk-related adjustments and remains poised to weather economic uncertainties.

Earnings Call Transcript 2023-Q3

[Marta Noguer, executive]

Good morning and welcome to CaixaBank results presentation for the third quarter of 2023. We are joined today by our CEO, Gonzalo Gortazar; and our CFO Javier Pano. In terms of logistics, just a brief reminder that we plan to spend about 30 minutes with the presentation and about 50 minutes to 1 hour with the Q&A. As you know, the Q&A is live and you should have [ received ] instructions by e-mail on how to participate. Let me finish by saying that my team and I will be at your full disposal after the call. And without further ado, let me hand it over to the CEO Gonzalo Gortazar.

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Marta. Good morning, everybody. Pleasure to be here, reporting third quarter results which we're obviously very happy with. And the title of the highlights of today's results is twofold, is a step-up in profitability, the numbers speak by themselves, but also the sustainable nature of the step-up in profitability. I think it's as important as the actual increase. Net income, as you know, is up 48% year-on-year. And the third quarter net income is actually 70% year-on-year to EUR 1.5 billion. Obviously, this response to a new normal, I would say is a new normal, which is also the old normal, where interest rates were at normal levels at which they are back. So clearly, we need to look at our current status of profitability and operations as a new base on which to further build the business.We have gone pass through our targets for 2024. We are planning to update those targets for next year when we present final results, the annual results for 2023. But obviously, at this stage the return on tangible equity is 14% versus plus 12% and cost income at 42.6%, well below the 46% once adjusted downwards for IFRS 17.From a balance sheet point of view, we keep very strong fundamentals. And actually, we have further reinforced our balance sheet during the quarter. We can talk about that later in terms of evolution of asset quality. And obviously, we're seeing that increased profitability is turning into increased tangible book value per share and are also turning into a higher capital distribution capacity compared to what we had indicated in our strategic plan for the period of 2020 to 2024.We are taking the opportunity of this presentation to improve the guidance we're giving for this year on NII. We're confirming the rest of guidance that we have given for this year. We feel NII will be at or above EUR 10 million in 2023. Most importantly, we're targeting to maintain that level into 2024.A few words on macro. Obviously, both Spain and Portugal are doing fairly well, certainly relative to what we're seeing around in the Eurozone, 0.5% growth versus 2.4% estimated growth for this year. Moving into next year, we see a slowdown in Spain and Portugal. Eurozone staying around that level from 0.5% to 0.7%, Spain and Portugal coming down as a result of higher rates and also the fact that our main trading partners are growing at a lower level, but still a significant positive gap vis-a-vis the rest of the economies. You see that in the outlook. You see that in employment evolution, actual figures in Spain that were published yesterday were very good, much better than what we were expecting.We keep seeing a fairly low level of indebtedness in Spain, as you can see, below the European levels and well below what it used to be when we had the trouble in the 2008-2012 period. And the real estate continues to show no signs of battle at all. In fact, prices are still -- as you see in the slide, well below what was the case in 2008. And hence, we're still seeing some nominal growth in real estate prices, both this year and even into next year, even if adjusted for inflation, it's slightly negative on -- in real terms. But obviously, from the point of view of asset quality, nominal is what is most relevant.I was saying the step-up in profitability, I was saying it's sustainable. And obviously, there's been a huge change, which you know very well in terms of the level of rates. We're seeing a normalization of rates. And obviously, the forward curve points towards that normalization as a sustained one.In terms of our balance sheet structure, I would like to highlight that over the last few years, we've made significant progress towards a higher proportion of business and consumer loans, which now account for 50% of our portfolios with a more balanced portfolio. And obviously, the trend continues to be of deleveraging on the mortgage front and better trends, both in business and consumer lending so that the mix will continue to change. And in terms of long-term savings, obviously, there's been a very significant move from on balance sheet to off balance sheet. And that is despite the fact that we have had integrations, which generally have had a mix of more on balance sheet rather than more off balance sheet. So the process we expect to continue.This year, we have a stable business volume. We'll see it later, a slight contrast between lending slightly coming down and offset by customer funds, which are growing particularly those of off balance sheet.You see the lending evolution here on this slide. And obviously, it contrasts on both business and mortgages with a fall versus the previous 9 months, but we wanted also to show you where we were in 2021 so that you can obviously have the full picture that there is no question a slowdown in lending demand, both in business and mortgages, and so on the consumer side, but we're still producing new loans at a faster pace than it used to be the case in 2021, obviously, with much more attractive yields given the new level of rates.On the deposit side, I think it's worth highlighting. We've been gaining market share during the year, both if we look at just deposits and if we aggregate it with long-term savings continue to benefit from a different position. Market share in payroll is 37% in round numbers, so slightly lower in pension deposit. It means that EUR 20 million of direct deposits of clients that have direct deposits with us every month. And that means EUR 25 billion that comes into our accounts every month just as income flows, which obviously is a very significant number, and it's a good indication of the kind of franchise that we have continued to increase the number of relational clients over the year.And all this is resulting in deposit beta evolution, which you see there from 11% to 13% in the quarter. The more time goes by -- and the more we have completed now our customer fund products with also time deposit offering, the more conviction we have in that we are going to clearly outperform the market and also outperform our own expectations in terms of beta development.You can look at the U.S., how different banks are having very different betas. And I'm saying the U.S. because they have had sort of a longer time frame since rates started to increase. And you can see in some franchises are doing much, much better. And certainly, we expect to be doing the same thing in Spain. And that has also a lot to do with our improved outlook for NII in 2024, obviously, in 2023 numbers speak by themselves. So feel fairly well about where we are in terms of our deposit and customer funds franchise, where we're going to be able to extract the right value that it really has.In terms of inflows and to long-term savings. And you can see here on the right-hand side, the statistic, I was mentioning before, we're also gaining market share where we will look at deposit and long-term savings. And that's mostly because on savings insurance we've been very active this year. You see we have now a 36.3% market share, up 73 basis points year-to-date.And obviously, the fact that we have higher long-term rates is making these products much more attractive when you look at them as fixed income insurance policies. And again, this is playing to our strengths. That's why we have this top line of net inflows. As you can see, 56% of those net inflows have been into savings insurance, the rest into mostly multiple funds.So you would have seen this year, inflows into mutual funds are actually generally generating a fairly low fee because of the type of inflows that the industry is seen into money market guaranteed funds with relatively short-term horizons. That's not the case for savings insurance. So obviously, we have a product that is yielding, I think, better value both to our clients but also to ourselves.Protection Insurance, again, a fairly good quarter, 5.4% growth in terms of annualized new production with MyBox being obviously the start offering. And as you can see on the right hand of the page, when we look at the total premia, we are actually increasing by a higher number, 9.5%. And these numbers are not completely comparable, but I think the one most significant reason for that is that actually, our retention rates are better and to a large extent, thanks to MyBox. So lapse rates have come down -- and obviously, that is having a positive impact on our insurance profits, which, as you can see in this quarter, have been particularly attractive for a number of reasons that Javier will comment on later.BPI, doing, I'd say, very well. Market share gains, loans, residential mortgage, long-term savings, credit cards, BPI in Portugal is set for a long-term cycle of market share gain and hence, revenue growth. And that is leading to a major step-up in terms of efficiency. You see the cost income ratio at now close to 40%. And obviously, a very significant increase in profitability where return on tangible equity in the first 9 months of the year is actually hitting now 15%. Asset quality continues to be very good, as you know, with 1.7% NPL ratio. So BPI continues to be one engine of growth and profits for the group and makes us feel obviously very good about it.Return on tangible equity at 14%, obviously, revenues and interest rates have a lot to do. With that, we have had some, obviously, impact of inflation on our cost base and I've had a very prudent loan provisioning policy, particularly this quarter because actually the outlook remains quite favorable.And just to finish before I hand over to Javier, just a few considerations on the next pages. First, going back to sustainability of where we are, I have to say, from a balance sheet point of view, we have not been in such a strong position for the last 15 years. You see a decade in this slide, but it's actually even longer coverage on nonperforming loans, NPLs, the fact that our clients are much less levered. As I mentioned before, obviously, pre-provision profit now north of 2% per annum compared to cost of risk is a major also line of defense vis-a-vis any deterioration if and when it comes. Very much improved cost income ratio, liquidity. MREL levels well ahead of the regulatory requirements and with substantial cashing on capital and certainly with a major improvement in return on equity and tangible equity. That is obviously going to flow through to higher shareholder distributions.You also have the statistics of EPS, tangible book value per share on EPS. Obviously, those are historic, to be honest, again. I think what is most important is that these levels are the new base on which we need to work on and certainly, that's the way we look at it. We have already distributed, including the ongoing share buyback, EUR 4 billion. We obviously have our cash payout target, which we are accruing dividends for the highest level of that range at 60% and looking at what remains of this year and next year, it is clear that we're going to be well ahead of that EUR 9 million initial estimate of how much capital will be available for distribution, which obviously makes us fairly happy about that.And just one final word. We are not forgetting that we're not just about profitability and that we have a major impact on society. And actually, that impact is quite positive. We have to make sure that we keep reminding everybody because in this difficult times, it's important people understand what are our commitments with financial inclusion, for instance, which we have on this slide and you know well, of not withdrawing from places where we're doing banking. Our microbank operation is the largest bank microcredit institution in Europe and other solutions that you know we are pursuing.I would highlight this quarter, we have also published decarbonization targets for 3 additional sectors. That's a goal where we want to basically terminate our financing by 2030 and then decreases in how our clients in the auto and iron and steel industry will do or we will do it with respect to our Scope 3 emissions based on our lending to these clients by 2030 with a reduction of 33% in one case and 10% to 20% in [ iron ore ]. As you know, iron ore still is one of the sectors where technology to decarbonize is less advanced and hence the lower initial rate. But obviously, we feel that this is very much part of our mission, and we are making fairly good progress on it as a bank, which we think is a reference in Europe for sustainability.And with that, Javier.

[Javier Pano Riera, executive]

Okay. So thank you, Gonzalo, and good morning to you all. As usual, from my side, further details on the P&L and the balance sheet. Let me start with an overview on the loan book. I could say that the trends remain broadly the same, although I could remark that on a quarter-on-quarter basis, we have the impact of a very positive seasonality during the second quarter. And the other aspect that we'd like to highlight is that on business lending, we have had a softer tone during this third quarter. But well, all in all, the loan book, down by minus 1.7% year-to-date, in line with our expectations. And you may see on the bridge below, that is a positive evolution on businesses, consumer deleveraging on mortgages, although I will mention that in terms of prepayments, the base is abating a little bit. And on other, we have had some maturities on lower-yielding public sector loans.On the right-hand side, you may see the evolution of the floating mortgage book where the index resets, you may see that we have already 50% of the loan reprice at between 3% and 4%, but still over 30% below 3%, already 19% over 4%. And this is a process that is ongoing, that's further supporting the back book yield of the loan book in coming quarters.Moving to customer funds. Those are up by 1.3% year-to-date. I will remark long-term savings, as Gonzalo was commenting, doing well, plus 5.3% year-to-date. On deposits, slightly down less than 1% year-to-date, but gain in market share. So the overall pool of customer deposits in the system is also shrinking and also quarter-on-quarter, the usual seasonality we had in the second quarter.On the bridge below, you see plus EUR 5.7 billion of positive market effects on long-term savings. The same figure of net inflows into long-term savings and that slight decrease in deposits minus EUR 3.4 billion.With that, I move to the P&L, the consolidated income statement, the most remarkable net income over EUR 1.5 billion. This is close to 70% year-on-year, close to 19% quarter-on-quarter. Strong revenues, generally speaking, but particularly NII that is increasing strongly on the back of continued margin expansion. We will focus on that in a minute. But also, we have a strong growth in insurance revenues and already a recovery in asset management fees, that is overall more than offsetting lower banking fees.Not much to say this quarter on noncore revenues, costs in line with our guidance for the year. No surprises there. And on provisions, we have an annualized cost of risk at 25 basis points and also in line to meet our guidance for the year. Note that on other provisions, this third quarter, we have a one-off.And with that to the details, NII now expected stronger for longer. You see a clear positive evolution quarter-on-quarter, up by 12.2%. Margins expanding the customer spread already over 350 basis points, 352 plus 32 basis points in a single quarter. And on the bridge on the right, you see clearly quarter-on-quarter, a positive evolution. Cannot be otherwise from client NOI, but also from ALCO and other, in this case, lower negative index resets on our floating wholesale funding, but also strong cash balances clearly yielding much higher. So this is a clear positive.Below, you have the evolution of the loan book and the customer funds on the loan book now yielding the back book 423 basis points. And on deposits, our customer deposits, ex foreign exchange and hedges now at a cost of 48 basis points, up 14 basis points in a quarter. And that moderate evolution of the deposit beta, Gonzalo has already commented now, at 13%.And as a reminder, that guidance that has been upgraded for the year, we expect at least EUR 10 billion for 2023 and targeting that to be stable. That's our guidance for next year, stable at the levels of 2023. The remainder of the core revenues. Here on this slide, you have the combined evolution of net fees, insurance service results plus the equity accounted by our insurance subsidiaries. I would say that the most remarkable here is that ex cash custody fees, the performance is positive, up by 3.6%. Remember that cash custody fees account approximately for 50% of the fall on fees this year and should be seen more or less an NII impact instead of a fee impact. We reiterate our guidance, circa EUR 5.1 billion for the combination of those revenues.And on the right, you may see the evolution of our core revenues, up by 34%, a strong contribution by NII, but also excluding cash custody fees also a positive contribution. You have all the details on this slide, plenty of information. On the left, you have the evolution of insurance revenues, remarkably plus 26%. You have also the details for life risk insurance over 23%; life savings insurance, plus 27%. Remember that this year, we're having more than 50% of the inflows into long-term savings precisely on annuities, and this is having a very positive impact on that P&L line.We have also a positive contribution from equity accounted, although in the first quarter, we had some inorganic positive impacts. And on the right, you have the evolution of fees. I would say that on recurring banking fees, we have the headwind from lower current account maintenance fees, trying to strike the right balance between charging for those current accounts and maintaining low funding cost.On asset management, we are starting to see a gradual recovery. You may see the average AUM balances on the top right that are gradually trending up insurance distribution with strong organic growth, but with some nonrecurring factors having an impact. And finally, wholesale banking, always more volatile. But despite a more difficult year, I would say, generally speaking, delivering close to 6% improvement year-to-date.In terms of costs, as I have said, no much to say, on track to meet our guidance. And as has been already commented the very positive trajectory of our cost-to-income ratio at 42.6%. This is more than 15 percentage points in less than 2 years, although it incorporates the impact of the banking tax approximately close to 2 percentage points.Cost of risk, a prudent approach in terms of provisioning in the third quarter, as always. And with that, we have an annualized cost of risk at 25 basis points, on track also to meet our guidance of less than 30% for the full year. We keep a strong coverage ratio at 76%. We keep also our EUR 1.1 billion of unassigned collective provisions unchanged for the quarter.And back to the balance sheet. Our NPLs broadly stable in euro terms. In terms of the NPL ratio, I would say the same, although we have a slight denominator effect, you have all the breakdown by segments and nothing material that is surprising in the evolution for us.And finally, a few words on ICOS, 50% of the original loans granted have already amortized the current outstanding balance is EUR 13.1 billion, all repaying principal, and I would say only 3.8% of those classified as Stage 3.A few words on liquidity. Well, ample liquidity is clearly a competitive advantage, and we see this every quarter. And this, at the end of the day, has a positive impact on this low deposit beta evolution. You have plenty of metrics here. I would remark a liquidity coverage ratio pro forma ex TLTRO close to 190%; loan to deposits, 90%; strong liquidity reserves, EUR 200 billion.And an update on an interesting benchmarking comparing the top 10 banks in the Eurozone by market cap. And on the first chart, you may see that we continue the poll positions in terms of liquidity despite we have had plenty of TLTRO redemptions across the sector. And on the right-hand side, also a chart that tells you about the differences in the mix of our deposit base, 79% of retail deposits. And obviously, this also having a positive impact on our deposit EBITDA evolution. Those are figures updated as of the end of June.And finally, capital; strong capital build, 70 basis points. We have also the full deduction of the share buyback on regulatory capital ratios, minus 23 basis points for the EUR 500 million share buyback that is ongoing. Then accruing 60% cash payout that is minus 40 basis points together with 81 coupons. And then minus 28% from markets and other that basically includes the regulatory impacts that we're expecting for this third quarter together with some other basically OCI negative impacts. With that, the CET1 ratio ends the quarter at 12%, 16%.And I would like also to remark the very positive evolution of the tangible book value per share this quarter, already reaching the EUR 4 mark.So thank you very much. And I think that we are ready for questions.

[Marta Noguer, executive]

Yes. Let's open it up for the Q&A. Operator, can you let it -- let in the first question, please?

[Operator]

The first question is from Maksym Mishyn from JB Capital.

[Maksym Mishyn, analyst]

I have 3 and the first one is on the loan book growth outlook. I was wondering if you could share some light on what you expect per segment and which segments you see as more attractive. Also what kind of loan book growth is baked in into your new guidance for 2024 for the NII? Then a second is a small follow-up on this. What kind of beta you assume in the NII guidance? And if you could remind us what is the NII sensitivity to interest rates right now? And the last one is on the recent proposal by the Spanish government of reducing labor hours. I was wondering if approved, it can have any impact on your cost base whatsoever.

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Maks. Let me say, in terms of the reduction of working hours, we already have working hours that are in practice in terms of annual hours below that level. So the answer is no, we do not expect any impact. Another question is whether this is approved because it will generate a lot of discussion in terms of impact on productivity in other sectors, but it will not affect us in any material way. With respect to the loan book outlook, you've seen that, obviously, the market, you saw some statistics that in terms of the survey, the bank central banks to demand is fairly low, particularly in mortgages and businesses, and that's affecting evolution of the market in this third quarter, and I would expect that to continue for a few quarters. Consumption is fairly resilient. And to be honest, given how inflation seems to gradually be, if not close to 2%, and less not growing. And with the kind of agreements we have, I think there's going to be some purchasing power recovered. So I would expect consumption to keep doing well. Certainly in -- if we look at next year, we should be having positive numbers there. Housing should continue to go down slightly or clearly a bit less than this year, where the main impact of prepayments and a significant increase in rates is taking place, but still mortgages should be coming down in 2024 in terms of the stock.And on the business front, I would expect that a year starts to be a bit weaker, but gains strength during the year. And actually, by the end of the year, will be in positive territory. But I think it's a bit too early to say how things would evolve the kind of flattish evolution for 2024 is something that would be certainly consistent with our NII targets. But on that front, Javier, please can you take from here.

[Javier Pano Riera, executive]

Okay. Well, yes, thank you. You asked it for beta -- just what -- we have reassessed the beta a little bit -- well, not a little bit, I would say that performance is being better than modeled expectations. So this is to say the summary, we were expecting beta to end the year circa 20%, and we are now expecting to be clearly well below that. And into 2024, we expect the average beta to be in mid-20s. So this is what we are considering. It has to do with plenty of things, but I would take the opportunity to mention a little bit the -- what is behind our upgraded guidance for the year. So it's from less to more importance is higher rates. Remember that ECB finally decided to hike rates to 4% after the summer. We were not -- and the market, I think I was not expecting that. And during the month of September and into October, what we are seeing is more disinversion of the yield curve, and this is actually a clear positive. So this is first thing. Second is about liquidity conditions in general, so are better than our initial expectations, not for us, but also for the system. So as a consequence, we see a less tight situation in terms of liquidity from our peers. So this is also a positive in terms of beta evolution also on our side, a better evolution in terms of deposit balances. And I understand that there is always a strong focus on the loan book in order to project NII. But I would say that also the projection in terms of deposits is really important because deposits obviously are at a margin. And well, at the end of the day, we realized as the quarters pass that our, I would say, our value relationship with clients is at the end of the day, resulting into lower betas, and we have reassessed our expectations according to that guidance I have already given you.You asked also about sensitivity. You have here a situation where sensitivity naturally is gradually being reduced. And this is -- it has to do with 2 effects basically. First thing is you have higher rates. With higher rates, you have higher betas, having higher betas is like having more, let's say, floating rate deposits. And as a consequence, sensitivities are, generally speaking, lower. And second is that, at the same time, we keep originating fixed-rate assets, basically mortgages, although less than we would like for sure. But at the end of the day, this is having a natural trend, reducing our sensitivity that so far is kept positive. Not now we have -- and the measure we are using, and we think it's the best way to see this is -- which is the change on NII after 1 year. Remember, this kind of 12, 24 months impact to 100 basis points shift in the yield curve, and this is now a circa 5%. This is circa 5%. And we are happy to keep that slight bias towards higher rates, which actually is what is going on in the market. And so far, we are having this positioning, I'm happy to keep that for the time being.

[Marta Noguer, executive]

Thank you, Maks. Operator, next question, please.

[Operator]

Next question is from Ignacio Ulargui with BNP Paribas.

[Ignacio Ulargui, analyst]

I have 2 quick questions, hopefully. One is on capital. I mean, given the strong improvement in profitability and the buildup that you are generating, what would be your preferred usage of capital besides improving the distribution capacity? I mean there are things that you can invest in your business where you see opportunities for revenue growth. Also a link on the capital front, if you could update us a bit on what would be the Basel IV impact, I think that you gave around 10 bps hit in the Capital Markets Day. Whether that still stays? And the second question is on insurance revenues, there has been a very good performance so far. Could you just help us to understand the trends going on going forward? And whether this is a kind of the benefits of Bankia merger and the benefits of increasing penetration of insurance into the Bankia customers?

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Nacho. In terms of uses of capital, our business is very simple. We are obviously in financial services in Spain and Portugal. We're going to use capital to pursue organic opportunities in those markets. But the lending growth, which is the main driver of capital in terms of RWA, is very limited. So our growth is going to be in other businesses. You mentioned insurance, I will let Javier comment on trends on insurance. But insurance requires capital. But as you know, given the Danish compromise, it's a very capital-light business at a consolidated level, and the growth we expect in payments is another example. So we expect growth, but not a capital-intensive growth, and we're not looking for acquisitions. There is no capacity we do not have or we cannot create organically in our markets, and we're not looking to enter other markets. So basically, profitability is going to turn into distributable capital. That's as simple as -- and that does not mean we're not going to be doing the investments. We need to do to create value, we'll do all those. But still, the numbers are very clear at this part of the cycle. We don't expect any impact from Basel IV, so that's not going to be a negative on capital either. And in terms of insurance trends, Javier, maybe you want to --

[Javier Pano Riera, executive]

Yes. Hi Nacho, Well, Bankia synergies are progressing gradually. Remember that this was a long shot. That was a long-term plan is doing according to our initial expectations. Remember, our 3 basic key areas, which is insurance, long-term savings and consumer lending. And what the penetration rates are well known. We have disclosed those in the recent past, gradually improving, but it's not only about the number of products that those Bankia clients hold but also about the value added of those products that is clearly higher compared to what was distributed in Bankia times. So this is ongoing. This is a tailwind that is always going to be there. But on the other hand, you should not expect a significant step-up year-on-year. So it's a gradual process. We are doing things wisely, professionally. And you know that it's part of the overall relationship with clients that we are building, and this is usually taking some time. But we are online with our initial targets.

[Marta Noguer, executive]

Operator, let's move on to the next question, please.

[Operator]

The next question is from Alberto Serrano with Morgan Stanley.

[Alvaro de Tejada, analyst]

One kind of follow-up and a question on capital, capital distribution. On your -- you've obviously given the EUR 10 billion guidance for next year as well. And Javier, you were explaining that you've got more confidence now. But in regards to the visibility you have on the term deposit mix, can you maybe elaborate a bit more on why you now feel confident on that 2024 guidance and talking about the mid-20s beta, because Bankinter seems to be saying the same that the 25% is where the mix is going to stay. Is -- have you seen the flows now the transaction rate you have a better understanding of what transactional balances are, what people are doing with their money? Just to elaborate a bit more on that to give us a bit more confidence, please? And second, on capital, I just wanted to confirm that there's no more capital headwinds relative headwinds you expect now that trend to 60 basis points is done and dusted and no more to expect. And as we think about distribution in Q4 and medium term, it's more a question for Gonzalo more around your thoughts, would you risk given how strong the earnings are having to cut the dividend in a couple of years' time? Or would you lower the payout and prefer to do more buybacks to avoid that risk, just a general philosophy of how you think about the mix between dividend and buyback.

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Alvaro. Let me address both questions in terms of beta. Obviously, we are making a significant change to the guidance we've made based on our experience. And a strong view we have that we are going to deliver a lower beta. And this obviously has to do with time. This is obviously now third quarter where we have had positive rates, and it's also a third quarter where we will have -- where we would -- we have had completed our offering, including a time deposit product. And hence, now we have, I think, most of the unknowns knowns, in that respect, we have a higher confidence, a higher degree of ability to give a guidance that is obviously better in terms of its impact on profitability. Yes, we've seen how people are when they look at the current environment, the various investment options they have, the fact that interest rates are even higher and hence we can create products that are very attractive for clients and are not based on time deposits. All that is giving us confidence in us and obviously, not just Javier, myself and the management, but also the people that are running our business units are clearly confident that we can be there. And again, when we look at other markets, we'll start to see very significant differences between various banks, depending on the structure of the deposit franchise. And the U.S. is one very clear example without giving you specific names. Anyone who looks at that market can see very different betas depending on the structure. And when you look at Europe and Spain and you look at us, we're clearly at the top of the kind of customer fund structure that would deliver the lowest beta. So that's why we're coming with a fairly degree of confidence that we can do better. And obviously, we're already showing it because our beta in this third quarter was 13%, basically. And obviously, as Javier said, we're going to be well below the 20% in the fourth quarter that was our original guidance. So not only what we are seeing now, but also what -- based on what we're seeing now, we expect for the next quarters, that's why we see that lower beta than earlier. And with respect to capital, obviously, we have booked this quarter the expected impact that we had pending on regulatory risk. This means that for the next -- for the foreseeable future, we do not expect any further impact associated to our internal risk models and the return to compliance after the Bankia integration. That's done. And hence, when we look at the fourth quarter, but particularly next year, because you may have some volatility in any given quarter. What I'm saying is basically our profits are going to translate into distributable capital. The RWA growth is unfortunately, because we'd love to have a healthy, growing lending business, it's healthy, but it's not going to be growing in the short and medium term. So we're going to have a substantial capital generation in the next quarters. And that's why, obviously, we're saying we're going to be well ahead of the EUR 9 million.In terms of, how do we return that capital to shareholders? We are going to obviously retain that 50% to 60% this year. That's clearly when we look at what do we do with next year and with the capital that is going to be available for distribution on top of the, let's say, ordinary payout level. I would not like to comment on it because, obviously, it's something that we will have to decide at the right time, and the Board will have the ultimate word. But I have no doubt it will be coming back to shareholders.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Sofie Peterzens with JPMorgan.

[Sofie Peterzens, analyst]

Just a quick question. On your hold to collect portfolio, can you just remind us how large your unrealized losses are in this book? And then my second question would be on the ALCO yield. It looks very low at only 1.4%, and the book is pretty large. So kind of could you just talk about the repricing of the ALCO portfolio book and kind of the NII benefits that we should expect maybe beyond 2024, assuming rates stay above 3%?

[Gonzalo Gortázar Rotaeche, executive]

Okay, if I may. Sofie, the fair value of our hold-to-collect portfolio is now at a loss of EUR 6.6 billion pretax. I just take the opportunity to remind you that you should look at this with a broader view considering the fair value of other assets and other liabilities. And we have a slide on the annex of our presentation with all the details, but all in all, that accumulates a net gain of EUR 34 billion, just to keep that in mind. And towards the ALCO portfolio, well, what I have been saying in recent quarters is that we saw that the yield curve was too inverted and actually adding to the portfolio was not being accretive in terms of short-term performance on NII. The market is moving towards our view, I would say. And as I mentioned to our previous question, we are retaining a slight positive gearing towards higher rates, possibly positive sensitivity of circa 5%. And we are happy for the time being with that positioning. And remember that as the time passes, just because we originate assets at fix is gradually being reduced, and we are monitoring that sensitivity, obviously closely. And as I say, we have a view that for the time being, we are fine with that positioning. Once we decide to hedge more, we can do it by using cash products. That means fixed income securities. Also, we can decide to use swaps let's say, swapping floating assets into fixed or also, I think on liabilities. But time will tell. So it's a little bit about market views and the way we see things going forward.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Andrea Filtri with Mediobanca.

[Andrea Filtri, analyst]

Yes. I'll start with a follow-up on the elaboration you have done on capital usage and organic growth. Does this mean that we can rule out M&A in Portugal? And can you confirm that you will not breach the 12% CET1 level in any circumstance? The second question is on the digital euro. What do you see as risks and opportunities of the digital euro implementation? Have you budgeted the impact to your business model? And can you share with us.

[Gonzalo Gortázar Rotaeche, executive]

Thank you Andrea. And I'll start with the digital euro. You may know that we were the sole bank that participated in the prototyping exercise that the ECB launched some months ago. The other 4 partners, including some big techs were not banks. And hence, we have been very involved on this matter, I mean 6 months working and working with the ECB, particularly we were in charge of the P2P model kind of equivalent for those of you who are familiar with [indiscernible] in Spain is a similar kind of proposal. So we're thinking hard about the digital euro, and we think the digital euro can be a threat and an opportunity. At this stage, what we are most focused on is to make sure that it becomes an opportunity generally for the industry and certainly for those banks like us that are fairly advanced in digital matters and fairly much willing to take advantage of the word that is constantly changing. And at the same time, obviously, there are issues around financial stability, whether the [ lineage ] with the costs associated to implementation, who bears them and all that, those are important things. In terms of budgeting them, as you know, this is a long term in our budget. We are in the process of finalizing it. And certainly, there's not going to be an impact associated to the digital euro in 2024. When we prepare our next strategic plan, which is 2025 to 2027 obviously, we will be taking into account whether digital euro is going to imply and if it will be sort of, in my view, back loaded. But certainly, the work that needs to be done, which we have started already will gain pace during that period. In respect to capital, I would say, rule out M&A is something that I would change into saying it's very unlikely that we will do M&A. That's how I would guess and certainly, we do not have any plans currently.And maybe you want to complement any --

[Javier Pano Riera, executive]

No, you mentioned -- you asked about the 12% CET1 ratio. Well, I would remind that our formal target is between 11% and 12%, and that from 12% is when capital evolution accelerates and we are happy with maintaining those targets, strong MDA buffers. So I think that there are no changes on that front.

[Marta Noguer, executive]

Operator, please next question.

[Operator]

The next question is from Carlos Cobo with Societe Generale.

[Carlos Cobo Catena, analyst]

One is a quick follow-up. I know you've been very specific about M&A, but I was wondering if it's more focused on big acquisition. When we look at bolt-on deals, small deals to complement your current businesses, insurance fee generating businesses. We haven't really seen much in Spain, probably because the sector was still building capital, but now we have the capacity to complement those good fee-generating businesses. And I was wondering why you are not considering doing that. And the second question is about the new deposit campaign. If you could comment about [indiscernible] 2% rate on time deposits, how do you expect to affect the evolution of the deposit beta next quarter if you see that accelerating a little bit? Or is it going to be managed and not going to have such a big impact on the evolution of beta?

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Carlos. In terms of M&A, again, we do not see any opportunity that makes sense for us. We are present in all the value chain in financial services in Spain and Portugal. It doesn't mean we cannot do better and that we're best at everything we do. Obviously, that's not the case. But clearly, we have the basis to compete everywhere on the basis of our own organic development. And my feeling and obviously, I personally have been involved in M&A for a long time is that very often people tend to relax the discipline that we have in managing our P&L when talking about M&A. It is much easier to make assumptions of what may happen in the future associated to transactions. And this generally tend not to be then materialize. So we are fairly conservative. You know we've done M&A. Obviously, Bankia is a recent example, but we've done other -- we did BPI, we did Barclays, Banca Civica, et cetera, Banco de Valencia. But the bar has to be very, very high for us to move. And clearly, with our position now in our markets and with a view that we do not want to go beyond our markets for retail banking, then it's just, in my view, just very unlikely that we will find some sort of bolt-on transactions that make sense for us. We do not see that as a good use of capital as a rule. And in terms of the new deposit campaign, this is all incorporated in our guidance for beta this fourth quarter and for next year. And in fact, it's not just incorporated is one of the reasons why we now have gone through this new set of -- or having a full offering, we know now how our clients are reacting to it and have a much high degree of confidence to say we're going to do better. So beta is going to perform, NII is going to outperform. It's all incorporated.

[Marta Noguer, executive]

Operator, next question, please.

[Operator]

The next question is from Britta Schmidt with Autonomous Research.

[Britta Schmidt, analyst]

On the net interest income, could you provide an update on your deposit hedge with regards to the size and also the maturities? And then on asset quality, there was a slight increase in NPL inflows. Are there any discernible trends by segments here? And do you expect there to be an IFRS 9 update in Q4? Maybe you can give us an idea of size? And also the third question would be, there are some troubles in the renewable energy sector to which you might be exposed. Can you give us any reassurance here on your exposure? Are there any equal guarantees? Or could you deploy some overlay here as required?

[Gonzalo Gortázar Rotaeche, executive]

I mean, on asset quality, and then Javier will complement and talk about NII. In terms of asset quality, Things are developing much better than we had anticipated. That is clear. But it doesn't mean that there's absolutely no impact. And if you look at the figures that are public for the market, and particularly the mortgage front you see some deterioration starting at the middle of the year. And that makes sense. Rates have gone up in a big way. And we have been discussing in these calls in previous quarters, what would the impact of that be. And we've seen some very moderate impact. In fact, again, it's something that now is giving us a bit more confidence because now we're starting to see what logic says that if rates go up and installments from clients are much more -- are higher and particularly for some clients, there's going to be some impact. But the good news is that rather than have a curve with the sort of going up in a very steep manner, it's actually a very low increase, very low rate of increase. So we have seen a bit of deterioration in the mortgage portfolio. And we have also decided because, as you know, there's the Spanish code of good practices. We have received around 6,000 applications. On that front, we have done another, give or take, 10,000 restructuring of mortgage, much less than what you would expect at this point. We're in September. And basically, our mortgage book has largely repriced as you've seen in the presentation. Again, there's still some further repricing, but the bulk of it has already happened and the majority of our mortgages are now above 3% Euribor plus the spread. So some deterioration, some refinancing, we have actually decided to reinforce and make even more conservative we're unlikely to pay sort of criteria. So we have to take some decisions to consider Stage 3 additional mortgages that are actually obviously performing but have some clear weakness associated to it. And in fact, that's part of a very prudent approach. We're having a very good year, obviously, compared to last year. We want to make sure that this is not a one-off. The main message from this presentation should be our profits are sustainable. NII is sustainable. Certainly, asset quality is sustainable. And even though we have an increase in cost of risk this -- in absolute numbers this quarter versus previous quarter, when you look at the annualized cost of risk is 25 basis points. Last year, we had a very sort of significant increase in the cost of risk in the fourth quarter. We're not expecting that this year, certainly not to the same extent so that we maintain our guidance. But actually, a lot of what we're doing in this front is anticipating potential problems if they materialize associated to next year, the usage of our unassigned provisions has been much lower than we had anticipated also for this year. So again, we have a pretty good buffer for next year. So in summary, there is some deterioration on the mortgage book. It's very moderate, is much lower than what we were expecting and certainly is one that we are very well provided for. And in terms of renewables, we are actually not concerned. We have been extremely prudent and continue to be extremely prudent. We have a very good profile. And at this stage, we are certainly comfortable with our exposures. I cannot comment on more details affecting individual names, but certainly, we're not concerned, Britta.

[Javier Pano Riera, executive]

Hi Britta, you had a question on hedges. We have those EUR 20 billion of deposits hedged to floating. We have EUR 5 billion of those hedges that are maturing by the end of the first quarter. So from then, we are going to have a positive impact on NII of slightly over EUR 40 million on a quarter-on-quarter basis. So the second quarter will already have a less negative impact, slightly over EUR 40 million compared to the first quarter. So that's it. The rest of the -- the remainder of the hedges are maturing later, basically end '26 early '27.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Ignacio Cerezo with UBS.

[Ignacio Cerezo Olmos, analyst]

I've got 3. The first one is on NII. If you can give us some color on the percentage of your deposit base, which is being remunerated around the Euribor levels. So what is the amount of deposits which you need to pay close to market rates right now? Second one is on asset quality. There's been, I think, it's EUR 1.4 billion increase of Stage 2 in the quarter. Maybe you can elaborate actually or explain what has happened? And also tell us what is the pace you're expecting in terms of using your EUR 1.1 billion overlays? And the third question is on costs. In the context of collective agreement, trade union negotiations, et cetera. Can you give us some color basically on how to think about costs into '24? Is the mid-single-digit growth is still a good benchmark or you think you can do better than that?

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Nacho. On costs, I want to be prudent because negotiations with unions will start early November. And obviously, we need to be -- it's a sector negotiable, sector in terms of the 4 main [indiscernible] bank but a sector negotiation, not just our negotiation with our own unions. And I need to be prudent in making statements there. I think we've been saying that we have an agreement at sort of economy -- level of the economy where the recommendation agreed with the unions was 4% in 2023 and then 3% and 3% each of 2024 and '25. That is going to be obviously a reference in the negotiations. What I would say in terms of costs, I'd like to think of them as, again, as our jaws going to evolve, and we certainly are setting a new level of efficiency, cost income ratio in 2023. And this has to be the base the reference on which we need to keep improving. And certainly, our aim is going to be to keep having positive jaws going forward once we reach this level, which in 2023 is obviously going to improve in a very significant manner. You can also project that the improvement we're having and look at what may be the end of the year, which given the guidance we've given is now fairly simple, and it means further improvements. From that basis of 2023, certainly, our target is going to be to keep improving jaws. But we're going to have this uncertainty on the negotiation, and we are going to be very prudent on what we comment ahead of that negotiation for reasons that I'm sure you understand well.Asset quality and Javier?

[Javier Pano Riera, executive]

Hi Nacho. Well, I will try to answer your question giving some data. I think that probably what is more useful is to see the percentage of our deposits that are being paid in interest, okay? Because we have also some sight deposits that are paid in interest and time deposits are still a few that are legacy deposits that are paid 0. So the percentage of our deposits that are being paid stands now at 16%. That has moved up from the previous quarter at 12%, slightly over 12%. And the average cost of that 16% that is being paid is between 2.8%, 2.9%, okay? So this is -- those are the numbers. I would say that in Portugal, you have a slightly higher percentage of time deposits than those that I mentioned you in Portal, you don't have sight deposits or current accounts paying an interest. But on the other hand, the average cost in Portugal is lower. So it's a little bit different mix. An additional comment I can make is that in terms of the breakdown of the deposit beta that is approximately a beta of 5% for retail and circa 30% for corporates and the public sector. So as you see, we have -- we hold still a high percentage of, let's say, corporate deposits that are still being paid 0. So this is the summary. I think that helps because also the portion of site accounts that are being paid in interest is also increasing gradually. And this is part of the beta development process. You had a question also on Stage 2. Yes, we have a slight increase this quarter, slightly over EUR 1 billion. You should think as this as something normal. And I think that probably the key message here is that you should not think that an increase in Stage 2 automatically results into an increase of the same amount into Stage 3 further down the road. So it has nothing to do with that. It's about the evolution of internal models, obviously, reflecting the new circumstances in terms of affordability, in terms of increasing rates and other impacts. And I think we should get used to higher volatility in the Stage 2 upwards and downwards. And considering our loan deposit balances, EUR 1 billion up or down, I would say, is something not material. But in any case, it's not the precursor of a deterioration for sure of the same amount.And about the overlays, well, I think that Gonzalo has just mentioned also, we are expecting to use part of those overlays. And there was a previous question from Britta about IFRS 9 models update that is this fourth quarter for -- precisely for that we expect and we are working now precisely which is the end result for that recalibration of internal models. And we are expecting that part of that -- those overlays will be used. Unfortunately, I cannot give you much guidance because we are just working on that until we have the end result, I don't know. But the message is that we are going to keep quite a significant part of that -- those EUR 1.1 billion unused and available further down the road. I think that we have covered all your questions in Ignacio.

[Marta Noguer, executive]

Operator, next question please.

[Operator]

The next question is from Marta Sanchez Romero with Citi.

[Marta Sánchez Romero, analyst]

I have 2 follow-ups and another question. On capital, the generation the underlying capital generation this quarter has been quite stingy given your profitability and the deleveraging of the book. So what's going on there? Have you been shrinking low-density books? Has there been a re-tweaking of models? And if you can give us a sense of what do you expect to generate pre-dividends and buybacks on capital per quarter over the next, I don't know, 18 months, that would be very helpful. The second question is a clarification on your hedging strategy and your guidance for NII next year. I gather that you have not swapped into fixed your floating rate mortgage book yet. We've seen that happening in places like Portugal, quite intensely actually. So -- but is that possibility already embedded in your guidance or that would be an additional positive impact? And then a third question on Angola. A few months ago, you were almost about to sell your 50% stake there or your 40% to make there. Any update here?

[Gonzalo Gortázar Rotaeche, executive]

Thank you, Marta. On Angola, nothing new in which we can comment at this stage. And on capital generation and hedging, Javier please.

[Javier Pano Riera, executive]

Hi Marta. Well on capital, we have had this quarter the loan book coming down, but basically on low-density segments because we have had the leveraging on mortgages. We have had basically public sector. We have had also ICOS coming down. So that is probably the reason why you have a different mix result on the evolution of risk-weighted assets on the quarter. But absolutely nothing beyond our expectations, and I would like here to remark that not any sign of, I would say, rating migration whatsoever. On hedging strategy, sorry, and you had a question about organic capital generation. So the message is clear. So net income at the end of the day, we're expecting to flow into organic capital generation, then depending on the final decision on our payout for next year, there will be a net accrual every quarter. But basically, the message is that we are not expecting any material risk-weighted asset inflation into next year. And as a consequence, it's quite easy to do the math. On hedging, no, we have not hedged anything this third quarter. And to your point, to what extent this is incorporated in our guidance. The answer is no because actually hedging is not adding NII, and I insist on that, the yield curve is negative. So hedging is not adding -- it's not accretive. And to what extent are we going to do it or not? Well, it depends on the overall organic sensitivity of the balance sheet, the evolution of the sensitivity of the balance sheet I commented before. And the view we may have at some point about rates going forward. And this is obviously an ongoing discussion, as you can imagine. And we have our views. And as I said before, happy to hold this positive bias towards -- small, although much smaller than 1 year ago towards higher rates for now.

[Marta Noguer, executive]

Next question, please.

[Operator]

The next question is from Hugo Cruz with KBW.

[Hugo Moniz Marques Da Cruz, analyst]

Just a quick question. The NII guidance, if I assume just the EUR 10 billion for this year, it implies actually a decline in Q4 of 4%. I wonder if you think that's something we should assume an NII peak was really in 3Q or actually, we should assume something a bit better and some stability. If you could clarify that would be great.

[Gonzalo Gortázar Rotaeche, executive]

Well, thank you for 2023, we said at least EUR 10 billion. We didn't say EUR 10 billion, at least EUR 10 billion; to be honest. It's difficult to tell you now if NII for the fourth quarter will be exactly at the same level, slightly over or slightly below third quarter NII. It's difficult to say. So far, the evolution in the quarter as we are already by the end of October is doing according to our expectations. So I think that we can really deliver a much lower beta compared to that 20% we guided last quarter, and we'll see. But just to be clear, that is at least EUR 10 billion for this year.

[Marta Noguer, executive]

I believe that was the last question. So thank you, Javier. Thank you, Gonzalo. Thank you, everyone, for watching. Have a wonderful weekend.

[Gonzalo Gortázar Rotaeche, executive]

Thank you very much.

[Javier Pano Riera, executive]

Bye-bye.

[Gonzalo Gortázar Rotaeche, executive]

Bye.