Banco de Sabadell SA

MAD:SAB

Earnings Call Transcript 2021-Q3

[Gerardo Artiach Morenes]

Good morning, and welcome to Banco de Sabadell's Third Quarter 2021 Results Audio Webcast. As in previous occasions, the presentation will be run by our CEO, Cesar Gonzalez-Bueno, and our CFO, Leopoldo Alvear. They will present the main highlights and details of the commercial and financial performance of the bank in the quarter. The presentation will be follow-up by a Q&A session. We expect the presentation and Q&A session to last for 1 hour altogether. Thank you, again, for your attendance. And let me now hand it over to Cesar Gonzalez-Bueno.

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

Thank you, Gerardo, and good morning, everyone. Beginning with Slide 4, I would like to start by going through the 4 key events of the quarter, which I will explore in more detail during my presentation. Firstly, we continue to see good commercial momentum this quarter with positive evolution of our transformation strategic initiatives. I will elaborate on this as we review new lending activity and the evolution of the credit book.Secondly, we have recently reached an agreement with the unions to reduce our workforce in Spain. This agreement, together with other additional cost reduction measures, will allow us to benefit from annual expected cost savings of EUR 130 million per year. I would also like to point out that TSB continues its good performance, recording a stand-alone net profit of GBP 47 million in the quarter, which means a very relevant turnaround when compared with last year's performance.Finally, the group net profit reached EUR 149 million in the third quarter and a total of EUR 370 million in the first 9 months. Meanwhile, our fully loaded core equity Tier 1 stands above 12%. As I said, I will now cover each topic in more detail.Moving on to the evolution of business volumes at group level in Slide 5. This quarter's loan evolution was stable, mostly supported by a very dynamic mortgage book at TSB. The good performance at TSB was offset by third quarter seasonality in Spain, also impacted by the reversion of the advance in Q2 of extra social security paychecks to pensioners. Following our strategy of optimizing capital allocation and deleveraging our other international businesses, the performing loans of these international businesses decreased in the quarter. The reclassification of Banco de Sabadell's performing loans to nonrecurrent assets held for sale as a result of the disposal of our stake in the bank had a relevant contribution to the decrease.Finally, on the right-hand side of the slide, you can see that customer funds increased in the quarter and year-on-year. I would like to point out the contribution of our good commercial momentum in off-balance sheet funds as net inflows remained strong during the quarter. The following 4 slides show our commercial performance in Spain. Starting with mortgages in Slide 6. I would like to highlight that this quarter we recorded robust figures of new mortgage lending, well above the level of the same period in 2020 and 2019, which was, in fact, pre-COVID. However, New lending decreased on a quarterly basis, impacted by the usual third quarter seasonality in Spain. August is a very slow month in Spain. As you can see on the year-to-year date bar chart, mortgage production in 2021 is well above pre-COVID levels. New lending in consumer loans slightly decreased in the quarter, mainly due to seasonality. When compared to 2019 pre-COVID figures, new production of consumer loans remains still subdued on the contrary to mortgage lending.Nevertheless, as we reported in our strategic plan, we expect volumes to gradually increase whilst the economic recovery consolidates. Finally, our positive commercial momentum can also be observed in our market shares for new production, which are ahead of our market shares for existing stock both in the case of mortgages and consumer loans.Moving on to Slide #7, we can observe that new production of protection insurance in Q3 was lower than last quarter due to a lower production of life insurance linked to the origination of mortgages, as explained before. Nonetheless, as you can see on the year-to-date bar chart, the new production of insurance is well above pre-COVID levels, driven by our good performance this year in mortgage origination and by health care insurance following our partnership with Sanitas. This good performance has led to a significant increase in our market share in life insurance premiums, which has risen by 78 basis points year-to-date, now standing at 9.5%. Regarding mutual funds, the stock of assets under management maintains its upward trend and once again, shows positive growth in the quarter. This is mainly due to strong net inflows, but also supported by the financial market performance. On the year-to-date chart on the lower right-hand side, you can observe that Sabadell has outperformed the market by 2 percentage points in terms of mutual funds assets under management growth. Outperforming the market has driven our market share in mutual funds up by 14 basis points year-to-date.Moving on to Slide 8, we can observe the evolution of our payment services business. Starting with cards, the turnover of our customer cards in the quarter reached almost EUR 5 billion, consolidating a positive growth trend. The figure on a year-to-date basis shows a positive evolution as well. However, our market share has continued to decrease slightly affected by the profile of our customers. Before COVID, our customers were more card intensive users than the average. And therefore, we have not benefited as much as others from the cash to card migration that has taken place during the pandemic. Regarding retailer point-of-sale payments at the bottom of the slide, the turnover evolution is positive as well, both on a quarterly and on a year-to-date basis. Despite the good performance of the turnover processed through our point-of-sale devices, the decreasing point-of-sale turnover market share in 2021 responded to our strategy of managing for profitability. In some cases, this strategy has resulted in a reduction of exposure to single name clients with higher turnover volumes but very low margins.Furthermore, market share was also impacted by our biased exposure to hospitality, restaurants and other tourist-related factors more affected by the decrease of activity.Let's now turn to Business Banking in Slide 9. As you can observe in the slide, new lending in Q3 declined quarterly and year-on-year. On a year-to-date basis, new lending decreased in the first 9 months of 2021 when compared to 2020. But as you can observe, non-ICO lending is increasing in the year. It is worth noting that despite lower new lending volumes, our market share in business banking lending has a strong momentum and increased 28 basis points in the year. And lower business banking credit demand was somehow expected after the large increase in 2020, which was driven by the development and deployment of ICO loans. Looking ahead, we are optimistic about the future. In the slide, we have included some information regarding next-generation EU funds. So far, a limited amount has been deployed in 2021, around EUR 12 billion out of the first EUR 70 billion tranche, which has been assigned to Spain.However, an additional EUR 31 billion will be deployed in 2022. Although it is soon to know, we are confident these large figures will be a key element to drive private investment and bank financing growth once the excess of liquidity derived from the ICO loans is absorbed.Let's move now to Slide 10. TSB has displayed very good commercial momentum in mortgages, consolidating the trend observed in recent quarters. New lending mortgage origination is still robust, although it has declined slightly in Q3. Nonetheless, new lending volumes at September are higher than the whole new production in 2020 and the applications pipeline is solid. TSB keeps gaining mortgage lending market share. And as you can see on the slide, the market share of new lending stands at 2.9%. This is above TSB's stock market share, which keeps driving the stock market share up.On the bottom of the slide, you can see that TSB's NII grew by 5.6% in the quarter. Looking forward, we expect interest rate hikes and higher yield curves to offset pressure on the front book yield, therefore, allowing volume growth to drive NII in the next quarters and furthermore through 2022. Now let's talk about transformation in Slide 11, which is on track with our expectations. Retail banking is undergoing a radical transformation that will bring significant cost reductions, but furthermore, will transform our commercial model. At the same time, in business banking, where we have a strong franchise, we are focused on reducing cost but also in the self-employed segment and on boosting growth. I will not go through the details of the main transformation initiatives. But as you can see, our transformation has good pace as defined in the strategic plan. There are multiple initiatives being deployed, some of them already completed and some of them in the pipeline. It is also worth noting that all these initiatives are being deployed without interfering with our commercial activity, which shows good momentum, as discussed in previous slides.Moving to Slide 12. You can see the 2 phases of the efficiency plan in Spain, which will have been executed in 1 year between Q1 '21 and Q1 '22. The first phase was successfully executed while maintaining strong commercial momentum, and we are already benefiting from annual savings in our cost base of EUR 140 million per year. The second phase has been launched this third quarter with similar characteristics in terms of timings and amounts. An agreement with the unions was reached last Friday, October 15, by the way, unanimously with all the trade unions and will be fully executed by the first quarter of 2022. Together with other cost savings initiatives, a total of EUR 130 million annual is expected. As you can see, the approach for Phase II is very similar to that of Phase I. And that one, Phase 1, has already been implemented successfully. The combination of both phases will have reduced our total personnel expenses by more than 20% and will lead to the closure of around 25% of the branch network in the total of our network.Now in Slide #13, you can see the financial details of the second phase of our efficiency plan, which allow this cost reduction of more than EUR 130 million. Please note that these plans will not accept and will not impact or affect our capital ratios as the restructuring costs involved are fully funded with the sale of part of our held-to-collect portfolio. The total restructuring charges will be EUR 331 million matched by this held-to-collect portfolio capital gains. As mentioned before, this plan should allow us to generate our annual savings of EUR 130 million, which -- with 85% of the amount already saved in 2022 and 100% in 2023 onwards.On Slide 14, looking at TSB's financials in greater detail. Our British franchise once again gave a remarkable performance across all P&L lines, as you can see on the slide. Firstly, if we look at the evolution of core results, they were up by 53% in the quarter. The year-to-date core results show a very significant swing from a loss of GBP 22 million in the first 9 months of 2020 to a profit of GBP 134 million in 2021.Secondly, the improved macroeconomic scenario in the U.K. related to a better unemployment outlook has allowed TSB to record relevant write-backs in the first 3 quarters of the year. Therefore, total provisions and impairments have improved significantly in 2021. And thirdly, the year-to-date net profits benefit also from a GBP 20 million tax reduction in the second quarter as we explained in our Q2 results presentation. Both the write-backs and the tax reduction are one-offs in the first 9 months of the year, but I would like to emphasize the string of TSB's core results. All in all, the year-to-date net profit of TSB stands at GBP 97 million on a stand-alone basis, again, a very relevant string from last year.Moving to Slide 15, I would like to mention that Sabadell has recently joined the United Nations' Net-Zero Banking Alliance. Sustainability is at the core of our future developments. We have a strong focus on it, and we are having a realistic and effective approach to define our road map. We are currently working intensely to define our short- and medium-term targets, both qualitative and quantitative. Our specific commitments in this field will be included in Sabadell's sustainability report which will be presented in our Annual General Meeting in 2022.Finally, moving on to Slide 16. I would like to summarize the good financial performance that Leo will explain in more detail in a few minutes. Firstly, core banking revenue once again continued to rise this quarter, supported by strong NII growth mainly explained by the remuneration charges on corporate deposits in Spain, coupled with strong growth in TSB. Recurring costs, which exclude the restructuring charges we incurred in the quarter, decreased both in the quarter and on a yearly basis. As a result, our good performance in both core banking revenues and costs, the evolution of our core results continue to be very positive. Provisions increased slightly in the quarter as we recorded some provisions related to the branch closures due to the new efficiency plan in Spain. All in all, the quarterly profit in the group stands at EUR 149 million. Finally, we have a comfortable solvency position with a fully loaded core equity Tier 1 ratio of 12.1%, and our return on tangible equity stands at 3.95%, close to 4%. And with this, I will hand over to Leo, who will discuss our financial results. Thank you.

[Leopoldo Alvear Trenor, Chief Financial Officer]

Okay. Thank you, Cesar, and good morning, everyone. Moving on to the financial results. I would like to start by going through our quarterly and year-to-date P&L. Although we're going to look at this in more detail on the next slides, I would like to highlight the fact that the evolution across all P&L lines has again been very solid this quarter. We see NII and fees growing both this quarter and for the first 9 months when compared to the same periods last year as guided. One of the key elements of the quarter, as Cesar has already pointed out, it's the agreement reached with the labor unions related to the second phase of the efficiency plan in Spain. In this regard, the rollout of the efficiency plan entailed EUR 331 million in the quarter, of which EUR 31 million were recorded in the cost line, while EUR 26 million as provisions and the remaining EUR 4 million as gains on other assets. The last 2 elements are related to branch closures. And in any case, we will see this in more detail in the following slides. This efficiency plan has been as previously disclosed, fully funded with ALCO bond sales from the held-to-collect portfolio as it can be seen in the trading income line. Therefore, both items had an extraordinary impact on the P&L in the quarter and were neutral on the bottom line. Additionally, as those capital gains came from the held-to-collect portfolio, they were not previously recognized in our capital ratios, and therefore, allow the efficiency plan to be capital neutral. Excluding these restructuring charges, our core results, this is the most recurring part of our business, increased by 5% and 12.6% in the quarter and in the year, respectively. This has been underpinned by the solid NII and fee evolution as well as by the cost savings already achieved due to the first phase of the efficiency plan carried out in Q1. All in all, net profit in the quarter stood at EUR 149 million, where TSB played a significant role with its contribution of EUR 43 million.Let's move now to the review of the different drivers. Starting with NII on Slide 19. It's worth mentioning that NII increased by 2.9% on a quarterly basis. This healthy grown has been driven by the different levers, which are included on the right-hand side of the slide. Moving from left to right, we have a positive impact. There has been an additional calendar day in the quarter. Also, the remuneration on corporate deposits have been a driver as we are currently charging a rate on current accounts over a base of EUR 12 billion of corporate deposits.The loan book has also had a positive contribution for the NII of EUR 5 million, which is explained by a negative EUR 7 million related to yields as a result of the downward in Euribor pricing and a change in the mix of the loan originations towards mortgages, which was more than offset by EUR 4 million related to FX and by EUR 8 million related to higher loan volumes, particularly at TSB.Finally, it's worth mentioning that the customer spread remained broadly stable in the quarter. In the following slide, we show a track record of NII over the past 3 quarters. As you can see and as anticipated, NII has witnessed increasing growth quarter-on-quarter, building from the bottom levels seen in the first quarter of the year. If we look at the expected evolution of Q4 '21 versus Q4 '20, NII would be supported by several tailwinds, such as the higher TLTRO III size, higher back book volumes, the remuneration and corporate deposits, along with significantly improved loan volumes at TSB as well as lower wholesale funding costs. As per the headwinds, we have a lower average loan yield than last year and a lower ALCO contribution as a result of the bond sales to fund the efficiency plans carried out. Adding all these elements together, the yearly performance makes us confident that we will achieve a positive growth rate this year. This is very much in line with our Investor Day's guidance.Turning now on to fees on Slide 21. Group fees declined in the quarter by 2%, driven by the usual summertime seasonality, which affected both service and credit and contingent risk fees. The lower service fee income evolution is explained by the absence of fees from the depository business, which you might remember, we sold in second Q '21 as well as by the progressive increase of the share of wallet of our clients, which results in lower current account fees, while higher fees derived from insurance, AUMs or payment activities. On the other hand, asset management fees recorded a positive quarterly performance on the back of a strong net inflows in mutual funds. In any case, as mentioned, the quarterly evolution is affected by seasonality. And as we can see, when comparing third quarter '21 with third quarter 2020, fees are up 10.3%, while on a year-to-date basis, they have grown north of 7%. In other words, well above our guidance of mid-single-digit growth for the year.Moving on to costs. The key element of the quarter is the second phase of efficiency plan in Spain. But let's focus first, if you will, on the current evolution of group costs. Therefore, leaving Q3's extraordinary costs aside and also for comparison purposes, excluding the EUR 71 million restructuring costs booked at TSB in Q3 last year. We can see that the underlying cost base is improving since it's decreasing by 1% and 3% on a quarterly and annual basis, respectively. This is explained by the fact that the savings from the execution of the first phase of the efficiency plan in Spain as well as the restructuring at TSB are yielding results. The results can also be seen in the evolution of the core cost as a percentage of the business volume, where we continue to reduce the weight of costs on our activity.Let's now take a look at the extraordinary costs charged in the quarter as well as expected savings in the following slide, on Slide 23. As Cesar mentioned earlier, in order to fund the efficiency plan this quarter, we have booked a total of EUR 331 million of extraordinary charges in the P&L. These amounts may be divided between EUR 301 million, which have been recorded in the cost lines, and a further EUR 30 million, of which EUR 26 million are recognized in the provisions line and 4 as gains on other assets.On the other hand, we expect to achieve EUR 130 million of cost savings. Around EUR 125 million will come in the form of lower personnel and general costs as well as lesser amortization charges, while a further EUR 5 million will be seen through the provision lines. In this regard, it's worth highlighting that already 85% of this EUR 130 million savings will come already in 2022.In Slide 24, we take a look at the core results, which include NII plus fees minus recurring costs. As you know and have said before, this is, in my opinion, one of the most important ratios in banks because it shows the recurrent part of the business. As you can see this quarter, group core results have increased by 5%, while they have increased by more than 21% on a year-on-year basis. The different elements that led to wider jaws in the quarter are included in the right-hand side of the slide, where you can see that both NII and cost savings contributed positively to the widening of the jaws and more than offset the negative impact of the third quarter seasonality on fees. Leaving the also side and moving on to cost of risk. The group's year-to-date cost of risk stood at 51 basis points in September, 47 basis points for the third quarter alone. The group total cost of risk, which includes all the provisions in the quarter reached 72 basis points, 68% for Q3.Now focusing on Q3. Group provisions amounted to EUR 197 million, with a consequent positive impact on coverage ratios as we will see later on. On the other hand, TSB released again provisions in the quarter given the very much improved macroeconomic outlook in the U.K. The release is very similar to the one accounted in second quarter this year.Now taking a view of the breakdown of total provisions at the top right-hand side, we booked EUR 197 million of loan loss provisions, EUR 41 million for changes on foreclosed assets, which include the before mentioned EUR 26 million related to branch closures related to the efficiency plan, whereas costs related to management of NPAs were booked at EUR 42 million and EUR 10 million were recognized for other provisions. These figures confirm our guidance to end the year with a credit cost of risk and total cost of risk at H1 levels. As always, in the following section of the presentation, we will review the asset quality dynamics, the liquidity and the solvency. Starting with the loan portfolio benefited from payment holidays in Spain. As of today, a total of EUR 2.9 billion. This is slightly ahead of 90% of the total moratory granted, have already expired. Of those, 13% are in stage 3, which accounts for less than 1% of the total mortgage and consumer book. It is important to note that this percentage has remained stable Q-on-Q. Moreover, 80% of these stage 3 loans are considered unlikely to pay, meaning that they're not more than 90 days past due. In terms of ICO state-guaranteed loans. To date, we have granted EUR 13.5 billion. Out of which around EUR 9 billion have been drawn with a state guarantee covering over 75% on average. Now that the deadline for the request of potential extensions has expired, around 40% of balances strong have requested it. Or in other words, 60% of the book will already pay principal in 2021. In any case, it's important to note that the vast majority of the existing ICO loans will mature beyond 2023.Moving on to Slide 28. We can see the evolution of our problematic assets. In this regard, NPLs remained flat in the quarter. And as a result, the NPL ratio remained stable at 3.59%, while the total coverage on NPLs increased 2 percentage points up to 58%. Regarding default rate dynamics, the new inflows of NPLs are lower than the previous quarter and in line with expectations. In addition, while our exposures across the states have remained stable Q-on-Q, stage 3 coverage has been reinforced and has increased by more than 2 percentage points, raising from 39.6% to 41.9%. Finally, it's worth remembering that half of our current NPLs are classified as unlikely to pay.In terms of foreclosed assets and total NPAs in Slide 29, you can see that stock of foreclosed assets also remained stable in the quarter and stood below EUR 1.4 billion. Coverage also remained steady at 37%. Regarding total NPAs, the stock amounts to EUR 7.4 billion, which is very much in line with that of the last quarter, while the coverage has improved by 1 percentage point, reaching 54%. Finally, the gross NPA ratio stands at 4.4%, while in net terms, it goes down to 2% due to the higher coverage. Both ratios, gross and net, have improved on a year-on-year basis and have remained broadly stable Q-on-Q.Moving now on to liquidity in the next slide. The group once again ended the quarter with a very strong liquidity position, reflected in an LCR of 223% and EUR 54 billion worth of high-quality liquid assets. Loan-to-depo ended the quarter at 97%. And in terms of European Central Bank funding, we currently have EUR 32 billion of outstanding TLTRO III. While in terms of TFSME, we currently have GBP 3 billion outstanding. Moving on to capital. Our capital position, our CET1 fully loaded ratio stands at 12.12%, having increased by 12 basis points in the quarter. While as in previous quarters, 30% dividend payout has been accrued and is deducted from the aforementioned ratio. From a regulatory perspective, the CET1 ratio stood at 12.4% on a phase-in basis. Consequently, our MDA buffer now stands at 388 basis points, above our requirement of 8.52%, having increased by 9 basis points in the quarter. This buffer remains well above our target of 350 basis points.Now to conclude my part of the presentation today on the following slide, we see our MREL requirements, with which we are already compliant based on both risk-weighted assets and leverage ratio exposure, and also both on a full requirement as well as in a minimum subordinated requirement perspective. Therefore, we do not expect to issue additional net amounts and we will just roll out over the existing debt. And with this, I hand over to Cesar, who will conclude our presentation today.

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

Thank you, Leo. I have to say that I always enjoy hearing you talking about numbers. You make it -- you made it quite clear, although it's a lot of them, but that was great. So to end the results presentation, I would like to highlight that we are on track to meet all of our strategic planned year-end targets. Our net interest income already shows positive growth of 0.7%, as Leo covered in detail year-on-year, fully in line with our year-end target of low single-digit growth. In fees and commissions, we are growing at 7% year-on-year, in line with our mid-single-digit growth target for the year. Credit cost of risk stands at 51 basis points, which is halfway between the 86 basis points we had in 2020 and the 32 basis points we had in 2019.Finally, our fully loaded core equity Tier 1 improved slightly in the quarter and stands at 12.1%, setting our MDA buffer at 388 basis points. And with that, I hand over to Gerardo for the Q&A.

[Gerardo Artiach Morenes]

[Operator Instructions] Could you please open the line for the first question?

[Operator]

The first question comes from the line of Francisco Riquel from Alantra.

[Francisco Riquel, Head of Research]

Yes. I will start focusing on TSB. Two questions here. First, NII. You can please comment on mortgage growth after the end of the stamp duty holidays. You mentioned in the presentation that you have a pipeline of applications, attractive ones, so you can give more outlook guidance on volume growth. And also on pricing, I understand prices have fallen recently. So you can comment on the implications in terms of front book and back book dynamics, where we are today and the impact on margins? And also separately, you can update on the sensitivity to pricing rates in the U.K., if you can also update on the size and duration of the interest rate swaps. And the second question is more strategically, if you can update your views on TSB after the recent approach by CoBank.

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

Leo, I'll give you the first shot if you agree, and then you can please complete my answers. On NII, the pipeline remains strong. I think we have seen very strong growth, but we forecast that the growth will continue. It's difficult to see if it's going to be at the same rate, phenomenal rate that we have seen in the past. But certainly, we still expect a significant volume growth. What we would like to share on the combination of pricing pressures and rates increase, is that our estimates are that they will, for 2022, more or less compensate each other. It's difficult to know exactly, but our best estimate is that the NII will be driven from now on, on TSB at least in the near future, mainly by volume. And that's our analysis at this point in time. From a strategic perspective, there is no change. There is no change in what we have been saying up to now. And I think we have been quite consistent for the year. We are not considering any corporate transaction in the near future. Let me try to give you the exact quote from the Board. Let me see if I can find it because I think it's -- it might be a recurrent question, and I think it's much better if we clarify it at once. So yes, indeed, we can confirm that we have received a letter from the Co-operative Bank outlining a proposal that was both unsolicited and preliminary. The Board of Banco de Sabadell has officially responded to Co-op in a letter saying that this is not a transaction that we wish to explore at this moment as we have previously expressed publicly. And that's all we have to say about the strategy. I think it's very clear, and we hope that, that's sufficient at this point. Thank you, Francisco. I don't know if you want to add anything. Leo?

[Leopoldo Alvear Trenor, Chief Financial Officer]

If I may, just for that not 2 questions, Paco, I will elaborate a little bit. So first one, on the pipeline of mortgages, what we've seen so far in October is that it's still very strong. So we haven't seen a big impact or impact coming out of the stamp duty end. So it seems like the market remains fairly strong. As for the prices, I think, as we mentioned, that what we see is that any compression in prices, which we have seen in the last few quarters or months, will be most likely offset by the increase in rates. TSB is quite sensitive -- positively sensitive to rates. So around 10 basis points would increase NII by around EUR 30 million in 24 months, that it takes a couple of years to fully fund -- sorry, to fully get the reprisal. And this is, among other reasons, because of the structural hedge, where we have, as you know, a kind of pillar for 5 years. And that structure right now is around -- has a yield of around 0.6%, while the current 5-year swap rate is well above that. Now is at 1.2%. So we are fairly confident that certainly positive sensitivity to rates will offset any compression in prices and on top of that is volumes. So we believe that certainly NII should go up next year given the current context.

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

Yes, just to add a minute point in terms of -- because it's quite obvious. We are very proud of the performance of TSB. We are very proud of their management. We are very proud of the people who work there, of how clients are reacting. And we are completely supportive for management and Board over there.

[Operator]

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

[Ignacio Ulargui, Analyst]

I have just 2 questions on the Spanish NII. I mean one related to the improvement in the cost of deposits and how you have been passing through the negative rates to corporates. So how much do you think that, that could come in coming quarters? What is the strategy there? And second question on NPAs. There has been a small increase in the quarter in the Spanish NPAs. I mean doesn't seem to be like -- at least -- but have you seen any indication of how credit quality is -- why this is deteriorating? And whether you see sort of like anything that goes more negative than your expectations?

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

Yes. On deposits, negative remuneration, we are charging fees to corporates, SMEs and self-employed related to excess liquidity in their current accounts above a certain level. We have increased the volumes to around EUR 12 billion. And we think that now we are reaching a level of stability and that we will move more or less around the figures that we have seen this quarter. So the significant increases, we don't expect them anymore. We think that it's going to be more or less in line with what we have seen this quarter. On the NPAs.

[Leopoldo Alvear Trenor, Chief Financial Officer]

Yes, on the NPAs, if I may. I think the quarter has been reasonably good. As you can see the -- I mean given the context, the net inflows have been even lower than in Q2. So I think the underlying the current cost of risk and their current asset quality is performing as it was in Q2 and as we have seen for the first 9 months. So as a matter of well better than what we budgeted. So we're not seeing any change in trends. I think as we have explained before, we believe that the peak on NPLs should be seen in 2022. In any case, I think, as I tried to explain before, already 90% of the moratorias on retail clients have expired. And have expired to some -- a while ago because 80% of that was already expiring in Q2. In other words, most of that book has already gone more than 3 months after the expirency and therefore -- and we haven't seen an increase in NPLs, Stage 3 ratio on that book remains at 13%. So very much in line with Q2 numbers. So a lot of stability there. And then -- so on that book, I think we've seen the worst in my opinion. On the other book, which we're all expecting to see how it finally develops, which is the ICO-guaranteed loans. Well, the fact that already, I don't know about 40% of the book is paying principal and Stage 3 ratios are very, very low, of around 3%. Well, it gives me some confidence that the outcome may be, may be reasonable on this book. But I think for this book, we will have to wait until next year. Nevertheless, in 2021, already 60% of the book will start to pay principle. So I think by year end, we should have a clearer view. But again, we will still have to wait until probably second Q '22 to have all the matters on the ground. In any case, I think the message I'd like to convey is that the evolution of NPAs is fairly similar to the one that we were guiding in Q2, nothing has changed, and everything remains in the same trend.

[Operator]

Next question comes from the line of Maksym Mishyn from JB Capital.

[Maksym Mishyn, Director]

I have just 1 on costs. After the Phase 2 of the adjustment program, I was wondering if you think there is more room to go with the headcount adjustments in Spain. And after the last agreement with the labor unions, you have any time restrictions before you can move with any additional restructuring?

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

Thank you very much for your question, Maksym. No, we don't have envisioned any further headcount reduction in the foreseeable future. We have, as you have seen, a major reduction of our headcount. By the way, around 75% is administrative plus head office kind of stuff, which means that our commercial capacity remains in place and will, in principle, allow us to continue our growth. And yes, that's basically -- we have undertaken a huge cost reduction in a period of 12 months and will stop at this time. Nevertheless, there are other sources of cost reduction that we will continue tapping, of course.

[Operator]

Next question comes from the line of Sofie Peterzens from JPMorgan.

[Sofie Caroline Elisabet Peterzens, Analyst]

Here Sofie from JPMorgan. I had a question on your net interest income from the sale of the ALCO bond. What kind of net interest income headwind should we expect in the fourth quarter and in 2022? And then the second question is also on net interest income. What kind of TLTRO headwinds should we expect or net interest income in 2022 and 2023 assuming TLTRO doesn't get extended?

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

Sure. So basically, in order to fund the restructuring, we have sold EUR 3.8 billion of bonds, which were dealing between the yield of the bonds and the cost of liquidity or the negative cost of liquidity, if you wish, around EUR 80 million, EUR 8-0 million, all right? So on a quarterly basis, we're talking about roughly EUR 20 million contribution. So that impact we will see in Q4. Nevertheless, as I tried to explain before, I think we have enough tailwinds coming through the books in order to more than offset that. So basically, as I said before, we have more volumes. We have higher TLTRO compared to last year. We're going to have lower wholesale funding costs. We've seen TSB that's going in the right direction, et cetera, et cetera, et cetera. Now for next year, then the difference between 2022 and 2021 would be minus EUR 60 million, okay, because it's a total of minus EUR 80 million, but EUR 20 million will come this year. And it's also very important to take into account that right now, we are short of bonds, if you wish. If we compare the current outstanding portfolio of bonds with the ones that we had in September 2020. This is before we sold some bonds in order to fund the first efficiency plan that took place in Q1 '21. We are around EUR 8 billion short. At some point in time, we wish to regain those kind of volumes because we were comfortable with those volumes -- with the volumes that we had before. So in other words, there is an opportunity to reinvest those bonds in 2022. You can make your numbers. We don't know where the yields are going to be. My opinion, probably long-term yields will hike much faster than short term. But on top of, you have the cost of liquidity, which nowadays stands at 50 basis points. So EUR 8 billion for whatever the rates you can come up in your mind, taking into account that liquidity -- only liquidity stands for 50 basis points. Well, that something that we will reinvest next year. We will cover -- will we cover -- sorry, the full EUR 60 million next year? I would say most likely not because we will not start buying bonds from day 1, if you wish now from first January. But I would -- we're budgeting right now. I -- my best guess here is that most of that impact will be offset by new bond portfolios, if you wish. So that's for the ICO. I hope it's clear. In any case, very happy to give you some more detail. On the TLTRO, what we have right now is around EUR 150 million this year, TLTRO III. So next year, roughly speaking, about half of that will go if it is not -- if the TLTRO as expected, is not extended. And then the other half would be in 2023.

[Operator]

Next question comes from the line of Mario Ropero, Bestinver Securities.

[Mario Ropero]

The first question is related to provisions in Spain. You mentioned that in the U.K. because of the adjustment in macro models, you have released some provisions. And my question is whether this is an exercise that can happen also in Spain. If so, when do you think that this could happen and the size of the impact, if any? And then the second question, I don't know if I missed this, but I don't think that you changed the guidance on fee income for 2021 mid-single digit, even though you are plus 7%, I think, in the first 9 months. So unless you expect some headwinds in the fourth quarter. And my question is you think that you will be north of this? Or if not, why not?

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

Take them if you wish. So on the first one, no, to be very clear. I think -- and I think you've heard this from me before. I think the situation in U.K. is very good. The macro is going very, very well. Unemployment rate is very low. Well away from the figures that we all thought 12 months ago. The real estate prices are going up. No, I think we've seen a write-back situation in the U.K. across all banks. I do not think we're going to see that in Spain in the short period, not in Sabadell nor in other banks. That's my personal opinion, if you wish. I, nevertheless, think that, at least for Sabadell, I assume for the rest of the market, but certainly for Sabadell, cost of risk next year will be lower than cost of risk for 2021. That's something, as I said, we're budgeting. But that's something I count on. I think that's completely feasible that should be reasonable. I'm not seeing write-backs yet, okay? And as per fees and the change of guidance. Well, no, I'm not saying that we're going to go down on fees versus the number that we have right now. The only thing I wanted to point out is that we are well within the guidance or actually above the guidance, which is a good place to be. So hopefully, we will be in those rates at year end.

[Leopoldo Alvear Trenor, Chief Financial Officer]

Yes. But in general, I think we are -- we have not the intention of updating guidance in the near term on any of -- I mean, you have to take into account that the guidance was done during the second quarter. There could be some deviations up and down here and there. But through the cycle, this is the guidance that we would like to give.

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

But that doesn't mean Mario that we think that fees are going to go down in Q4, okay?

[Operator]

Next question comes from the line of Carlos Cobo from Societe Generale.

[Carlos Cobo Catena, Equity Analyst]

A couple of questions for me. One is on cost and a little bit of color, if you could please add on the previous phase 1 of the headcount reduction. I was looking at the slide 22 where you've presented the total cost base, excluding exceptionals. If I'm not reading something wrong, the total reduction in the cost base between Q3 2020 and now is around EUR 70 million annualized, something like that. That is around half of the total cost savings target of the previous second reduction. Could you explain a little bit what is the cost inflation that has eroded those savings? Or is it that you are still delivering of that reduction, and it's going to take a little bit longer to extract. That would be the first one. And the second one is about the rate sensitivity following up on Sofie's question before. Could you please elaborate a little bit on the overall balance sheet sensitivity to, say, 50 basis points hike when it comes. So of course, you could start to see the end of TLTRO III, we see higher rates, but some of those negative rates on corporates will also disappear. I was wondering what's the real underlying sensitivity to that scenario. It's true that the cost of funding shouldn't move much up, but I was wondering if the higher yields will be broadly offset by all those natural hedges that you have from TLTRO III and the negative rates that they're charging.

[Leopoldo Alvear Trenor, Chief Financial Officer]

First with the second one, if you wish, with sensitivities and hedges. Well, it's uncertain to know what's going to happen in the future. Nevertheless, I think, as I said, I think, in my opinion, I think the most ag scenario, and I may be wrong, but the most likely scenario that I foresee is that long-term rates are going to hike sooner -- way sooner than short-term rates. So we should be benefiting from that, for example, if and when we replace the portfolios that we have sold, okay? I don't think we're going to see any impact, for example, on the liability side of the balance sheet. I mean in terms of funding nor on deposit and nor on SMEs and corporates because unfortunately, I do not see a hike in short-term rates in the short term in Continental Europe, while I am very positive on that in the U.K. as I think the market is. So -- and I think the cost of funding on the liability side is very much driven by the short-term rates. So if the biggest competitor to banks is, for example, the 12-month T-bill in Spain, and that is way negative. I don't -- I haven't seen it today, but way below [ 50 ], probably minus [ 50 ] until that changes, and that gets into positive. And as I said, unfortunately, I'm not saying that in the short term, I don't think we're going to have any kind of pressure on the cost of deposits, for example. Because all banks are working on the other hand, with a loan to depo well below 100%. So there's no eager for volumes. Actually, we are growing volumes because liquidity is bumping up. And that's the same for corporates. I don't think in the short term, in next year, for example, I don't foresee that the remuneration that banks are getting out of the corporate is going to change because I don't foresee that the Euribor, for example, to make it simple, it's going to move in any material way. And in my opinion, both things are very -- should be very much linked. So I don't think we're going to see any kind of that.

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

I think in a nutshell, I think we could say that there are many, many moving parts, but that we are positively moderately positively placed towards positive interest rate movements.

[Leopoldo Alvear Trenor, Chief Financial Officer]

Yes, absolutely.

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

So we are confident there.

[Leopoldo Alvear Trenor, Chief Financial Officer]

Yes, absolutely. And as per the first question, I didn't get it very well. Carlos, no, I think you were talking about the differences between Q1 costs last year -- sorry, third Q costs last year and third Q costs this year without extraordinaries, where we're seeing that costs are coming down at 2.4%. And, well, I think it's in track with more or less -- more or less, it's in track with what we guided.

[Operator]

Next question comes from the line of Stefan Nedialkov from Citi.Sorry, the line of Stefan has disconnected. Next question comes from the line of Benjie Creelan from Jefferies.

[Benjie Creelan-Sandford]

Just 2 questions for me. First of all, on capital. I mean you're already in line with the full year guidance. And I think there's still about 15 basis points of gains still to come through from the disposals in 4Q. I just wondered if you could update us on any potential headwinds going forward in terms of regulation into next year? And what do you think the sort of normal organic level of capital generation should be going forward? The second question was just more general around corporate lending and the pickup that you expect next year. And I guess, is there any more color you can provide on what's holding back corporate lending at this point? Is there still a lack of willingness to invest on the corporate side that you're seeing? Or is it purely the fact that corporates are still awash with liquidity following the drawdown post COVID?

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

I'll take the second one and leave -- as it is a tradition in these situations. I'll leave the easy one about the capital to Leo. I think as we have expressed, I think, during the presentation, you're absolutely spot on. I think corporates now are washed with liquidity in preparation for a much higher covet than the one that we have experienced. In this quarter, we have had, as every quarter, the seasonality of low activity, especially due to August, which in Spain is very hot here and the activity goes down significantly. And furthermore, the new generation fund has not -- has started, it's being deployed, but has had no impact yet, first, because the amounts that are out there are still small. But furthermore, the initial elements of the amounts, the initially deployed have much less multiplying effect in terms of lending volume. This is key to our business, and we are expecting. I mean, we are satisfied in the sense that we have seen an increase in our market share during the year in this area despite that the activity and the volumes are low for the reasons that we have mentioned. We think that those elements are going to reverse next year, and we expect a positive trend for all the previous reasons, we think that the liquidity will start being reduced because of the lesser activity of this second part of the year because of the ICO loans. They will start to be absorbed. We expect the European funds to start, although it is somewhat back loaded towards the end of the period, but we still expect that '22 where that would have an impact. And all of that, and we are ready for that. We expect an increase of the activity in SMEs and hopefully even an increase -- further increase of our market share.

[Leopoldo Alvear Trenor, Chief Financial Officer]

Okay. And per the C1 on capital. I think -- well, the good news is that so far, we've been able to fund an increase of EUR 5.5 billion in loan volume so far this year. Actually, EUR 7 billion, if we exclude the asset protection scheme payment, which for capital purposes is important. And despite that growth of EUR 7 billion in terms of capital, if you wish, we have been able to increase our capital ratio, slightly by 10 basis points. In other words, we are certainly being able to fund our growth on the balance sheet with organic capital generation, which I think it's a fairly good news. As per the headwinds, no, we don't see -- we don't have big headwinds ahead of us, not that we can foresee. So the only one that comes to mind in case my mind, it's I think we've guided this before, minus 15 basis points, sorry, coming from EBA guidelines, and this will -- this shall take place in 2022. And of course, it's -- in my opinion, it's a very manageable impact. On top of that, the second one is Basel IV. But the latest trends on this topic seems to imply that this is going to be delayed. And more important than the delay in self in my opinion because I think -- well, this has just started and has to be discussed in the trial process, with parliament and the council, and this may take a while. But it's pretty clear that the data is going to be 2025. But more importantly, as I said, they have shown quite a lot of clearance on several topics. For example, CVA issue is not going to be an issue for the European banks. Good. I think that's something we all counted on, but it's clear now. Second, there's not going to be any change on the SME risk weighting. So again, good solution. It's again, what we all counted on, but it's good. And third and more important for Spanish bank in my opinion and specifically for us, it's the operational risk impact, which is diluted as the ILM is set at 1.0. So I think this is all good news and on top of delayed. So for the coming 2, 3 years, well, I'm sure something will come up. But right now, we don't foresee any material regulatory impact aside from the EBA guidelines of minus 15 basis points next year.

[Gerardo Artiach Morenes]

Thank you. We're already into the 1-hour territory. So if we have Stefan available, as he missed the previous call, we can give access to Stefan. And if not, we'll leave it here.

[Operator]

Yes, question from the line of Stefan Nedialkov from Citi.

[Stefan Rosenov Nedialkov, Research Analyst]

Just quick clarification on the Basel IV. Are you in a position to give us some guidance here, especially when it comes to operational risk? I assume that's going to be the biggest driver of the Basel IV impact. And a quick second question on the COVID overlay reserve. Are you thinking that next year's cost of risk will be lower than this year because of underlying development or because you plan to release the COVID reserve in 2022?

[Leopoldo Alvear Trenor, Chief Financial Officer]

Sure. Thank you, Stefan. So on the first one, it's difficult to give you a guidance right now because we have to put the numbers through. But in any case, I would say the Basel IV impact is in the lower part of the range that we were thinking about. Now I think we -- when we talked about Basel IV before, in my opinion, well, there are several numbers out there for the European banking average, which I think I've seen a few reports coming from Basel, which talk about 100 to 150 basis points impact for the industry. I think that, that impact is going to be way lower in Spain because the biggest impact in Spain is going to be operational risk. I think from a credit risk standpoint, there should not be an issue because we've already gone through several thresholds in Spain. So I think that's covered in general terms. So the big issue is operational risk. And by setting the ILM at 1.0, I think we are talking about the lower range of the curve. But in any case, there's negotiation around this because you need to -- that's the ratio, that's fine, but then you have to take into account what are you including as per the operational risks that you've had in the previous years. The fact that Basel IV is delayed a couple of years, I think it's good also in terms of the events that you have to take into account in that operational risk because they are 2 years wait further down the line. So I think in general terms, it's good news. I'm sorry, I cannot give you guidance right now. As I said, way, way lower than the average for the industry. I think at some point, I've said that I thought first main was going to be less than 100 basis points. But that was before I saw all this package. So we need to go through with it. Okay.And as per the cost of risk for next year, I think it's -- I'm thinking about a reduction in cost of risk because of the underlying. I think the macro is going in a very good direction. And what we're seeing out of the balances of companies is that things are improving and are improving reasonably, given the context fast. So I think this should drive for lesser requirements next year. That's what I'm seeing. I'm not saying as I tried to explain before, write-backs, if you wish.

[Gerardo Artiach Morenes]

Thank you, and thank you all for your questions. Thank you, Cesar and Leo for your answers. We now wrap up the Q&A session. And as always, the full IR team is available for any further questions that you might have. Once again, thank you all for your participation and for joining us today.

[Cesar Gonzalez-Bueno Mayer Wittgenstein]

Thank you very much.

[Leopoldo Alvear Trenor, Chief Financial Officer]

Thank you. Bye-bye.