Banco de Sabadell SA

MAD:SAB

Earnings Call Transcript 2020-Q2

[Cecilia Romero, Head of Investor Relations]

Good morning, and thank you for joining us for Sabadell's results presentation. My name is Cecilia Romero. I'm Head of Shareholder and Investor Relations, and presenting today is our CEO, Jaime Guardiola; and our CFO, Tomás Varela. During our webcast today, we plan to spend around 45 minutes presenting our results and then we will answer your questions for an additional 20 minutes. Today's presentation will follow a slightly different structure to last quarter. Our CEO will start by going through an update on the effects and implications of COVID-19 and will then provide details about commercial activity and business performance. Our CFO will then discuss financial results, credit risk profile, asset quality, liquidity and capital before our CEO concludes with some brief closing remarks. I will now hand over to Mr. Guardiola to kick off our presentation.

[Jaime Guardiola Romojaro, CEO, MD & Executive Director]

Thanks, Cecilia, and good morning, everyone. We trust and hope you are all keeping well. I will start with a few remarks about the economic situation, both in Spain and the U.K. In Slide 4, you can see that economic activity in Spain started to improve in May, when the lockdown began to be gradually lifted. Just to highlight 2 points. High-frequency indicators show clear signs of recovery while economic sentiment has returned to levels compatible with economic stability. To date, the Spanish economy has shown a quick recovery. In Slide 5, you can see that in the U.K., economic activity also started to recover in May. The economy has been gathering steam since June according to both the Bank of England and economic sentiment indicators. Manufacturing, construction and online retail spearheaded the initial recovery. This has led to a prompt recovery of high-frequency indicators of consumer spending. Moreover, the labor market has been particularly resilient. And in the housing market, prices have held up relatively well and activity has already started to recover. In Slide 6, we summarize the additional measures taken by governments and central banks to reactivate the economy and support the overall stability of the financial system. Because of the support, the received banks have been able to focus their full attention on helping to minimize the economic consequences of the crisis for their customers. Fiscal support, which subsidies, payment holidays as well as government-backed business loans, have been vital in supporting the economy in both Spain and the U.K. Moving on to business performance. In Slide 8, we show some key metrics that demonstrate that we are well prepared to face the current challenges. This quarter, we have increased our core Tier 1 capital by 55 basis points to 12.7%. This means that we are operating with a substantial capital buffer of 331 basis points above MDA requirements. Our liquidity position has improved further in the quarter with a liquidity coverage ratio of 214% and EUR 49 billion of high-quality liquid assets. Moreover, our balance sheet has shown resilience with an NPL ratio of circa 4%. And finally, our volumes have continued to grow substantially at 4.2% year-on-year, demonstrating our continued support to our clients and the economy. Looking at our performing loans by region. In Slide 9, you can see that loans grew year-on-year across all geographies. This growth was mostly driven by government-guaranteed loans to corporates, SMEs and self-employed individuals. Overall, group performing loans grew by 2.1% in the quarter and by more than 4% year-on-year. This is a similar level to that of first quarter. Slide 10 shows customer balances, excluding TSB. On the left-hand side, you can see the breakdown of performing loans. Overall, performing loans increased by 2.4% in the quarter and by 4% year-on-year. The corporate and SME segments were the strongest drivers of growth in the quarter, mainly due to the new production of ICO-guaranteed loans. Loans to public administrations were also higher. Mortgage loans showed a resilient performance due to the new production and a lower level of repayments. Our customer funds increased by 2.5% in the quarter and by 0.6% year-on-year, driven by both on and off-balance sheet funds. This was the result of lower cash drawdowns by corporates, individuals and higher mutual and pension funds valuations. Moving on to Slide 11. In terms of commercial activity in Spain, the figures clearly show how the government's lifting of lockdown measures has translated into improved activity levels. Indeed, by June, the figures for the main activity indicators were already at or near pre-COVID levels. In addition, market share showed a strong growth year-on-year. Regarding mutual funds, assets under management evolved in line with financial markets performance. Although the market share has decreased in year-on-year terms, it is important to highlight the increase of 7 basis points recorded so far this year. Continuing with Slide 12. We can see how new lending to individuals was steadily recovered in the second quarter while SME lending has increased substantially. Around 60% of new SME loans recorded in the second quarter are ICO-guaranteed loans, the public guarantees program for lending for SMEs. This means that the new SME lending in the second quarter was 2.4x higher than in the first quarter. In terms of credit facility drawdowns, these have started to come down after increasing by the end of the first quarter. Looking at the right-hand side of the slide, we can see how the recovery of our lending to individuals in terms of both consumer loans and mortgages, has taken hold in the second quarter. In fact, as shown in the graph below, outlooks regarding new mortgage lending are positive and new mortgage simulations in the last few weeks are close to pre-COVID levels. In Slide 13, we provide details about the key financial solutions we have offered to our customers in Spain. Regarding payment holidays, at 30th of June, we have granted EUR 895 million worth of statutory moratoria and EUR 1.4 billion in sector-specific moratoria. These figures include the outstanding principal of both mortgage and consumer loans, representing around 6.4% of our stock for these products. It's important to highlight that we are progressively receiving fewer applications for payment holidays, as shown in the graph on the right-hand side. In terms of ICO loans, at the 24th of July, we have already granted EUR 9.3 billion, and we have further EUR 1.7 billion in the pipeline. Turning now to TSB, in Slide 14. On the asset side, net lending grew in the quarter by more than 1%. This quarterly growth reflected an increase in business banking loans under the U.K. government's Bounce Back Loans Scheme. Mortgages grew slightly despite COVID-19 disruption and there was a reduction of unsecured balances due to lower consumer spending following the lockdown. Overall, year-on-year, net lending was up by circa 3%. On the liability side, customer funds increased both in the quarter and in the year, with growth across all products. Strong deposit growth across current and saving accounts was a result of lower consumer spending. Furthermore, deposit growth also benefited from business banking deposits following the strong take-up of the U.K. government's BBLS. Moving on to Slide 15. We can see TSB new lending performing in the first half of the year. Commercial activity in TSB is recovering, particularly in mortgages. As shown in the graph on the upper left-hand side, new mortgage lending in June was almost back to the pre-COVID levels. It is also worth looking at the line graph on the left. As you can see, mortgage applications in recent weeks have been even higher than in the first weeks of the year. The peak was reached in June due to the increased demand once lockdown restrictions were eased. TSB also continues to make progress on its strategic plan. Regarding customers focus, TSB NPS has reached its highest level in over 2 years. And it's also important to highlight the continued growth of the business banking customer base. In terms of simplification and efficiency, TSB has closed 43 branches in the first 6 months of the year, and this, along with other measures, has enabled the reduction of 1,000 FTEs year-on-year. Operational excellence benefits are also beginning to be delivered. Our cloud-based IT infrastructure has delivered stability and has seamlessly supported close to 3,500 employees working full-time from home through the lockdown. Furthermore, 80 positions at TSB's new IT center in Edinburgh have been filled during the lockdown, part of our GBP 120 million investment in digital. On Slide 16, we include the actions that TSB has taken to support its clients during the COVID-19 crisis. As of 30th of June, TSB has granted payment holidays with an outstanding balance of around GBP 4.9 billion. This is in line with U.K. peers in terms of payment holidays as a percentage of the stock. As shown in the graph on the right-hand side, the number of payment holiday applications has fallen considerably in recent months following the peak in April. As of 24th of July, TSB has already granted GBP 445 million worth of BBLS, which are 100% guaranteed by the government and was processing applications for a further GBP 185 million. In Slide 17, I would like to highlight the ways in which our customers in both Spain and the U.K. have taken up digital channels, enabling us to take a great leap forward in consolidating our digitization. In the second quarter, the number of digital interactions with the bank has been far higher than in the previous quarter. This has been supported by an accelerated development of new digital products and services. In short, this leap forward in digitization is expected to be consolidated after the lockdown, which will enable us to improve our efficiency as well as our commercial productivity. To finish this section of the presentation, in Slide 18, we show the most relevant milestones for the first half of the year on the field of sustainability. I would like to highlight that in June, the Board of Directors approved a sustainable financial plan to further integrate sustainability in Sabadell's business model and strategy. This slide shows the key ESG milestone achieved this semester. This include, among others, our commitment to align our report practices with the recommendation of the task force on climate-related financial disclosures and the launch of our framework for the issuance of bonds linked to the sustainable development goals. It is also worth noting that we have included sustainability as 1 of the 6 group corporate objectives, therefore, impacting on the variable compensation of our employees. And with that, I hand it over to Tomás.

[Tomás Varela Muiña, GM & CFO]

Thank you, Jaime. Good morning, everybody. Regarding our quarter results in Slide 20, we reported a net result of EUR 52 million in the quarter. Our quarterly results were impacted by the final impairment of SAREB subordinated debt, which is now 100% provisioned for. The single resolution fund payment, usually incurred every year in Q2, the increase in provisions following updates made to our IFRS 9 provisioning models to incorporate new macro scenarios and the capital gain on the disposal of Sabadell Asset Management. I will go through the results in detail in the following slides. In Slide 21, you can see that group net interest income fell by 7.3% in the quarter and by 5.6% in the year. Relative to the first quarter, NII was positively driven by higher volumes and cheaper wholesale funding. Factors which reduced NII include lower overdraft fees in both Spain and the U.K., with an even split between the 2 regions. In Spain, corporates and SMEs had higher liquidity positions, which impacted overdraft balances and commissions. In the U.K., the impact was the result of the new overdraft policy put in place and the high-cost credit review as well as the overdraft waiver supplied as part of our client support packages launched post-COVID. Other factors impacting NII include lower asset yields, including lower U.K. interest rates, a smaller ALCO contribution and the impact of FX. Overall, NII, ex TSB, was down 3.5% in the quarter, while TSB's NII fell 17.5%. Finally, it is also important to highlight that NII is not expected to fall below the levels reached in Q2 during the rest of the year. Indeed, there are a number of tailwinds that will lead to a growth of NII over the next 2 quarters. TLTRO III will contribute circa EUR 150 million to NII in the next 12 months or EUR 74 million in the second half of the year. Other tailwinds include: loan volumes; overdraft income, which will recover gradually as the situation normalizes; the increase of the ALCO portfolio size in the quarter will slightly improve its contribution to NII from Q3; and higher NII at TSB due to a lower cost of deposits, the end of overdraft waivers and high volumes. Turning now to Slide 22. Here, we specifically look at front book credit yields, ex TSB. Overall, the front book yield was impacted by the new lending mix, which was predominantly led by loans and credit lines to SMEs and corporates, which amounted to about 80% of the new production and mainly comprised lower-yielding ICO-guaranteed loans. In Slide 23 now, you can see that group NIM was impacted by lower loan yields, resulting from changes in the credit mix, lower U.K. interest rates and lower overdraft fees. In the next slide, 24, we show the changes in composition of our ALCO portfolio. On the left-hand side of the slide, we show how the size of the overall portfolio increased by EUR 3.6 billion in the quarter as we invested in Spanish bonds. The quarterly increase in size of the ALCO portfolio will mean a slight increase in its contribution to NII from Q3. We also have no significant maturities occurring during the rest of the year. Finally, we wanted to highlight that the sensitivity of our capital position to movements in bond spreads remains low as our portfolio structure has been broadly unchanged this quarter. In Slide 25, you can see that group fees were down by 7% in the quarter, impacted by the effects of the lockdown on customer activity, which was particularly noticeable in service fees. Corporate lending activity, however, was robust, which helped credit and contingent risk fees. In the year, group fees fell by 4.6%. During the second half of the year, it is worth highlighting that the closing of the Sabadell Asset Management business disposal will represent a fee reduction of EUR 26 million for the last 6 months in aggregate. Other than that, improved activity levels and the growth of corporate lending should have a positive impact on fees during the rest of the year. Moving now on to Slide 26. Group total expenses were up slightly in the quarter and ended flat year-on-year as lower personnel costs, both in TSB and ex TSB, were offset by higher general expenses and amortization. Moreover, TSB recurring costs were lower, once again, as we continue to make progress on our restructuring plan. TSB restructuring costs amounted to EUR 11 million year-to-date. Overall, we expect total costs for the full year to decrease year-on-year. In Slide 27, our credit provisions, excluding costs, amounted to EUR 486 million, which were higher quarter-on-quarter as we updated our IFRS 9 models by incorporating a new macroeconomic scenario. The front-loading of provisions due to our models update brought our NPL coverage up from 53% to 56% at the end of the quarter as a result. It is also worth highlighting that our models update has been based on the probability-weighted macroeconomic scenario shown in the slide, which is in line with the central case recently published by the Bank of Spain when looking at cumulative GDP growth over the next 2 years. Overall credit cost of risk year-to-date was 107 basis points as a significant amount of provisions have been front-loaded to the first half of the year. We expect provisions to fall from now until the end of the year, meaning that we can confirm our credit cost of risk for the full year at the guidance actually, at a level of 90 to 95 basis points. I will turn now to credit risk. This quarter, we are including a new disclosure, starting on Slide 29, that we hope will be helpful to better appreciate the quality and performance of our portfolios. Next slide, the nature of the current crisis has brought forward the need for a different kind of analysis in order to get the calibrated effects. Impacts on individuals, corporates or businesses in the form of reduced income will be massively mitigated by state programs involving guaranteed financing and public transfers. As a result, financials will worsen as debt increases and profitability and income become depressed. But at the same time, a very significant proportion of defaults will be prevented for good due to these measures. We have developed a structural analysis framework to assess and monitor credit risk behavior under these specific patterns. It involves a methodology to speed up the vetting of some key financial metrics of customers, stressing them according to the scenarios and the use of models to estimate PDs more closely adapted to the current setting. In the case of corporates and SMEs, we have developed specific new models that yield statistical performances that match the standards commonly required. The framework covers more than 90% of the portfolio. The financials of customers after being updated have been stressed to levels consistent with the macro scenarios that have been used in the models. The corresponding PD estimates are obtained from the models and the resulting multipliers to the pre-COVID levels are 1.3x in the base scenario and 1.7x in the adverse scenario. So now we'll be sharing some of the metrics and data coming out of this framework to illustrate -- to illustrate these numbers. Turning now to Slide 30. As shown in the previous quarter presentation, our EUR 143 billion portfolio is well diversified, and the exposure to the considered more sensitive COVID-19 sectors is limited to 8%. The percentage of ICO-guaranteed lending to these sectors as of the end of June amounts to 14%. A 65% of the portfolio is secured and circa 80% of it has investment-grade equivalent ratings. In Slide 39 -- sorry, 31 now, we highlight the reasons that make this a different crisis, in particular, more than EUR 200 billion in financing and transfers have been swiftly made available to mitigate the shock. There were no significant previous macroeconomic imbalances and it is especially worth noting the very relevant difference in the current indebtedness and interest rate levels in Spain as compared to the levels of 2007. The shape of the crisis itself is also different, even if very deep, it is now much more concentrated in time. In the next slide, 32, the outline of the overall methodology is explained. I don't intend to go into the details. It can be read in the slide. I only will cover some highlights. Both in SMEs and corporates and retail, and in retail, I mean the relevant metrics are updated from some sources and stressed in alignment with the scenario. In SMEs and corporates, the relevant metrics involve EBITDA and debt. EBITDA is heavily stressed and also is as a consequence that models based on 10-year deep history of our data have been developed to estimate PDs based on these metrics. References made in the slide to the GINI index, that shows the quality of the models. The output is also complemented with the current models. In retail, the metrics are equally stressed using high-frequency indicators and the proportion of unemployed in our portfolio is also stressed to match the macro scenario expected unemployment increase in Spain. The current models are run with the stressed data. In Slide 33, the key metrics profile of our corporates and SMEs is presented as well as the EBITDA stress levels that have been used for the adverse scenario. Average debt to asset levels range in a healthy range of between 22% and 34%, which as can be appreciated in the lower left-hand side chart, have been kept basically stable, with a downward trend over the last more than 10 years. On the other hand, in the next to the right chart, it can be appreciated how average EBITDA to asset levels have been consistently growing since 2012 to reach an also healthy level of between 6% and 8%. Average debt amount growth rates from March to May give some color on to which extent corporate and SMEs have increased their debt in a period where providing financing, in particular, ICO loans, has been at the top of the agenda. The implied impact in average on debt to assets doesn't appear to be very significant. In the upper right-hand side, the levels of collateralization and LTV show very good levels. In the lower right-hand side, the haircut supply to EBITDA show the range for 2020 from an average of minus 44% for not affected sectors to a minus 222% for sectors with a recovery pattern in the form of an L. And the bulk of our customers that are considered to have a recovery pattern shaped as V or U have an average haircut of minus 99%. All of them show recovery on average in 2021, but still only to challenging levels. As for the retail customers, in Slide 34, data are shown for both individuals and self-employed. Collateralization levels are higher than 85%. And debt-to-income levels range between 33% and 35%. On the lower left-hand side, debt-to-income is shown to have been continuously decreasing since 2012. On the lower right-hand side, haircuts to income are shown. They range from an average of 15% to 19% for individuals to an average of 25% to 33% for self-employed, but with wide ranges. In Slide 35 now, it can be seen for the 3 big segments how the annual haircut levels applied under stress go well beyond the actual average decreases in income observed in the 3 months from March to June. The next Slide 36 shows data for the specialized lending portfolio, which represents 5% of the total. The biggest part of it is related to energy. The charts show for production levels, a high degree of stability. For price levels, the long-run stable range of price fluctuation. And in the lower right-hand side, the evolution of the debt service coverage ratio with safe buffers above a coverage level of the debt of 1x. This portfolio is little sensitive to the crisis. Finally, in Slide 37, on the right-hand side, the COVID-19 PD multipliers to the pre-COVID-19 levels obtained from the models are shown for scenarios, for both scenarios: the base, and that shows a 1.3x multiplier; and the adverse, 1.7x. To the left-hand side of the slide, this outcome embedded in the current macro scenario can be compared with 2012. The strong difference in the macro can be appreciated. The macro scenarios in both episodes are represented by the dotted lines. These lines plot the Z, which is a systemic factor variable that synthesizes basically GDP and employment and housing prices. When above the 0 level, it shows expansion and below 0 level, it shows a slowdown period. 2012 and 2020 are the 2 bottoms of the episodes. In this case, in 2020, according to the current view of the COVID scenario. The bottom here in both cases, was the PDP -- the PD multiplier to the previous year PD is not that different in the 2 crisis, as can be appreciated, which shows the challenge in the stress imposed in this exercise. Though, of course, after 4 years of crisis in 2011, the PD levels were significantly higher than in 2019, which determines a big difference in the absolute levels of the 2 episodes. Now in the following section of the presentation, we'll start with asset quality in Slide 39. In this slide, you can see that NPLs were slightly higher in the quarter, driven by lower recoveries due to lockdown and an increase of unlikely to pay exposures or qualitative NPLs at TSB. This quarter, as part of the bank's COVID-19 risk management assessment, TSB has classified all loans that already had amounts more than 30 days past due before they apply for a payment holiday, as stage 3. This measure has entailed recognizing NPLs ahead of their 90 days past due date. So they would be or they are subjected for unlikely to pay, stage 3 exposures. As a result, NPL ratio increased slightly at group level but remained stable at ex TSB level. Foreclosed asset exposure was at circa EUR 1.5 billion. And finally, it is also worth noting that more than 60% of Sabadell's NPLs are secured loans. Turning now to Slide 40. The group ended the quarter with a strong liquidity position, reflected in a higher LCR of 214% and high-quality liquid assets of circa EUR 49 billion. The loan-to-deposit ratio ended the quarter at 99%. Furthermore, in terms of Central Bank funding, we currently have EUR 27 billion of TLTRO III outstanding, of which EUR 13.5 billion was rolled over from TLTRO II and III -- sorry, and EUR 13.5 billion is new funding. In terms of TFS, we have GBP 3.1 billion outstanding, which will likely be rolled out into the new TFSME facilities. Moving on to capital in Slide 41, we show the evolution of the group's CET1 ratio during the quarter, which increased by 55 basis points as well as our pro forma position. Starting from the reported CET1 ratio at the end of the first quarter and following the graph to the right, we show the different drivers and capital impacts in the quarter. The Sabadell Asset Management disposal closed this quarter and the inclusion of the SME supporting factor added a total of 56 basis points in the quarter. Other aspects, including the quarter-on-quarter change in transitional IFRS 9 net profit net of AT1, intangible assets, tax loss carryforwards as well as lower RWAs reduced the ratio by 1 basis point. Taking all of this into account, our CET1 ratio on a reported basis stood at 12.7% at the end of Q2. In addition, there are a number of business disposals that bring us to the pro forma ratio and added of 14 basis points. Firstly, the sale of our real estate developer will add 6 basis points. It is worth highlighting that we have now received all relevant authorizations to carry on and close this deal in due course. And the disposal of our depository business will add 8 basis points. These elements bring our CET1 ratio to 12.8%. Also before year-end, we are expecting an additional regulatory tailwind, not included in our pro forma currently, which is the change in prudential treatment of software assets, which will impact our ratio positively. On the following Slide 42, you have the details of our current reported capital base in relation to requirements. Our reported total capital ratio stood at 16.3% at the end of the quarter, 331 basis points above our requirement of 13%. In addition, our leverage ratio stood at 4.7% at the end of the quarter. To conclude now my part of the presentation with regard to our funding plans in Slide 43, we have no immediate pressure to issue as we are in very compliant. Our eligible MREL securities as a percentage of total liabilities and as -- and our own funds, stand at 8.6%, which is above the requirement of 8.3%. We have issued circa EUR 5 billion of MREL-eligible securities from the beginning of 2019 to date. We have also met our subordination requirement, which is 5.2%, as our current position stands at 6.4%. Finally, for the rest of the year, we are planning an inaugural sustainable bond issue, a benchmark transaction. And with this, I will hand over to Jaime, who will conclude our presentation today.

[Jaime Guardiola Romojaro, CEO, MD & Executive Director]

Thank you, Tomás. Just to finish, I would like to go over a few takeaways from this quarter's performance and look at our key priorities going forward. As you have been able to appreciate throughout the presentation, this quarter, our commercial performance has been impacted by the current macroeconomic environment and by the low levels of economic activity during lockdown. Since the gradual lifting of lockdown measures, we have seen -- we have been seeing early signs of economic and commercial recovery in our core markets, which should rise our revenue for the rest of the year. Economic expectations have changed since the beginning of the pandemic, which has required us to update our provisioning models this quarter. We have front-loaded a significant amount of provisions in the first half of the year, meaning that we are well prepared for the start of the credit migration cycle. We feel confident that our credit cost of risk guidance will remain at 90 or 95 basis points for the year. So we confirm our year-end guidance. Based on the evidence so far, the second quarter will be the period with the lowest core revenue and the highest level of provisions this year. We expect to see core revenue start to pick up in the second half of the year as we gradually consolidate the movements towards the new normal. Regarding provisions, they should decrease in the second half of the year. Finally, and despite the extraordinary circumstances, the bank has increased its capital position considerably this quarter. Our solvency position remains strong, with a Common Equity Tier 1 capital ratio of 12.7%. To finish our presentation today, I would like to highlight that the current situation presents us with a number of strategic opportunities which we can leverage on to improve our performance going forward, both from the revenue and cost sides. First, we have identified opportunities to cut costs in Spain by increasing the automatization of our services, speeding up our digitization and redesigning our organizational structure. Second, we will also be focusing on rebuilding our commercial momentum by enhancing our SME offering and focusing particularly on growing our lending volumes in target segments. For individuals, we will be prioritizing insurance, mutual funds, pensions and mortgages. In the U.K., TSB continues to make progress on its restructuring plan, meeting our expectations in terms of the restructuring milestones it has achieved. We are currently looking at how to speed up and make further headway in cost initiatives so as to alleviate the pressure on revenues caused by the pandemic. And finally, we also want to continue to show our commitment to our customers while preserving the strength of our balance sheet and capital position by focusing on risk management. And with that, I will now hand over to Cecilia.

[Cecilia Romero, Head of Investor Relations]

Thank you very much, Jaime. Now we're going to open the line for a round of questions. Operator, please, first question.

[Operator]

The first question is coming from the line of Mario Ropero from Fidentiis.

[Mario Ropero, Senior Banking Analyst]

[Audio Gap] I think you said that you were expecting this to be flattish. And then the second question is on capital. If I'm not mistaken, you showed a pro forma of 12.1% in March, but the fully loaded reported was still 11.9% in the end. So am I missing something there? Because I think you generated 50 basis points of capital on a phased-in.

[Cecilia Romero, Head of Investor Relations]

Mario, I'm not sure if we could hear the first question. You were asking about P&L guidance, correct?

[Mario Ropero, Senior Banking Analyst]

Yes. I mean on the operating corporation profit, I think you were guiding for a flattish performance.

[Cecilia Romero, Head of Investor Relations]

Yes, we heard. Okay. Thank you.

[Tomás Varela Muiña, GM & CFO]

Mario, yes. Sorry, because we missed this part, but now it's clear. So what we see, as we have developed in the presentation, is NII improving in second half of the year due to strong drivers, tailwinds. So clearly, TLTRO III, which provides EUR 150 million in first 12 months and EUR 75 million in the second half, actually. Also the normalization of overdraft fees, as lines become to be renormalized in Spain. A somewhat higher ALCO contribution due to the investments, the increase that we've executed in this quarter. And also improvements in TSB's NII due to lower cost of deposits; the end of the overdraft waivers and higher volumes; also the normalization of overdraft fees there. In terms of fees, we have 2 effects. One is that we will -- we won't have EUR 26 million in the second half due to the sale of the Asset Management business. But excluding this effect, also, fees will improve in comparison with the first half, due to activity levels recovering and dynamic corporate lending that will drive additional fees higher in the second half. Costs are expected to fall this year. And for the full year, we see a slight decrease in costs. And we think that we could find -- we will be able to find plans to save even more. So this is -- those are the main lines to come up with a view on the operating profit. So in terms of capital, I'm not sure I understand your question. But what we are showing is the ratio that has benefited of 17 basis points due to the IFRS -- IFRS 9 transitional arrangements and also 20 basis points from the SME supporting factor. Going forward, we will have maybe headwinds and tailwinds, basically regulatory tailwinds, mainly from the IT software EBA position that is due to be released by the end of the year. So this we expect that could be around 20 basis points by the end of the year. So this will complete the picture on capital.

[Cecilia Romero, Head of Investor Relations]

Thank you, Tomás. Thank you, Mario.

[Operator]

Next question is coming from the line of Carlos Peixoto from CaixaBank.

[Carlos Joaquim Peixoto, Analyst]

Just a couple of them. So starting with trading gains or basically what you're provisioning profit guidance for the year. What is the level of trading gain that would be embedded in there? What should we expect in the second half of the year, relating on that front? And then basically on the provisioning side, I was wondering if you could give us some color on what was the impact from the model updates in terms of provisions? How much of provisions were related in the quarter, specifically to that end? And finally, if I may, on the capital side. So from what I understood you, you mentioned that there will be a 20 basis points positive impact from the software IT reductions, from lower software IT reductions. I was wondering if on the other side, in terms of TRIM impacts, if there's still something pending that we could see either this year or next year? And also, any color in terms of expected impact from EBA guidelines going forward?

[Tomás Varela Muiña, GM & CFO]

Thank you, Carlos. So last year, we had some EUR 85 million in the second half trading income. This year, we don't see potential for a significant impact in the second half. So there is -- I wouldn't call out any relevant impact for this in the second half of the year. In terms of the impact of the update in the models, of course, when we run the models with the whole framework of the models with the new scenarios, the whole provision is aligned with the scenario. So it's -- everything is embedded there. But our calculation is that the additional impact of the update of the scenarios is around EUR 550 million year-to-date. In terms of TRIM, we don't expect anything, as we've been communicating. In fact, our TRIM cycle was completed almost in full. There is only a very minor portfolio, a low default portfolio, which is pending final closure. But for that, we already have a margin of conservatism embedded in RWA. So we don't expect anything from, from TRIM reviews. And in terms of EBA guidelines, nothing new to call out. So we are in the same position. If anything, the stocks have been reducing. So I wouldn't call out anything in particular there.

[Cecilia Romero, Head of Investor Relations]

Thank you very much.

[Operator]

Next question is coming from the line of Carlos Cobo from Societe Generale.

[Carlos Cobo Catena, Equity Analyst]

I appreciate the extra disclosure efforts you've done on the models and all the details that you've presented. It's helpful, because right now, the provisioning of the banks is becoming even more confusing with all the model-driven provisions. And actually, the first question would be on that PD multiplier that you've presented, could you help us to understand that a little bit better? How should we interpret -- should read that? Is that a leading indicator for the expected increase in cost of risk? So are you saying that the stress scenario could imply 1.7 multiplier on the cost of risk in 2019? Is that something that could make sense with a lot of the caveats that you will probably present? If that's true, why is your cost of risk guidance already 2x higher, almost 2x higher, than the 2019 cost of risk? And just to finish with that questions, are you reiterating the 90 to 95 bps cost of risk for 2020? How do you reconcile having such a low range in the cost of risk guidance and not increasing guidance despite the substantial reduction in the GDP for Spain? How do you -- can you help us to reconcile that? Why aren't you increasing provisioning guidance? Other banks have moved to the high end of the range, but they have a wider range that you presented in Q1. So just trying to think about that. And I think I'll leave it there, because I asked you a lot of questions.

[Tomás Varela Muiña, GM & CFO]

Thank you. Yes. It's interesting. As I explained, we are using this framework for risk management, actually. So it's not only an exercise to assess impact. But it works as a Challenger to the provision or the use of the IFRS 9 model. So we are leaving unchanged the guidance for the year because we would rather wait until Q3 to see the evolution of it. But as you rightly point out, implicitly in the guidance, it's actually more than twice, more than 2x multiplier, of the credit risk provision, cost of risk for 2020 over 2019. So actually, it's more than twice. So what it means is, of course, there is -- there are other companies of provisioning in IFRS 9 because, to a certain extent, the way that IFRS 9 works anticipates or upfronts some provisions, calculating expected losses due to future credit migration, so future migration to stage 3 from stage 1 and stage 2. And therefore, also, the model updates impacts on LGDs. But in short, so we have headroom in this guidance to accommodate all these impacts and to allow for changes or variances in the scenarios going forward. So we found it useful to present here the result of this exercise, because including in it has been able to see a significant level of stress on EBITDA and consequently, a strain on that. The multipliers show this behavior. So the look -- the way to look at it is that with the current cost of risk guidance, we have some headroom that we will try to confirm in the coming quarters. You're referring also, if I understand correctly the question, you are linking this with the GDP reduction. Our view on the ranges of scenarios that different banks have been using, my view on that is that at this huge level of GDP impact, deltas in GDP, in the GDP decrease, have limited additional deltas on cost of risk. We've tested this with several iterations with the models and this is the case because the impact is so big already that the more sensitive parts of the system already suffered with the first, let's say, 9 or 10 percentage points of GDP impact. And also, because what we are saying with this structural model is that in this crisis, it was looking sector by sector, was looking how the metrics are stressed and then use this to put at the forefront of the model usage to come up with PDs. Using for retail high-frequency indicators, so that is where you start losing a little bit of direct link with the scenario. Because updating the metrics with high-frequency indicators, as I say, gives you more color on how things are evolving. And I think this is the reason why there can be some differences that don't easily reconcile between levels of cost of risk guidance and levels of the scenarios used. We try to be conservative here.

[Cecilia Romero, Head of Investor Relations]

Thank you, Tomás. Thank you, Carlos.

[Operator]

The next question is coming from the line of Britta Schmidt from Autonomous.

[Britta Schmidt, Non]

I've got 3 questions, please. Just a follow-up, Tomás, on these models. You're saying they're used for risk management. So this is basically what you're suggesting gives us an insight into the IFRS 9 modeling of PDs. Maybe you can just comment on that. My second question would be on TSB. The pre-provision profit remains negative and you've been talking about accelerating cost savings, but wouldn't it be time to look for more cost savings versus the original plan, given that revenues are falling so far behind the business plan? And would you also consider perhaps M&A as an option to crystallize more value there? And then thirdly, on the NII, can you give us a little bit more insight as to what sort of level of improvement we should expect, especially at TSB in the second half?

[Tomás Varela Muiña, GM & CFO]

Yes. So was -- what I -- yes, I would say that you are right. So I think this piece, the structural model, gives additional color and additional perspectives on the, on the modeling in IFRS 9. So we haven't changed the modeling in IFRS 9. We've used the traditional models, of course, but we are using Challenger models based on this structural view updated with high-frequency indicators to -- and as I said, we use them also for risk management. So we will be deciding on exposures, actions, anticipation and actually managing the positions. But we use the outcomes that we have out of this in terms of PDs that are actually very granular, so exposure by exposure, to challenge the IFRS 9. We haven't changed the provisions coming out of the IFRS 9 model. But what we are doing is using this to test and we will be doing it in the coming quarters to test reasonability and sufficiency or even excess of the provisions run under the IFRS 9 model. In terms of -- I hand over to Jaime for costs.

[Jaime Guardiola Romojaro, CEO, MD & Executive Director]

Okay. Regarding your second question about TSB, as I said in the presentation, TSB continues to make progress on its restructuring plan. We have -- in fact, we have closed 43 branches so far out of the 82 expected in the year. And at this moment, our position is that we are currently looking at how to speed up and make further headway in cost initiatives, in order to alleviate the pressure on revenues that has been caused by the pandemic. And that's our position regarding TSB at this moment. Number three, Tomás?

[Tomás Varela Muiña, GM & CFO]

Yes. In terms of NII, I would say that the view for NII in the second half of the year and the full year, would be around or align broadly with the market consensus, a visible better performance in the second half of the year ex TSB and some slight performance, but visible performance as well in TSB, but to a lower extent.

[Cecilia Romero, Head of Investor Relations]

Thank you very much, Britta.

[Operator]

The next question is coming from the line of Marta Romero from Bank of America.

[Marta Sánchez Romero, Director and Analyst]

I've got 2 groups of questions, the bond portfolio and asset quality. First, on your bond portfolio, you've rebuilt it to EUR 27.5 billion. Do you have appetite for more? I believe your historical peak was around EUR 29 billion. What's your target for volumes and what maturities are you buying? And also, what is the ideal balance between amortized cost and available for sale, given that the relative weight of your amortized cost is too big? Is this a point of debate with the supervisor? And also, is your large maturity profile, 9 years, a point of debate with the supervisor? Are they fully on board with your ALCO strategy? The second one is on NPLs, NPLs disposals, in particular. Do you think the gap between bid and offer prices is widening? Do you have a target of NPL disposals this year? Do you think you've taken the right markdowns to set at a fast pace? And whether you expect any impact on your capital position from calendar provision? I'm sorry, just a follow-on on the ALCO. In TSB, what is the size of your structural hedge there? The last time you updated, it was around EUR 15 billion. Has it gone up?

[Tomás Varela Muiña, GM & CFO]

Thank you, Marta. We -- you are right. We were around, at the peak, around EUR 29 billion in the ALCO portfolio. Now we stand around EUR 27.5 billion. We could have appetite for more in the current setting. I think opportunities will be limited, so not sure that we will do more. We will be alert. And if interesting opportunities arise, we could top it up. But we also are satisfied with the current levels if this doesn't happen. We -- in terms of maturities, we've done basically 2 types of things. One, we've matched maturities with the TLTRO. And also, we've purchased in other issues, some more -- somewhat longer maturities to our amortizing cost portfolio, like 7 years. And no sign of considering that there is no any topic on the amortizing cost to be too big, not the rate at all, neither in terms of maturities. In terms of NPL disposals, we -- last year, we had targeted to tackle the market and see whether there was interesting levels there. We've always had this in our toolkit. But when the COVID started, we realized that it would be very difficult to actually execute deals this year, actually, not because of -- not necessarily because of prices, but because probably the markets will be affected as many other markets have been, by widespread, different positions on expectations. So we are not expecting to do anything relevant on this front. And about the ALCO, the structural hedge in TSB, we don't disclose this, Marta. But happy to keep the conversation going in terms of qualitatively assessing things, but we don't disclose the size of the structural hedging.

[Cecilia Romero, Head of Investor Relations]

Thank you very much. Thank you, Marta.

[Operator]

The next question is coming from the line of Andrea Filtri from Mediobanca.

[Andrea Filtri, Research Analyst]

One question on your portfolio analysis and one on costs. Following from what others have asked already, could you give us an idea of what distribution does your model suggest of provisions over time? I mean the speed of decay of this and what indications we could get on 2021 from it? And finally, what would be the equivalent impact to risk-weighted assets from your portfolio analysis from the rating migration that you have modeled in the severe or adverse case? And secondly, on costs, why are costs growing ex amortization quarter-on-quarter during the lockdown quarter?

[Tomás Varela Muiña, GM & CFO]

Thank you, Andrea. In terms of provisions, what our models show and so there is an alignment between the IFRS models and the structural analysis. What they suggest is that the peak in NPLs would be basically this year, but we -- but NPLs could keep being relatively similar next year, but the peak for provisions would be in 2020 this year. So therefore, we should see relevant provisions decrease in 2021 and still maybe some NPL inflows, not very different from those of 2020. In terms of RWAs, our view -- so RWA inflation coming from credit migration. The most -- at the end of the day, the most relevant driver there is change in -- so forbearance. So if we see surges in forbearance, then we would see RWA inflation. Other than this, it is very slow, because customer ratings change, but most of them change within the bucket, where they don't jump from one rating level to another one. And therefore, this is -- and this is also slow-moving. So it would be spanning little by little without peaks between the end of this year and 2021. But the only thing that might -- well, that actually can be visible is if forbearance appears as a toolkit -- sorry, as a tool. So -- and therefore, we have more refinance loans and this kind of thing, which we don't expect significantly, because the ICO loans have spread the shock in revenues over 3, 4 years, usually well balanced. And therefore, we don't expect to have significant needs of refinancing. And cost, as I said, costs are expected to -- so the behavior of costs last year were increasing quarter-by-quarter. This year, they will be much more stable quarter-on-quarter. And in the whole in the full year, it will be decreasing on year 2019. The pace at which they evolve quarter-on-quarter depends on a number of things. COVID-19 has meant that some -- some costs related to travel, meetings, usage of spaces and these things, we've seen savings, but they haven't been significant. I think in this path to having a full year cost amount lower, we will see some of this happening in the second half.

[Cecilia Romero, Head of Investor Relations]

Thanks, Andrea. Thank you, Tomás.

[Operator]

Next question is coming from the line of Ignacio Ulargui from Exane BNP Paribas.

[Ignacio Ulargui, Analyst]

Yes. I have 2 questions related to costs. One is you could specify a bit more on what kind of measures you are planning to implement in Spain in terms of cost-cutting? It was in the press that you were planning to close some branches, whether that's going to be really the main driver of the cost savings? And also, if you could elaborate how much the Asset Management disposal impact the cost base in the second half?

[Jaime Guardiola Romojaro, CEO, MD & Executive Director]

Well, regarding the first question. The opportunity that we are seeing going forward are connected with the redesigning of our operational model. We expect significant migration of nonsale interactions with customers to self-service. We have also opportunity in process reengineering and automatization of back-office processes. Obviously, as you said, there is also an opportunity in terms of reducing our footprint. In fact, this year, we had planned to close 140 branches. And finally, we are adding 95 more branches. And finally, we think that we have also an opportunity simplifying our organizational design, our structure. So I think that there are a lot of opportunities and we are planning to launch a plan in the next term. Second, about 7?

[Tomás Varela Muiña, GM & CFO]

Yes, I don't have the exact number with me now, but it's a little bit less than EUR 8 million, what we will save in the second half.

[Cecilia Romero, Head of Investor Relations]

Thank you very much, Ignacio. Thank you, Tomás.

[Operator]

Next question is coming from the line of Sofie Peterzens from JPMorgan.

[Sofie Caroline Elisabet Peterzens, Analyst]

Sofie from JPMorgan. One of your peers saw quite big DTA write-downs earlier this week. How should we think about your DTAs? Is this something we should potentially expect to see at Sabadell as well at some point? And if not, why not? And then my second question would be on the payment holidays that you have both in the U.K. and Spain, what kind of NPL ratios have you seen here? And then my final question would be on securitization. How should we think about any potential securitization in the second half? Is this something that you're considering?

[Tomás Varela Muiña, GM & CFO]

I think you referred to DTAs in your third question. Most of our DTAs are deferred tax credits, also known as monetizable DTAs. So those are which are guaranteed by the state in Spain. They are not contingent on future profits because they are guaranteed by the state. So we are not going to deteriorate them. The loss carryforwards that are contingent on profits in our case are very small. And those are subject to recovery tests. And we don't have any pressure on those recovery tests at all on our portfolio. In terms of U.K. and Spain, you asked about NPL ratios. The group NPL ratio in 2021, we expect it to grow, but not reaching any level beyond 5%. So we see it below 5%. In terms of securitization, we keep an eye on these opportunities. So we recently, in this quarter, closed one. But we neither are looking actually very actively on that. So we have a number of things that -- in our toolkit that we can do, but no specific plans for H2. If the levels would be attractive, we could do several things, but not -- actually not looking to execute anything in particular.

[Cecilia Romero, Head of Investor Relations]

Thank you very much, Tomás. Thank you, Sofie.

[Operator]

Next question is coming from the line of Stefan Nedialkov from Citi.

[Stefan Rosenov Nedialkov, Research Analyst]

It's Stefan from Citi. I have 2 questions on your stress scenario, which is pretty interesting, thanks for that disclosure. I think you will be the first one to like really show quite granular color on the various components of your clients, small businesses, SMEs and corporates. My first question is on LGDs. You have shown us quite a bit of detail on the probability of default evolution under the base and the stress case. What happens to LGDs under the base case versus pre-COVID and under the stress case versus pre-COVID? And the second question, is just looking at one of the slides, and I'll give you the slide number exactly, it's 33, the key metrics profile and stress exercise for corporate and SMEs. What the slide tells me is that SMEs increased their debt by around 10% of assets from March this year to May of this year. So that's 10%, which is most of the increase over the past couple of years. Yet EBITDA to assets is around 7%. So basically, connecting the dots here on the same slide, you expect around 100% of the EBITDA to disappear this year. So if I'm correct in interpreting this data, the SMEs have -- will lose all of their EBITDA. They have taken out more than that in loans, which should see them through 2020. But then you also have a 35% decline next year. So how do we square the circle here in terms of the SMEs being able to survive the next 1 to 2 years, especially if refinancing dries up in 2021?

[Tomás Varela Muiña, GM & CFO]

Yes. Thank you, Stefan. In terms of LGD, so the -- I think the right way to look at it would be in the base scenario, basically the multiplier that comes out of this is around 1.1 and in the adverse scenario, is like 1.2. So those are basically the levels. And clearly, as compared with our cost of risk guidance, multiplier that we have commented earlier, clearly, there is headroom for this and it's considered there. In terms of your comment on Slide 33, it is a very good one. So this is the kind of thing that we look at. So this is how we clusterize customers, depending on the impact of the financial metrics. The only thing is that I'm sorry that probably we misled you, because the 10%, we try to -- we try to make this clear when we say debt amount increase. So it's not an increase on the debt to total assets metric; it's actually the percentage of increase in the absolute amount of debt. So this 10% increase from March to May in SMEs means that all other things being equal, the debt to assets metric would increase in sort of close to 3%, so becoming on average 29%. So -- and for -- on the wider approach of your question, in general, what we are seeing, because, of course -- there is one slide that I mentioned, where we compare the haircuts that we are using, we show that they are really very aggressive, because we want to be sure. This is -- it's Slide 35. And when we compare them with actual evolution of income from the -- for the 3 main segments, we see that they go well beyond the level, the observed level, in the lockdown. So it means that in -- except for those particular customers that are in clusters that have been more affected than in all the -- in the 3 segments, the addition of the 2 clusters that are worst position is less than 30%, 35%. And so all the rest are showing significant recoveries in the level of observed with high-frequency indicators, observed income in their accounts. So -- but the stress in terms of EBITDA for companies is really, as you referred to, many of them lose all their EBITDA in the year, they recover in 2021, but still, the levels are challenging. The ICO loans fund them and distribute these impacts over 3, 4, 5 years. And that's why I say that the government-guaranteed lines for lending are very effective in preventing defaults. But the other thing to point out, which is very interesting, is that we, of course, have worked here to stress liquidity with the debt levels, the EBITDA, with allowed in the model for, or have forced in the model to keep a coefficient, a minimum coefficient of cash, not using all the cash to fund the needs for companies and SMEs. We also have imposed on the model a minimum percentage of CapEx to keep up with the reposition of the fixed assets, all that. So with the derived liquidity needs from this, we eventually spread the debt levels. When they need to -- so assuming that in all the viable cases, these liquidity needs are covered with ICO loans or non-ICO loans. But the interesting thing is in many companies, actually, even with the stress of EBITDA, they can survive 1 year or 1.5 years without significantly increasing their debt because the cash position, cash and treasury, the short-term liquidity position of companies and SMEs in 2018, 2019, was very, very significant in relation to their total assets. And we've actually been observing this in the market. So we've been offering ICO loans to companies that they've -- and in companies where we felt that the sector would require so. And they -- some of them, rejected the offers. So thank you for the question. I think it's a very good one. Sorry for the -- maybe the confusion around the debt amount increase in absolute levels. And in general, I think what we are seeing is that the financial position that companies and SMEs have been building over the last year in terms of debt stability, cash building and EBITDA to total assets improvement, as can be seen also in Slide 33 and where -- from 2012, the levels have been continuously increasing and up to this between 6% and 8% of total assets. I think those are shields that are going to be very helpful in this crisis.

[Cecilia Romero, Head of Investor Relations]

Thank you very much, Tomás.

[Operator]

The last question is coming from the line of Fernando Gil from Barclays.

[Fernando Gil de Santivañes d´Ornellas, Research Analyst]

Thank you for these disclosures that are very helpful. A question on Mexico. I mean the trends show that you made money in the first quarter and the second quarter and then loans are growing quite significantly. If you can comment on the trends, it would be very helpful. And a follow-up question on the U.K. and TSB. On mortgage prices and new production coming, what are the trends that you see, if you can comment on that?

[Jaime Guardiola Romojaro, CEO, MD & Executive Director]

Well, regarding the situation in Mexico, in the second quarter, we have made more provisions in terms of NII and fees, the evolution has been very good. As it was planned and what we have had is an increase in provisions, but the strength of the portfolio is very high, we are -- remain being the bank with the lower NPL ratio among the Mexican banks and also with a lower cost of risk. So the trend in Mexico is preserving the revenues and finish the year in positive terms in profits.

[Tomás Varela Muiña, GM & CFO]

Fernando, as for the second one in TSB, mortgage prices, all -- for all last year long, margins in the U.K. market for mortgages were compressing for all banks. So TSB suffered this. In the -- actually in the first quarter of this year, in the first half, prices have been a little bit better than -- or margins, than what we had anticipated. The thing -- the main thing for NII in the U.K. has been both the measures taken in terms of moratoria for which customers don't pay interest. And also overdraft and all this. But in terms of pricing, it hasn't been bad. Also, TSB benefits from a loyal fixed-term base, so stickiness of the fixed rate portfolio in TSB is above the average in the U.K. And for new mortgages, TSB has benefited at some point from almost being, there was some time in which TSB was offering product in the market, in segments, conservative segments where other competitors had left for some reasons. So LTVs of 60%. And so we had a good take-up there also in terms of pricing. We are not -- we are actually being very thorough in pricing in some buckets. We are some basis points better than the competitors. But in general, we are in the backer part, we are not aggressive in pricing. So I think actually, so as I say, we are suffering from those factors this year, but TSB's NIM doesn't compare that with the market. There are some competitors where that -- with NIMs that are much lower than TSB in the U.K. market. When we can deliver the execution of the restructuring and the reduction in costs, that, of course, in TSB, we all know that this is a matter of time and time is looking too long for what we would wish, but it's coming. We are delivering on that side. So with this, NIM is actually one of the positives that we have there, even in best times where the rates are so low. Thank you, Fernando.

[Cecilia Romero, Head of Investor Relations]

Thank you very much, Tomás, and thank you, everyone, for participating and for joining us today. That was the last question. Our Investor Relations, we obviously remain available throughout the day to help you with any questions that you may have. So now I just want to -- we want to wish you all a great day.