Intesa Sanpaolo SpA

MIL:ISP

Earnings Call Transcript 2022-Q3

[Carlo Messina, Managing Director and Chief Executive Officer]

Welcome to our nine month results conference call. This is Carlo Messina, Chief Executive Officer; and with me are Mr. Stefano Del Punta, CFO; and Marco Delfrate and Andrea Tamagnini, Investor Relations Officers.

Today, I'm going to walk you through a high-quality set of results. Let me start by saying that in Q3, we delivered a 65% reduction of our exposure to Russia that now is just 0.3% of group's total loans. We can already be considered a zero Russia exposure bank, and we will continue to work to reduce the limited remaining exposure. Whenever we see a problem emerging, we face it immediately and put rather solutions into action. Whenever possible, we rapidly remove the problem from our balance sheet, so removed from our balance sheet. We did this with Intesa. We did this with the pandemic, and now we've done this with Russia.

It is our managerial approach, and it is one of our secrets to delivering high and sustainable profitability and not short-term profitability. Nine-month net income was €4.4 billion when excluding provisions for Russia de-risking. The best nine months since 2008. This is fully in line with the 2022 business plan net income target of more than €5 billion. We are upgrading our net income guidance for this year to more than €4 billion. It is thanks to the strong Q3 operating performance coupled with massive Russia de-risking and despite the deterioration of energy supplies and the provision for Russia de-risking booked in future.

We have already accrued €2.3 billion in dividends. And in a few weeks, we will distribute €1.4 billion as an interim dividend. Our commitment to a 70% cash payout remains unchanged. A few weeks ago, we concluded the first tranche of our share buyback, repurchasing around 5% of shares. We will decide about the second tranche of the buyback by the time the full-year 2022 results are approved also because we will pay the interim dividend just in some weeks. And so we think that investors can be already empty of our dividend distribution policy.

Rewarding our shareholders remains our and my priority, and we remain committed to the value distribution embedded in the business plan. Thanks to the strong tailwind from interest rate increases and our resilience as zero-NPL Bank and zero-Russia exposure bank. The €6.5 billion net income target in 2025 will be exceeded. In the first nine months, we worked along two dimensions. First, delivering high-quality results in the short-term; and second, building a strong bank for the next 10 years by continuing to execute our business plan.

All the key industrial initiatives are well underway. In particular, our technology evolution is moving quickly with significant investments and the rollout of Isybank, our new digital bank, in accelerating with around 300 specialists hired. And I'm just waiting for the end of the focus on Russia and de-risking to be ready to meet with you, a clear explanation of the potential that we can have in this sector and an improvement of the technological base of the group that will happen in 2023. I'm proud of our results and then call our people for their work. So I think that our people are the key factor of success of Intesa Sanpaolo.

Let me also say a few words on the overall macro situation. I remain positive and my confidence is based on facts, even if there are elements of concerns like inflation and more. First of all, the Italian economy is much stronger than it was during the previous crisis, thanks to solid fundamentals.

Even in 2023, there is a slowdown in economic growth or a light recession, the Italian economy will keep quickly recover in 2024. Secondly, our bank is fully equipped to face challenging environments for multiple reasons. We are delivering excellent performance with growing revenues, driven by strong net interest income acceleration and the top notch cost/income. We enjoy best-in-class risk profile with an NPL stock and this fraction of what this was in the past and a far stronger capital position.

But I'm also sensitive to the fact that many people are suffering from the increases in energy and living costs. This deepening social inequality should concern all of us. As ISP, we are providing €400 billion lending to real economy. We have already allocated €30 billion to help families and businesses face high energy costs. Not to mention our main social and climate initiatives, which we are stepping up. And to support our own people, we provided a one-off contribution of nearly €50 million to mitigate the impact of inflection.

Now let me provide the highlights of our nine months results. Slide number 1. In the first nine months, we delivered high-quality earnings with net income of €4.4 billion when excluding Russia de-risking. We massively reduced our exposure to Russia, and we achieved the best-ever nine-month revenues and operating margin. Net interest income is gaining momentum. Insurance income was the best ever. We reduced costs, and we reached one of the lowest NPL stock and ratios in Europe. And ISP Zero-NPL Bank status is driving a very low underlying cost of risk.

Slide number 2. In this slide, you can see the evolution of net income. Overall, when excluding Russia de-risking, we delivered the best nine months since 2008, fully in line with our €5 billion business plan net income target for this year.

Slide number 3. While delivering this excellent net income performance in just three months, we achieved an impressive Russia de-risking. Thanks to the sale of €2.5 billion in cross-border loans such exposure is now very limited in high quality, while the local loans to customers are just €300 million.

Let me take you to Slide 5 to give you some color on the P&L. Slide number 5. We delivered the best ever nine months for revenues and operating margin. Net interest income grew more than 8%. Commissions were resilient, and the decline is due to negative market performance. Insurance income reached a record high, also thanks to strong growth in non-motor P&C revenues. Profits on trading were solid, and operating costs decreased by almost 2% despite inflation. We have been conservative in provisioning and net income was €4.9 billion when excluding costs concerning the banking industry and provisions for Russia and Ukraine.

Slide number 6. In Q3, we delivered high-quality operating performance. Net interest income was up 14% quarterly despite the lower benefit from TLTRO, more than compensating for lower commissions in part due to the unusual -- to the usual summer slowdown. Insurance income was the best Q3 ever. Overall, the total contribution from net interest income, commissions, and insurance income was up over 6% on a yearly basis and more than 3% quarterly demonstrating the resilience of our business model.

In light of the strong core revenue performance, we didn't push on profit from financial assets and at the same time, reducing the total amount of government bonds that we have in our portfolio. We have reduced the size of the goods portfolio to avoid an impact from volatility and that action impacted trading profits in the quarter. As I have always said, we manage revenues in an integrated manner, and we are entering stronger and stronger in 2023 without Russia exposure and with limited exposure to the goods portfolio.

Operating costs decreased on the quarter -- on a yearly basis. Provisions were down despite further provision for Russia-Ukraine and net income was €1.4 billion when excluding costs concerning the banking industry and provisions for Russia and Ukraine.

Slide number 7. In this slide, you can see the strong acceleration of net interest income, up €300 million in one quarter. Rate increases are a strong upside for us. Net interest income will grow by €2 billion, assuming one month Euribor reaching an average of 2%. This is the area in which I think we will elaborate in question-and-answer. But believe me, it is the real engine for growth for the next years, and we will have billion and billion of increase in terms of net interest income in the next years.

Slide number 8. In this slide, you can see that the net interest income growth on a quarterly and yearly basis. So it was delivered by the commercial component, despite the impact from NPL stock reduction on a yearly basis and from the lower contribution of TLTRO in Q3.

Slide number 9. Customer financial assets were around €1.2 trillion. Short-term direct deposits increased €12 billion on a yearly basis. This is a valuable asset in the new interest rate scenario and remains fuel for our Wealth Management engine. The decrease in assets under management and assets under administration was due to negative market performance. In the first nine months, Valore Insieme, our advanced advisory service for affluent and exclusive clients and €11 billion in customer financial assets inflow.

Please turn to Slide 10 to have a look at the costs. We continue to be very effective at managing costs, down almost 2% despite inflation. Depreciation is up as we keep investing for growth, especially in technology.

Slide number 11, we continue to have one of the best cost/income ratio, and this slide illustrates our leading position in Europe.

Slide number 12. Thanks to massive deleveraging, the net NPL ratio is the lowest ever at 1%, already achieving the business plan target. We reduced NPL stock by almost €7 billion on a yearly basis. Moratoria has expired and yet the lowest ever nine-month NPL inflows even lower than [indiscernible] prices levers.

Slide number 13. Our underlying cost of risk stood at 27 basis points. Loan loss provisions were down sharply compared to last year when excluding Russia directly.

Slide number 14. This quarter, we had the lowest ever Q3 gross NPL inflow and NPL coverage was up two percentage points compared to the last quarter.

Slide number 15. NPL stock reduction was €4 billion in the first nine months of the year and €53 billion since the peak of September 2015. Net NPL stock is at just €6 billion with 28 quarters of continuous reduction.

Slide number 16. As a result of this impressive deleveraging, NPL stock and ratios are now among the best in Europe, and our underlying cost of risk is in line with being a zero-NPL Bank.

Slide number 17, ISP fully phased-in Common Equity Tier 1 ratio is 12.4%. This already includes €2.3 billion of accrued dividends, a 50 basis point impact from the second tranche of buyback authorized by the ECB. It also does not include the 110 basis points of additional benefit from DTA. And the [indiscernible] DTA is something that we will record in the short and in the mid -- in the short-term 40 basis points just in the next three years' time. So our real fully phased-in is much higher and is really the one that we call the fully loaded Basel 3 Common equity Tier 1 ratio.

Slide number 18. Contributing to society has always been a key part of our DNA and our excellent performance allow us to create sustainable benefits for all stakeholders. I know that we show this slide to you each quarter, but it really does show what we are and how sustainable our business is year-after-year. Slide number 20. In addition to delivering excellent results driven by high quality earnings, the business plan is proceeding at full speed. The people with Intesa Sanpaolo are working across all the industrial initiatives of our business plan to build a strong bank for the future. You can go through the details of the ongoing initiatives in the next 11 slides.

In Slide 29, you can see our leading ESG position in the main sustainability indexes and rankings. But for the sake of time, let's move to Slide 34 to see how ISP is well equipped to succeed in a challenging environment.

So Slide 34. If we compare our current position to where we were at the beginning of the last downturn, we are better prepared for multiple reasons. Our capital position is much stronger, and our NPL stock is only a [indiscernible] in the past.

Slide 35. Our business model is more resilient and efficient with commissions exceeding 60% of our revenues and strong net interest income tailwind from rate increased.

Slide 36. At the same time, when compared to our peers, we are far better equipped. We have a best-in-class risk profile. We have a solid capital position, and we are one of the cost income leaders in Europe.

Slide 37. We are a best-in-class model of resilience across all dimensions from the financial to the technological ones. We already have a top-notch digital proposition with nearly all clients already multi-channel, but our technology evolution is still moving very quickly, and the setup of our new digital bank is well underway.

Slide 38. Finally, let me remind you that the Italian economy is stronger than in the past. The national debt is much more sustainable. Italian corporates are more resilient and the banking system is more solid.

Slide number 39. Thanks to solid fundamentals, more leading household wealth and resilient SMEs, even if there is a GDP slowdown or mild recession in 2023, we expect a quick recovery in 2024 based by the continuation of strong government intervention and significant EU financial support.

Let me also highlight that taking into account the Q3 growth of GDP recently announced. The 2022 growth should be higher than the 3.3% previously expected. And now let's move to Slide 41 for the final remarks.

Slide 41. Let me now recap the key points that demonstrate the sustainable strength of Intesa Sanpaolo. Our resilient and profitable business model over delivered even in the nine months. We achieved the highest ever operating income and operating margin with net interest income gaining momentum. Costs are down nearly 2% year-on-year, and cost/income is best-in-class. NPL stock and ratios are at record loans and ISP is now a zero-NPL Bank with a low underlying cost of risk. We reduced our exposure to Russia by 65%, bringing it down to 0.3% of our customer loans. And we maintain a very solid capital position with low leverage.

Slide 42. To finish, let me turn to the outlook. As you may remember, we said in July that year-end guidance was supposed to be fine-tuned based on the [indiscernible] of the Russia-Ukraine conflict. In Q3, we delivered a massive reduction of Russia exposure coupled with strong operating performance with clear tailwinds to net interest income. Thanks to this achievement, we can now upgrade our 2022 net income guidance to more than €4 billion, even taking into account the worsening of energy supply and the provisions on Russia-Ukraine booked in Q3. This upgrade is even more valuable when considering our exposure to Russia is now close to zero.

Slide 43. Our net income outlook for this year also means that we can continue to generally reward our shareholders, always a priority for ISP and me personally. We have already accrued dividends of €2.3 billion this year, and we will pay a €1.4 billion interim dividend later this month. We recently returned €1.7 billion through the first tranche of the buyback equal to around 5% of shares. We will decide about the second tranche by the time the full-year results are approved.

The key point I want to make is that our commitment to be a strong and sustainable better creation and distribution does not change. We remain fully committed to the value distribution embedded in the business plan. Our resilience as a zero-NPL Bank and as a zero-Russia exposure bank and the tailwind deriving from the interest rate increases means I can say this with confidence.

Thanks to the strong tailwind from interest rate increase and our resilience as zero-NPL Bank and zero-Russia exposure Bank with €6.5 billion net income target in 2025 will be exceeded and we remain committed to a 70% cash dividend payout in each year of the plan, with a common equity ratio higher than 12%. As proven again and again Intesa SanPaolo is an unstoppable delivery machine. This is thanks to all our people.

Thank you for your attention, and I'm now happy to answer your questions.

[Operator]

Thank you. [Operator Instructions]. We are now going to proceed with our first question. And it's from the line of Christian Carrese from Intermonte. Please ask your question. Your line is opened.

[Christian Carrese, Intermonte]

Hi, good afternoon everybody. Thank you for the presentation. My first question is on net interest income together with cost of risk, because I think that we have to look at the net interest income together with cost of risk for a zero-NPL Bank as you are. So I was wondering, taking into account a mild recession in 2023, what do you think is a reasonable level of cost of risk, taking into account that you didn't release the €400 million overlays. And on net interest income, looking at the guidance you gave the sensitivity. I suppose Euribor 1M by the end of the year could be near to the 2% you provided as a guidance. So what does it mean in terms of net interest income. Should we look at that item higher than €10 billion for 2023? I don't know if you can provide a guidance on that?

And the second question on the buyback program. Your capital is flat, still solid. I was wondering if you are planning to anticipate the execution of the second tranche before the full-year results or not? Thank you.

[Carlo Messina, Managing Director and Chief Executive Officer]

So thank you for your question. I will start from the 2023, because as you had the occasion to look at our presentation, we prepared in this quarter the 2023 strong acceleration in our results. So my point is that during 2022, I have to eliminate all the potential risk that we can have in 2023 and remaining with the stock of exposure to Russia, this can be considered in any case, a potential risk in terms of increasing of cost of risk.

So not only zero-NPL Bank and zero-Russia exposure in terms of impact to our figures. So if I have the opportunity, I will continue to reduce and bringing to zero the exposure towards Russia. At this level, we do not expect to have impact -- significant impact on economic figures also in 2023. That's the reason why we are talking about zero-Russia exposure.

So we enter into something like this, what would be the dynamics of net interest income and cost of risk, because you're rightly have considered these two points as the key drivers for the results in 2023. So I will start from net interest income. So just to give you the idea and I don't want to answer in any kind of discussion on sensitivity on net interest income, because I will give you the figures that we are working on with our people within the organization.

So the real world and not the theoretical impact of sensitivity. We think that at Euribor 2%, we have already embedded in our figure increase of €2 billion of net interest income in comparison to the end of 2022. So our expectation is to have in 2023 net interest income that can be well above €11 billion. So that's our expectation, working with our people, then I will confirm in occasion of the presentation with all the final results for 2022, where we will have the budget figure.

But for sure, now we are receiving back what we had to -- what we had in negative in the last years. And if you compare the position of the net interest income of Intesa Sanpaolo in the year in which interest rates were 2%, 3%, 4%, you will have the evidence that it is absolutely achievable. Also, the impact that we have in this quarter is the result of this strong attitude of the bank of increasing net interest income in case of increase of Euribor and do not forget that we had such a negative markdown impact during the last year that we are now coming to a position of recovering the negative markdown. So strong tailwind during 2023 coming from net interest income.

Then looking at figures on cost of risk, and I have to say the starting from what we can consider a level of cost of risk that is between 25 basis points and 30 basis points in case of not significant recession during the 2023, the increase in the cost of risk should be not so significant. So what we can consider in the course of 2023 is to make a further, potential disposal of non-performing loans. And in that case, we can have some more 10 basis points increase in the cost of risk.

So for this guidance, I will wait to have the budget figures negotiated with my people. But in any case, our expectation on 2023 is to have a cost of risk that could have an increase in comparison with the Italian and the ex-Russia cost of risk, so an increase in comparison to the 27 basis points, but not so significant in case of a dynamic of GDP flattish or slight negative, but we will have such a strong contribution from net interest income. So for us, 2023 can be a year of significant growth in terms of net income.

Looking at share buyback, share buyback is something that we -- when we decided to make a €3.4 billion of share buyback, and we worked also on the number of shares that we can buy through the share buyback. The reduction in terms of the pricing of Intesa Sanpaolo now has put us in a position to the €1.7 billion to have already completed 5% of the share reduction in the market.

But at the same time, deciding to give an interim dividend of €1.4 billion at the end of November, I think that it is absolutely the right position to move quarter-by-quarter in giving a return to our shareholders. So that's the reason why we will wait for the final results of the group in order to give the positive view on the share buyback. So that's my view.

In any case, also the considerations on the potential recession now, in my view are moving into a positive mode, not in a negative mode. And in any case, we will have enough time in two or three months in order to understand if there could be a block in terms of imports from Russia, that is not what all the most important institutional researchers are considering in their scenario. So if the scenario repeat, the one that is likely, we will take our decision within the period of the approval of these figures for the end of 2022.

[Operator]

We are now going to proceed with the next question. The next question is comes from the line of Azzurra Guelfi from Citi. Please ask your question.

[Azzurra Guelfi, Citi]

Hi, good afternoon. Two questions from me. One is on the banking tax. Do you have any view that you can share with us on the potential introduction of banking tax also in Italy?

And the second one is going back on your buyback if I can. Just want to understand better what is the ultimate data point that will drive your decision on the execution of this buyback? Is it the total amount of net profit? Is it the absolute amount of capital? Because you sound very confident on the profitability for next year given the upside from rate. But I just wanted to understand a little bit better what is the constraint that we should look at as the main driver for that? Thank you.

[Carlo Messina, Managing Director and Chief Executive Officer]

So thank you, Azzurra. I will start from the point of the share buyback, just to be completely clear with all the investors. I think that making my job, so the CEO of a very important European institution you have to consider what is the right way to manage an organization. So in strong recession, it is not the right solution to give back capital. But the only point is to give a significant dividends on the cash flows.

So what I want to be sure is not we have a significant transaction. So the worst-case scenario that just a limited part of the institutional counterparties are considered likely. As I told you, my expectation is absolutely that this is not the case. But due to the fact that we already paid, we will pay in November an interim dividend. There's no hurry, no need to take decision today, we have already performed a significant portion of the share buyback. So what I want is to be sure not to have a significant recession during 2023, but not because we will not have enough capital, because all our estimates looking at capital position we will remain well above 12% after the share buyback also in case of a recession. So just to give you the clear position of Intesa Sanpaolo.

But I don't think that it is the right approach for a CEO that want to look at sustainable results in case of significant recession. So the worst case scenario in which we can enter in 2023 to give back the capital. In that case, we'll move in six months, nine months, 12 months in giving back again the capital, because all the estimates also in case of a severe recession with the rebound in 2024 are bringing us due to the net interest income contribution to a significant cash flow. So what will happen would be to have a significant dividend, cash dividend on the side of cash dividend for 2023, in 2024, and 2025. And possible postponement in case of a severe recession of the share buyback to the end of 2023. That's my position.

I'm really convinced that we will be able at the beginning of 2023 to give green light on the share buyback because the recession, in my view, will not be severe, will be only a technical probably reduction during the first quarter of 2023, and that will be all what can happen. So that's the position on the share buyback.

[Operator]

We are now going to proceed with our next question.

[Carlo Messina, Managing Director and Chief Executive Officer]

Looking at in the tax -- banking tax on the other part of your question. I have no evidence that in Italy, the government is starting a banking tax. That's what today I'm in a position to tell you. If you compare the taxation in Italy with all the other European countries, there's no -- it is clear that we have such an excess of taxation in comparison with all the other European banking system that there is enough space to say that we have already a significant taxation.

At Intesa Sanpaolo, we think that it is a duty of a bank to move into the support to the social needs and to the -- inequalities, and we are doing this through significant actions that we are delivering for the people in need and also for working and also for family that needs some assistance. So we decided to give a platform of €30 billion in order to support companies and families that can need to have some support. So we are doing the best of our job as bank. Then the decision of tax is in the end of government. And obviously, we will fully respect any kind of decision coming from the government.

[Operator]

Thank you. We're now going to proceed with our next question from the line of Delphine Lee from JPMorgan. Please ask your question.

[Delphine Lee, JPMorgan]

Yes, good afternoon. Thank you for taking my questions. My first one is, sorry to come back on NII. On using that guidance, that €2 billion additional, just to clarify, this is €2 billion additional compared to '22. So it doesn't -- can you just maybe just reconcile this with your interest rate sensitivity that you have given before? And also does -- what kind of deposit beta assumption are you taking now? Just trying to understand a little bit the different moving parts within NII to get to your new above $11 billion guidance.

And my second question is on provisions. Have you done any kind of assessment just to understand a bit better, if the recession is not mild, if it's a little bit more severe and you get maybe not just a slight decline in GDP in '23, but something more significant where your cost of risk could go to? And do your overlays largely cover the additional loan losses or not? Thank you very much.

[Carlo Messina, Managing Director and Chief Executive Officer]

So I can tell you that starting from the net interest income. So just to give you what I consider important. Now we are entering not in the sensitivity world, but in a real world. So the sensitivity is very important if you are in an environment of negative interest rate, if you have no evidence of what happened in case of rebound of interest rates. We have already -- we are already in an environment of increasing interest rates. Just the last quarter, you have the evidence of the real increase, not the theoretical coming from sensitivity.

So what will be important is what you call beta. So the portion of deposits that can be repriced. And in this respect, all our analysis are considering the historical situation of the bank and working client by clients, what will be the different action coming from the bank. We are moving between 35% and 40% of beta in case of the Euribor 2%. Then if I can give you some more figures, some more color on our net interest income, our estimates are in this sense with the people in the field that have real relations with the clients. So that was really important in order to understand what would be the impact on net interest income.

So in case of 2% Euribor, so that is already embedded, because we are already there at the end of the year, we will be there. We will have an increase of €2 billion in terms of net interest income with beta 35%, 40%. Then if interest rate will be 2.5, we can have €2.5 billion increase in comparison to the end of 2020. So €2 billion for 2%; €2.5 billion for 2.5% Euribor be delivered and €3 billion for 3% Euribor. That's our estimates and working with our people with the beta increasing in terms of moving to 40% and 45% as soon as you have an increase in terms of Euribor.

So just to make a summary, 2% Euribor with 35%, 40% beta increase in terms of net interest income, €2 billion, 2.5% Euribor, beta 40% increase in terms of net interest income, €2.5 billion; 3% Euribor, beta above 40% and increase in terms of net interest income, €3 billion. That's all for net interest income. So please do not enter into something different from this indication of the level. We gave the clear disclosure and sensitivity is not the way in which you can understand the dynamic of our net interest income dynamics.

Looking at provisions, in case of severe recession. So the real point on a severe recession and a rebound in 2024, sorry, because the real way in which you have to look and what can happen in the future also in the worst case scenario, so also looking at the worst scenario, you will have a rebound in any case in 2024. So that's one of the impact in order to understand the real dynamics of the increase in terms of potential provisions.

So we will have an increase in terms of provisions. Overlays in my view are not so significant in this scenario, because the overlays are related mainly with Stage 2. We have not such a significant consideration of clients in Stage 2. So we have a good quality within our portfolio. We think that we will have an increase in terms of cost of risk. The expectation is that, in any case, will not be so significant as in the previous crisis, because the majority of the cost of risk increase in case of a recession is mainly related to the stock of nonperforming loans.

And in our case, the impact coming from the stock on non-performing loans will be close to zero. So the dynamics will be only related with inflow. And on inflow, you would have to consider the rebound in 2024. So it is not mathematical that you have a recession and you will have a significant decrease in terms of cost of risk. But at the same time, we will benefit from significant net interest income increase. So that's the reason why I can tell you that in any scenario, we are just looking for very good results in terms of net income.

[Delphine Lee, JPMorgan]

Thank you.

[Operator]

We are now going to proceed with our next question and it's from the line of Ignacio Cerezo from UBS. Please ask your question.

[Ignacio Cerezo, UBS]

Yes, hi. Good afternoon. Thank you for the presentation. I have one question on TLTRO and the other one in on Russia. On the TLTRO, if you can clarify three things, how you have accounted for the cost in Q3 and what is the guidance in terms of contribution in Q4? And what are you planning in terms of repayment? And on Russia, if you can give us a little bit more color on why and how the exposure, especially the cross-border has declined so much in the quarter without cost. What action basically have you taken there? Thank you.

[Carlo Messina, Managing Director and Chief Executive Officer]

So I will give you the answer on Russia and then I will leave the floor to Stefano Del Punta in order to give you all the clarification on TLTRO. So on Russia, we decided to accelerate. So the first point in all the dynamics of this quarter, as usual, you know that our attitude is that in the second part of each year, we prepare the sustainable results for the future. And we started from the consideration that we had such a positive tailwind coming from net interest income that we can deal with two significant points that we want to assess. We obviously see different dimensions. One is the Russian exposure. The other one is the government bond exposure in the different countries in which we decided to invest. So for the first part of Russia, we decided to accelerate some negotiations that we started at the beginning of the crisis with the counterparties that can be ready to buy our loans.

Our loans used to be of good quality. But we decided that could be better to have zero exposure through clear derisking and avoiding to have into the balance sheet figures. So that's the reason why when we gave the slide of the outlook we gave also the exposure embedded in the different outlook that we gave to the market. So if you remember, when we talk about giving €4 billion, about €4 billion guidance, the implication was to have no critical changes to commodity energy supplies.

So a net exposure to Russia of €3.6 billion. So this means entering into 2023 with an exposure to Russia of €3.6 billion. In the other scenario, with well above €3 billion net income, we have considered to have 40% coverage. So with an exposure net of €2.7 billion. So this means entering in 2023 with €2.7 billion of Russia exposure and believe me, when you have all credit cross-border or credit in the local bank because you know that it is practically impossible to make a clear disposal of the bank without the authorization of the #1 in Russia, you will have a significant exposure to Russia and each 10% increase in terms of coverage, you can have a massive impact on figures.

So we decided to accelerate the negotiation, to have with the right coverage on our exposure to Russia. And now we are at a level of below €1.3 billion net exposure and entering with this exposure 2023 will be in a clear, strong position because also in worst case scenario, what we will need due to the quality of these loans would be to have a marginal increase, and we're not talking about marginal increasing. I'm talking about €100 million, €200 million. So no more something that can change the figures of sustainability of our results.

So reduction of stock has been considered very important to enter into 2023 in order to be sure to assess all the potential coming from net interest income or the need to be sure to have the right limited increase in cost of risk, maintaining significant increase in terms of net income in 2023.

Also, the concentration in government bond has been considered a priority to assess also because we had significant revenues. And so we decided to reduce concentration and to move into a proxy of equivalent dimension between Italy and Spain and the AAA, AA, A portfolio, other government bonds in portfolio, reducing the stock of the exposure to government bonds.

Just to tell you this because we had enough room to make a clear derisking of the position. And I think from my experience, looking at nonperforming loan or each kind of risk that's it is absolutely the best solution to remove the risk from the balance sheet and not to maintain the risk. And in any case, I and also to your question to see some recovery or some positive components in economic figures coming from this risky situation.

And I think that's -- it is not a way in which it doesn't follow -- want to proceed looking at exposure into risky countries. That's a position related to Russia. That's the reason why we accelerated. And I can tell you that if we have occasion to reduce -- to further reduce our exposure, we will continue to reduce the exposure until 0. Then TLTRO for Stefano.

[Stefano Del Punta, Chief Financial Officer]

Yes. On TLTRO, we have a very standard way of accounting for TLTRO. So we account the balance sheet on the current basis, so not on a amortized cost as other banks do. So there's not going to be any significant impact from -- going forward from TLTRO, meaning since the realignment of the funding cost of TLTRO, so the pricing condition of TLTRO and the deposit facility rate of ECB, basically the TLTRO will become completely renewed.

So from December onwards, there's not going to be neither any benefit nor any disadvantage from keeping or repaying TLTRO. So of course, all the numbers that Mr. Messina gave on the sensitivity of interest rates in the next 12 months in 2023, of course, are, of course, already discounting not benefit, zero benefit from TLTRO. The strategy at this point, I mean, we are not -- have anything today. There's no reason to keep the TLTRO after December. But of course, you're not going to substitute TLTRO with more expensive funding.

And so we will keep the TLTRO that we need to avoid issuing cover bond or issuing senior, non-preferred or senior preferred. So the fact that we have no benefit, it doesn't mean that we instantly will be paying entirely TLTRO. The liquidity position of the bank is very strong. So I think that we will repay in a relatively short period of time. But in any case, I mean, we don't have defined -- it depends also on the volumes of new loans that we -- and the -- so we are on the budget exercise. So depending on the volumes of loans and the volumes of deposits, evolution, et cetera, et cetera, we will repay TLTRO in a way that, of course, we do not have to go to the market to replace TLTRO with cover bonds or other non-eligible bonds.

[Ignacio Cerezo, UBS]

Thank you very much.

[Operator]

We are now going to proceed with our next question. And the question comes from the line of Andrea Filtri from Mediobanca. Please ask your question. Your line is open.

[Andrea Filtri, Mediobanca]

Thank you for taking my questions. I have two and just one clarification following Ignacio's one. I'll start with the clarification. I just didn't understand what indications you have given on the quarter-on-quarter impact in Q4 2022 from TLTRO hedging contribution, Q3 versus Q4?

And I have two questions. First is on fees. If you can give an indication as you have given on NII on fees, whether they can actually grow in absolute terms in 2023? And the second question is on capital. If you are seeing any deterioration of regulatory headwinds and/or a harsher stance by the supervisor. And if you can just remind us of the pending regulatory burdens from here? Thank you.

[Carlo Messina, Managing Director and Chief Executive Officer]

So TLTRO, Stefano, if you want to give...

[Stefano Del Punta, Chief Financial Officer]

Well, I mean, of course, the contribution of TLTRO depends on the average rate that you pay your TLTRO, which is indexed to the deposit facility. So as long as the deposit facility rate was going up, the benefit of TLTRO was going down, considered that we use TLTRO to fund loans to corporates. Of course, when you're funding for these loans, the loans remain the same, the funding costs go up. And so the contribution, the ideal contribution of TLTRO to that interest margin in Q4 was in excess -- about €200 million lower than it was in the previous quarters when TLTRO was priced between minus 4% to 5%. But I mean this is becoming irrelevant going forward because, of course, of the new pricing rules that unilaterally CBI has changed.

[Carlo Messina, Managing Director and Chief Executive Officer]

Okay. So on fees, the -- there is a clear correlation between the inflows coming to assets under management through conversion of retail deposits in for the future. So the decision that we have to take in terms of commercial indication to the people within the organization is if to reinforce the action in terms of conversion of retail deposits into asset under management product, obviously, we're expecting the position of the clients.

Today, it is clear that we can receive much more contribution maintaining the money into retail deposits, then converting into asset under management product. So that's from a strategic point of view for the next two years, these are some point of retention related to the potential conversion of retail deposits. Different story is for the assets under administration and different story is what we are in a position to work in terms of new money coming from other banks.

So we will accelerate the potential conversion of assets under administration and the new money that we can receive from the other players into the market. We are reinforcing the private bankers within the private banking divisions because we are still maintaining significant new inflow of money that can be used for the reinforcement of wealth management proposition.

So net-net, looking at the figures today, the majority of the impact is clear deriving from the performance effect. Performance effect has two impacts. One is performance fee and the other one is the dimension of the stock that is a dimension in which you receive a lower amount of fees.

But looking at our expectation also in adverse scenario, more or less fees will remain at this level. So my expectation is that fees can only accelerate in the next quarters. The dimension of the acceleration will remain obviously by the market attitude and by the attitudes of clients that today prefer to remain with retail deposits, and we are happy to maintain clients with the retail deposits.

Looking at capital, our -- we remain with more or less 45 basis points of impact coming from headwinds from a regulatory point of view. We have already prepared actions in order to compensate this impact. And we are already in 2022 ready to have the compensation in case of an impact in this quarter or any impact coming in the first quarter of 2023. So I have to tell you that from this point of view, we are able to prepare a clear hedging strategy in case of an impact coming from regulatory headwinds. So I'm not worried at all from this point of view.

[Andrea Filtri, Mediobanca]

Thank you.

[Carlo Messina, Managing Director and Chief Executive Officer]

Thank you.

[Operator]

We are now going to take our next question and it is from the line of Benjamin Kevin Roberts from Goldman Sachs. Please go ahead.

[Chris Hallam, Goldman Sachs]

Yes, hi it's Chris Hallam here from Goldman. Just one question from me. The move higher in rates is clearly a very large tailwind to your revenue performance as you've outlined on the call today. But I wondered whether it's also leading to any changes in strategic thinking. And you already mentioned you discussed this topic, the conversion of retail deposits into wealth products and how that might be slowed.

But I wondered -- what I wanted to check, I'd say, whether there would also be any changes to either the pace or the scale of the Isybank rollouts because I think initially that was focused on 4 million relatively unprofitable customers whose profitability has probably now improved.

[Carlo Messina, Managing Director and Chief Executive Officer]

So the -- this is a good point because it is related with our business model. We are in a unique position in the European landscape because we can call wealth management products today also the retail deposits. Let me say, in another word, we manage all the money of our clients in the interest of our clients, but then there is a clear implication also on our figures.

When we discuss in different occasions with the potential that we have in commissions, we used to have at the beginning of our business plan, some years ago, if you remember, we used to talk about conversion of assets under administration. Then due to the fact that there was an attitude from the Italian families to maintain a very conservative approach and using -- especially during the COVID-19, their attitude to place into retail deposits, we started to talk about conversion of retail deposits into asset under management product.

Today, if I have to tell you from a medium-term perspective, I remain convinced that we need to move into a conversion for sure for assets under administration. And I want to remember that we remain with more than €200 billion of asset under administration, out of which €100 billion can be a more convertible portion in order to be converted into assets under management programs. Then we have between €50 billion and €80 billion of retail deposits that we need to check with the clients, what kind of allocation they can prefer.

So if they want to remain into retail deposits or they want to subscribe bonds of Intesa Sanpaolo, or if they want to move into asset under management product. Another very important lever for us is the property and causalities business. That would be in other part of the story in terms of commissions. So it is likely that if we will not have significant conversion in terms of retail deposits, we will have an acceleration, in any case, in the property and casualties business. It is anticyclical. So that's for sure an opportunity to accelerate in this area.

So the clear point for us is that today, we think to be at the real minimum level of the fee and commission as soon as the performance will move into a positive attitude, we will have, again, an increase in terms of stock of asset under management product. But the combination between the wealth management or the retail deposits and assets under management will bring us such an increase during the next years that we are really in a position to upgrade our figures for the business plan, and we will work in order to be sure to give the right figures to the market in the next quarters.

[Chris Hallam, Goldman Sachs]

Thanks very much.

[Operator]

We are now going to proceed with our next question. And it's from the line of Benjie Creelan-Sandford from Jefferies. Please go ahead.

[Benjie Creelan-Sandford, Jefferies]

Yes, good afternoon. Thanks for taking the questions. My first question was on net interest income. I mean thank you for the guidance. You've been very clear on that. I was just wondering if you could give us a bit more color on the moving parts this quarter. So just looking at Slide 8, I wondered if you could break out in a bit more detail that spread component. I mean how much of that related to loan yields, did anything happen with deposit costs in the quarter. And also what was the hedging contribution? How did that move as well?

And I guess just a follow-up on the TLTRO. Could you just tell us what the euro amount contribution from TLTRO was in the third quarter? And my second question, again, just a bit of a follow-up, really, just on capital. Did you take any regulatory impacts this quarter in the capital ratio? And also, perhaps you can tell us what the CET1 sensitivity is to the move in BTP spreads going forward now that you have reduced the exposure. Thank you very much.

[Carlo Messina, Managing Director and Chief Executive Officer]

So I want to start from the capital ratio. The -- we had no impact coming from regulatory in this quarter. As I told, our expectation is to have in the last quarter and more likely in the first quarter of 2023. But as I told, we have already prepared the contingency in terms of reduction of risk-weighted assets remain under the impact.

Looking at the sensitivity now, we have a sensitivity of 15 basis points impact for 100 basis points movement in terms of the spread BTP bond. That's our position. We consider this a fair position, and we are confident to enter into 2023 with a very limited exposure also to this potential risk during 2023. Looking at the dynamic of the net interest income during the third quarter, in comparison with the second quarter, we had a clear and significant markdown positive that more than compensated negative hedging.

So we had -- we started to have a negative in terms of our delta contribution of the hedging facility. So in reality, the markdown was really accelerating and more than compensated a reduction in terms of contribution from the hedging facility. We had a slight new contribution from markdown. And so the majority benefit in terms of medium-term cost of funding. And that's the most important part of the story. But if you want to look, the fundamental part of the story is mark down.

So it is the clear evidence that we have an increase in terms of net income that is really impressive during the rebound of the interest rate in the market. On TLTRO...

[Stefano Del Punta, Chief Financial Officer]

Yes, I mean it depends how you look, the benefit of TLTRO, the benefit in terms of the -- what we've always given to you in these numbers is the difference between basically how much we were paying with TLTRO and how much we were getting from the clients with the loans that we have used when we have taken TLTRO to do loans. And this, of course, this advantage was progressively going down because TLTRO was being repriced following the repricing of -- the increase in interest rates by ECB.

And of course, instead, the loans that we did to the customers remained at the same conditions. So in terms of the commercial benefit from TLTRO, it was basically disappearing, okay, because ECB was bringing up the pricing of TLTRO. Then there was another advantage, which is basically the excess liquidity, there is -- the reason why, in the end, ECB decided to change the pricing mechanism because, of course, the bank with excess liquidity where the possibility to do deposits mainly with ECB at higher interest rates and continue to pay on TLTRO an interest rate, which was lower than the -- but this is, in a sense, different because the money funds, also the excess liquidity can come from many sources.

So I would say, as I answered AA, AAA before, the difference in terms of benefits from TLTRO, the real benefits of them, the one kind of or the use of TLTRO to make loans to clients. In Q3, it was already down or above or more than €200 million vis-a-vis Q2. It was progressively disappearing. So this is what I can tell you. Otherwise, I mean, the money that we have deposited in ECB doesn't come from TLTRO, comes from the overall management of our liquidity.

So whether deposit money with the ECB either loans and deposited TLTRO money on deposits from customers and from corporates. So I don't have an answer for, on top of what I gave to you. So the benefit from TLTRO from the real use of TLTRO in Q3 was already disappearing.

[Benjie Creelan-Sandford, Jefferies]

No, sorry, I sort of asked the question the wrong way. I mean, basically, what I wanted to know was what was the cost of the TLTRO in the third quarter, i.e., what did you accrue it at in terms of the cost, not like kind of the net in terms of the reinvestment potential.

[Stefano Del Punta, Chief Financial Officer]

According to TLTRO contractor rules, well, it depends, of course, when the TLTRO has been taken, but the cost was definitely negative, so it was, I don't have that number. Maybe we can -- you can refer to our Marco Delfrate or Andrea Tamagnini to have that number. I don't have that in mind, certainly was negative.

[Benjie Creelan-Sandford, Jefferies]

Perfect, thank you very much.

[Stefano Del Punta, Chief Financial Officer]

Thank you.

[Operator]

We are now going to proceed with our next question. The next question comes from the line of Andrea Lisi from Equita. Please ask your question.

[Andrea Lisi, Equita]

Hi, thank you for taking my question. The first one is on what are you observing in terms of operating costs going on. So if also the target you have for operating cost, is confirmed given the high inflationary environment and the measures you have taken on them? And the second question is specifically on Banca dei Territori. I saw that in the third quarter, the NII was lower than the second quarter. Was it entirely due to TLTRO effect slightly lower volumes? Or are other effects in place? So just to understand that. Thank you.

[Carlo Messina, Managing Director and Chief Executive Officer]

So looking at the -- that point of Banca dei Territori, I'm happy that you have asked because also, I saw it in another report this point on the allocation of the growth in terms of net interest income. You have to consider that in order not to penalize the Banca dei Territori division that is the clear engine for the liquidity for the relation with clients, with the wealth management, with all the clients [indiscernible] in our group. So it is for sure an engine in terms of sustainability of our results.

In the period of very negative interest rate, we used to use within the intra-group fees Euribor and zero Euribor for the Banca dei Territori division. So also in the period in which you had a significant reduction in terms of Euribor, all the negative has been placed in the corporate center. So today for 2022, we will maintain for all 2022 just for the budget proposition the same approach for the -- also in the divisional disclosure of our figures, then starting from 2023 you will find all the positives coming from Euribor into the Banca dei Territori.

That's to put emphasis on the fact that this will be the division that we need in charge in terms of responsibility to allow the acceleration in terms of net interest income. So that's the reason why you find, you have this evidence included in the divisional figures of the group. But in terms of real dynamics, it's all placed in the Banca dei Territori that was for sure the division that from a substantial point of view suffered much with the negative interest rates. Looking at operating costs, we have a clear track record of managing the cost base of the group.

So for sure, there will be a component of the group to be 10%, 20% of our cost base that can have an impact coming from inflation, but we are working to mitigate and compensate this impact. What I consider strategic for sure, the cost or the technological improvement of the group, we have already said that I want to be sure to enter in 2023 in a position not to talk about the rising cost of risk, sensitivity, but talk about what is the real future of this group, that is technological improvement, the agreement with that, the Isybank and what we can do for the real bank for the next 10 years.

So operating costs, we increase for the technological improvement of the group that will be reduced in all the other areas that we have within the group. So my expectation is that we will be able to manage cost in order to move into a negative side also during next years.

Then if in some quarters, we can have some spike deriving from inflation, we will see, but in any case, we will find areas in which we can compensate. So cost control and cost reduction will remain a top priority for Intesa Sanpaolo.

[Andrea Lisi, Equita]

Thank you.

[Operator]

We are now going to proceed with our next question. And it's from the line of Giovanni Razzoli from Deutsche Bank. Please ask your question.

[Giovanni Razzoli, Deutsche Bank]

Good afternoon to everybody. A quick clarification on the cost of risk because you've been pretty clear in saying that your best scenario incorporates a mild recession in the -- at the beginning of next year with a rebound afterwards. In the previous conference, you've mentioned that instead in a severe recession, you wouldn't have expected your cost of risk to have exceeded, even in the severe recession, 60 basis points. Would you stick to that level? Or shall we assume that in light of a slightly better evolution of the macro in Italy so far this guidance could be worst case. Thank you.

[Carlo Messina, Managing Director and Chief Executive Officer]

Sorry, could you repeat the figures because I lost you when you were talking about the amount of basis points.

[Giovanni Razzoli, Deutsche Bank]

Yes, in the previous conference call, you mentioned that in extreme scenarios, you wouldn't expect the cost of risk to reach 60 basis points even in extreme scenarios, if I'm not mistaken.

[Carlo Messina, Managing Director and Chief Executive Officer]

I was -- I understood 16. So I was just .

[Giovanni Razzoli, Deutsche Bank]

Not 16, if it's 16 would have been really -- a little bit too lower.

[Carlo Messina, Managing Director and Chief Executive Officer]

So I can confirm. So if you look at our -- let's make it easy, so because if you look at the figures that we have today, with a massive derisking that believe me was considered mission impossible to reduce Russia exposure in the dimension in which we realized during this last quarter, But the cost of risk to the group today is at 54 basis points. So you can move -- if you decide to move to have some further reduction, you can have a slight increase or slight reduction. But to consider that in a severe recession, you can have €1.3 billion because you have a recession in a country with a zero NPL like us because, I want to repeat again, in all the different recession, more than 50% of the cost of risk was deriving from the stock of nonperforming loans. So we enter in 2023 with practically zero NPL in terms of impact that you can have.

So the cost of risk embedded also in case of a recession, due only to a new inflow. And due to the fact that only today, the position of companies in Italy is really unbelievable in terms of comparison with all the other countries. In Italy you have a system of corporate clients that are really in a strong position. So there are a portion limited to small SMEs, to families that can suffer from the crisis, but we are not talking about something that could change the dimension.

So my expectation is that in any case, we can remain below 60 basis points. So no possibility to have a cost of risk on the basis of what we are seeing today that can exceed 60 basis points also in very negative scenario. But yes, that are not scenario that we are today looking for. And believe me, I think that once again, I see in the market an attitude to create this worst-case scenario, the end of the world, you have to consider that there will be a stock of everything in the world. In Italy today, you cannot find a place in a hotel, so that is why you have a GDP that is positive.

And our expectation is that also in this last quarter, you can have some positive news coming from the tourism and other components of GDP in the country because we have full of USA tourists coming in our country, international tourists. So there's a boom in Italy in this situation. So we are entering something that could be, is structurally problematic. I have to tell you, it's something that I -- it is difficult for me to consider. So the cost of risk will be, for sure, below the 60 basis points.

[Giovanni Razzoli, Deutsche Bank]

Okay, thank you. So the 16 was not enough. Thank you. Thank you.

[Carlo Messina, Managing Director and Chief Executive Officer]

We can try to work for 16 in case of positive GDP dynamics also in 2023. This could be a clear challenge.

[Operator]

We are now going to proceed with our next question. It's from the line of Andrea Vercellone from Exane. Please ask your question.

[Andrea Vercellone, Exane]

Just one question left. IFRS 17, some banks have now given guidance as to what they expect the impact being next year on capital, if any. Are you in that position or not, i.e., can you tell us something? And if there's any impact on revenues, it'd be interesting to know as well. Thank you.

[Carlo Messina, Managing Director and Chief Executive Officer]

No, we do not expect a significant impact. That can be five basis points. There will be an impact, okay, but it is negligible in any case for our figures. We used to have no traditional products that the products can have a significant volatility in terms of impact. And so our expectation is not to have impact coming from IFRS 17.

[Andrea Vercellone, Exane]

Thank you.

[Operator]

We are now going to proceed with our next question, is from the line of Domenico Santoro from HSBC. Please go ahead.

[Domenico Santoro, HSBC]

Thank you. You already answered to all of my questions. Thanks.

[Operator]

Okay. We are now going to take our next question. And it comes from the line of Anna Maria Benassi from Kepler Cheuvreux. Please ask your question.

[Anna Maria Benassi]

Yes, good afternoon. All my questions have been answered. Just a couple of comments. You were giving the sensitivity of capital ratios to the BTP bond spread. Actually, we have seen large movements in all the government bonds. So can you tell us how much in Q3 was the impact of all the position on your capital, Isybank U.K., so you had diversified your portfolio to escape a bit the Italian volatility that then materialize elsewhere.

And the other point is, if you can provide the deposit EBITDA split between retail and corporate, just to have a view on the next trends. And finally, just a small remark. I see now that I have €5.7 billion net profit estimates already for '23. Consensus is €5.1 billion. So I'm discovering a bit live that maybe has been too optimistic for '23. But now I hear you saying that the €6.5 billion for '25 could be subdued compared to what you can achieve. So what should I do? Thank you.

[Carlo Messina, Managing Director and Chief Executive Officer]

So in the third quarter, it has been 11 basis points indeed was coming in all our portfolio. So deposit split, the majority of our deposits are related with retail, €50 million is related with corporate clients. So that's, that's more or less the dimension of the level of the deposit base. On the net income, I have to tell you that the acceleration coming from this Euribor will bring us such a positive debt. We remain in a unique position in comparison with the original business plan and having realized in the first part of 2022, the derisking of the nonperforming loans exposure.

So now the clear position in terms of risk coming from nonperforming loans is close to zero. We will have a clear acceleration in terms of net income. Then on the specific figure, I would prefer to discuss in occasion of the presentation of the final and figures for 2022 because of the timing, I will have also the budget approved and also some revised position of the business plan also agreed with all the managers of the bank.

But it is clear that you can do your calculation. The trend of the bank is to generate apart from the Russia exposure in which we will not have more impact during the future that the run rate is more than €5 billion, then with interest rate negative now considering that in 2023, we will have more than €2 billion in excess contribution and looking commissions, we think that we can continue to have a good contribution and not a reduction from commissions.

You will have your own calculation on the initial net income that we can generate. Then you can add some provision, if you want, having in mind that we are at zero NPL and zero Russia exposure. So at the end, I'm really confident that we can give good satisfaction to our shareholders in terms of net income generation and so in terms of cash dividend that we can give to our shareholders.

And that's the reason why I think that the original business plan can be absolutely overperformed and at the end maintaining 70% payout ratio, we can continue to be probably the best cash dividend provider in the market.

[Anna Maria Benassi]

Thank you.

[Operator]

We have no further questions at this time. I hand the conference back to Mr. Carlo Messina for closing remarks.

[Carlo Messina, Managing Director and Chief Executive Officer]

So thank you very much. I want just to confirm you that I'm really satisfied from these results. As you understood, we decided to use this quarter in order to prepare 2023 results through a clear reduction to zero of the risk that we can have during 2023. And any eventual reduction in terms of GDP dynamics will be absolutely more than compensated by this acceleration in terms of net interest income that will be the clear engine for growth and for over delivering on our promises on the original business plan. So thank you very much.