UniCredit SpA

MIL:UCG

Earnings Call Transcript 2020-Q3

[Operator]

Good morning, ladies and gentlemen. Today's conference call will be hosted by UniCredit's CEO, Mr. Jean-Pierre Mustier; and CFO, Mr. Stefano Porro. [Operator Instructions] Today's conference call is being recorded.

At this time, I would like to hand the call over to Mr. Jean-Pierre Mustier. Sir, you may begin.

[Jean-Pierre Mustier, executive]

Thank you very much, and good morning and welcome to the analyst call for our third quarter results. These are unprecedented times, and the emerging second wave of the pandemic means that many of our countries face a challenging period.

On behalf of all of us at UniCredit, I would like to express our sympathies for anyone impacted by COVID-19. We will continue to do everything we can to protect the health and safety of our colleagues. And we will continue to support our clients, the real economy and our communities in the countries where we are present. Just as during the first wave, we are committed to being part of the solution.

As you will have all heard, Pietro Carlo Padoan was recently coopted to our Board of Directors as Chairman designate. So before we start, I would like to warmly welcome Pietro Carlo Padoan. His extraordinary professional experience and deep knowledge [indiscernible] regulatory environment as well as his outstanding public service record [indiscernible] will be of great value to our group. I very much look forward to working with him.

I would like as well to thank Mirko Bianchi for his hard work and dedication as co-CFO. Mirko was instrumental in the Transform 2019 and Team 23 and will bring substantial experience to his new role as CEO of the group Wealth Management and Private Banking [indiscernible]. Stefano Porro will assume sole responsibility for the CFO function and will present the results with me today.

Turning to our results. We saw a pronounced recovery underlying net profit this quarter, up 31% quarter-on-quarter, thanks to lower loan loss provisions and higher revenues. The pickup in revenues was driven by increased customer activity and higher fees following the easing of lockdown restrictions towards the end of the second quarter. At the same time, we maintained our strict cost discipline, leading to positive operating [indiscernible] that gave us a more than 3% point improvement in our cost-to-income ratio over the quarter. Our commitment to cost discipline means that we are always looking to further optimize our cost base.

Following the substantial reduction delivered during Transform '19, we committed to further gross savings of EUR 1 billion as part of Team 23 last December. Thanks to our continued cost control and the acceleration of changes in our business model, these cost savings are now expected to reach EUR 1.25 billion, some EUR 250 million better than the original Team 23 target. As a result, we expect cost to be flat between 2020 and 2021.

Our stated cost of risk guidance for 2020 is confirmed at 100 to 120 basis points due to our willingness to anticipate conservatively future impacts, including increased overlays, proactive classification and regulatory headwinds. The combination of this conservative approach and seasonality means that the stated cost of risk in the fourth quarter will be materially higher than the 63 basis points in the third quarter.

In the face of the emerging COVID-19 second wave, having a solid balance sheet and a conservative approach to risk are very important. With record levels of capital, our fully loaded CET1 ratio is at 14.4%, and our fully loaded MDA buffer is at 538 basis points. Our liquidity coverage ratio is at 183%. We are, therefore, in a strong position to continue supporting the economy while returning capital to our shareholders.

Our culture and values are fundamental part of how we run the bank. Our commitment is and remains to do the right thing for all our stakeholders, favoring long-term sustainable outcomes over short term-solution. This means doing the right thing for employees for whom we want to be not only the best place to work, but also, as I have already said, the safe place to work. The health and safety of our colleagues and our customers will always come first.

Our ongoing commitment to sustainability received further recognition this quarter. We're ranked #1 globally for sustainability-linked loans by Bloomberg and were awarded Best Social Impact Bank in Europe by Capital Finance International.

Let's turn to our key financial on Slide 5. Stefano will take you through this in more detail later, but I wanted to highlight a few key points. Revenues for the quarter were up 4.4% compared to the second quarter and broadly in line with our performance in the first quarter. The progressive easing of lockdowns across many of our core markets and positive effect from client activity where we were primed and ready to capitalize on.

Of particular note, the recoveries in investment fees up 12% quarter-on-quarter. Thanks to robust AUM trend, primarily in Commercial Banking Italy, we delivered a strong quarter despite seasonability and the comparison against a particular strong period last year.

Our third quarter '20 underlying return on tangible equity reached 5.4 percentage points, an improvement of 1.3 percentage point quarter-on-quarter in spite of the extraordinary macroeconomic backdrop. This reflects our continued conservative approach to running the bank, our tight cost control and our strict underwriting discipline.

The reduction in gross NPEs continued at a brisk pace with a further reduction of EUR 1 billion over the quarter, down more than EUR 6 billion over the past 6 months. This reflects continuing hard work and disposals within noncore. As a result, our gross NPE ratio for the group improved further to 4.7%. If we focus on the figure for the group excluding noncore and use the EBA definition, our NPE ratio remains at 2.7%, below the average of other European banks.

Our capital position strengthened further in the quarter with a fully loaded CET1 MDA buffer reaching 538 basis points. This represents an increase of 58 basis points over the quarter and is 286 basis points higher than a year ago. This improvement is thanks to lower risk-weighted assets, mainly resulting from lower overall loan volumes in CIB and the increase of guaranteed loans in Commercial Banking Italy.

Now it's my great pleasure to hand over to our CFO, Stefano Porro, who will take you through the details of the quarter. Stefano, all yours.

[Stefano Porro, executive]

Thank you, Jean-Pierre, and good morning, everyone.

Revenues stood at EUR 4.4 billion, reflecting the recovery in client activity after the easing of lockdowns, up 4.4% quarter-on-quarter. This recovery was supported by stronger fees up 6.4% quarter-on-quarter. Costs were lower by 1.4% quarter-on-quarter, reflecting our strict cost discipline and continued focus on further efficiency gains, which more than offset COVID-19-related expenses.

I will comment on revenue and cost components in more detail in the following slides. But I would like to make 3 specific comments on items below the net operating profit line. Systemic charges in the quarter increased by 36.4% year-on-year, mainly due to additional contribution to the deposit guarantee scheme in third quarter '20 for 2 single names in Austria and in Italy. As a result, we have revised up our full year '20 outlook for systemic charges guidance from EUR 0.9 billion to EUR 0.95 billion.

Profit on investment in the quarter was affected by mark-to-market losses of EUR 126 million on our remaining stake in Yapi. The stated group tax rate of 12.4% in third quarter '20 was positively impacted by a tax credit recognition in Italy, thanks to NPE disposal executed in the quarter, in line with the Cura Italia decree.

Let's turn to Slide 8. This quarter saw limited nonoperating guidance. Underlying net profit stood at EUR 692 million. For further details, please see the annex on Page 40. If we look at the distribution of underlying net profit across the group in the quarter, you can see that our diversified business model underpins our performance at group level.

In the third quarter, all business divisions were profitable, with standout contribution from CIB and CEE. CIB benefited from high revenue growth in the third quarter, mainly thanks to XVA, which led to underlying net profit of EUR 394 million, up 87.2% quarter-on-quarter. CEE's third quarter underlying net profit of EUR 226 million, up 2.4% quarter-on-quarter was underpinned by lower LLPs and continued cost discipline.

Let's turn to Slide 9. Before looking at net interest income in detail, let me remind you, our commitment to generate long-term sustainable return. This means that we do not do volume lending nor carry trades. We will not compromise our future asset quality to boost net interest income in the short term.

Focusing on the quarter. Net interest income was down 3.8% quarter-on-quarter. These can be attributed to 3 factors. First, loan volumes. Just under half of the reduction in the contribution from loan volumes came from the repayment of revolving credit facility within CIB, reversing some of the benefit seen in second quarter '20, the rest of the reduction being in CEE. German corporate clients refinance liquidity lines in capital markets and run down working capital financing as their sales recover.

Second, guarantee business. Guaranteed loans are good business opportunities, given their low risk and capital consumption. Such loans, however, are not only retained at lower spread than normal loans of an equivalent maturity, they also substitute higher yielding short-term loans in the quarter. This mix effect was a particularly important driver for Commercial Banking Italy.

Third, 3-month Euribor. This fell almost continuously throughout the quarter, reaching historic lows by the end. Its average value dropped by 17 basis points compared to the prior quarter, impacting all floating rate euro asset and liabilities. While fee continues to feel the impact from reduction in base rates, the net impact on group net interest income in this quarter was limited. The successful repricing on deposit offset the lower contribution from both customers loan volumes and rates. With further deposit repricing becoming more difficult, net interest income in CEE is not expected to trough until second quarter '21.

The quarter also saw an initial contribution from TLTRO3 of plus EUR 18 million. As a reminder, we have accounted for the net benefit in a conservative manner, assuming reinvestment at the ECB deposit facility rate and amortizing the benefits across the 3-year maturity.

Looking forward, assuming 3-month Euribor remains at current levels, we expect net interest income for the group in the fourth quarter '20 to be broadly in line with the third quarter '20. For full year '21, we confirm our guidance of EUR 9.5 billion.

Let's turn to Slide 10. While we normally discuss fees year-on-year, I want to focus my remarks today on a quarter-on-quarter basis to better capture the underlying dynamics. Fees were up 6.4% quarter-on-quarter as client activity increased despite the third quarter being seasonally weak. Please remember that if you do make year-on-year comparison, third quarter '19 was an exceptionally strong quarter, characterized by the unusual lack of seasonality.

Once again, we're seeing a varied increase in commercial activity in terms of geographies and fee categories. In part, this reflected where each market was in terms of lockdown cycle. While our Western European market had exited lockdown, in CEE, some countries only entered lockdown during the third quarter. The annex on Page 34 provides a detailed managerial breakdown of monthly fee trends by geography and product.

I would therefore like to limit my remarks to the following. As Jean-Pierre already said, investment fees delivered a strong performance, up 12% quarter-on-quarter. This reflected robust growth under management sales as client activity shifted away from asset under custody product, especially in Commercial Banking Italy, driving the material increase in upfront fees. We expect the recovery investment fees to continue into fourth quarter '20.

Financing fees were impacted primarily by lower activity in Corporate & Investment Banking. While debt capital market has had an outstanding year, it could not match the activity of the prior quarter due to usual seasonal slowdown in August, which also impacted structural finance. Financing fees are expected to enjoy the usual seasonal pickup in fourth quarter.

Transactional fees recovered in third quarter '20 as expected. GDP-sensitive transactional fees, such as cars and payment services, rose. Overall, October saw a continued positive performance for fees at the group level. For full year '21, we confirm our guidance of EUR 6.4 billion.

Let's turn to Slide 11. Trading income in the third quarter was up 27.7% quarter-on-quarter at EUR 455 million, thanks to a significant increase in XVA. Client-driven trading income, excluding XVA, stood at EUR 246 million in the third quarter, down 33.6% quarter-on-quarter. This was mainly due to the Equities & Commodities business where there was less structuring on certificate as client activity shifted more towards asset under management products, a move which, as previously mentioned, has supported our investment fees. There was also an impact from lower flows in fixed income and currency due to August seasonality.

Non-client-driven trading income was down 31% quarter-on-quarter, mainly due to fair value adjustment. Trading income, excluding XVA, is normalized in line with our quarterly guidance of around EUR 350 million on average. For full year '21, we confirm our guidance for trading income of EUR 1.4 billion.

The lower contribution from dividends year-on-year was driven by the strategic disposals of stakes in Yapi and Mediobanca over the last 12 months. However, the trend quarter-on-quarter showed an increase, mainly thanks to a recovery in the profitability of some financial investment in Austria.

For Yapi, intergroup funding fell to EUR 1.1 billion in the quarter, 58% below the level of third quarter '18 and thus delivering on our target, set back then of ousting our intergroup exposure.

Let's turn to Slide 12. On cost, I would first like to remind you of the scale of cost cutting done during Transform '19 and what is underway in Team 23. In Transform '19, we decreased FTEs by over 14,000 and branches by more than 900. This led to net cost savings of more than EUR 2 billion, materially beating the original target. In Team 23, we plan to decrease total FTEs by a further 8,000 and branches by an additional 500. As we explained at the Capital Markets Day in '19, this would generate gross cost savings of around EUR 1 billion, equivalent to 12% of our 2018 Western Europe cost base.

Between the 2 plans, we'll have delivered a 24% reduction in FTEs and a 38% reduction in branches. And yet, in addition to these sizable planned reductions, we have reduced costs both year-on-year and quarter-on-quarter and now expect to beat our original Team 23 target for full year '20 by more than EUR 250 million. As a result, we are targeting updated gross cost savings of EUR 1.25 billion, 25% better than our initial plan. Our continued cost discipline allowed us to fully offset COVID-19-related costs in quarter and full year '20.

Total COVID-19-related costs amounted to EUR 18 million in the quarter and EUR 88 million in the 9 months. For the full year, such costs would be around EUR 100 million and will be fully absorbed by savings made elsewhere. These include a significant reduction in variable compensation equal to around EUR 100 million less compared to last year. Please remember that we expect higher cost in fourth quarter '20 due to seasonality, both in terms of HR and non-HR. For the full year '20 overall, but also for full year '21, we confirm our guidance of flat costs relative to full year '19.

Let's turn to Slide 13. First, let me remind you of our approach to provisioning that we introduced during 2020. The aim is to proactively capture the future cost of defaults in the loan portfolio and properly reflect the forward-looking economic component of COVID-19. Loan loss provisions, therefore, include overlays as well as specific provisions and regulatory headwinds.

We also explained that since part of the loan portfolio is likely to be under moratoria for a large part of full year '20, specific LLP would likely lower than would have otherwise been. This has been the case with the moratoria on Italian SME loans having being extended January next year. For further details of our approach, please see Page 49 in the annex. We also provided further disclosures on the staging of our loan portfolio on Page 48.

Let me now turn to our performance in the first 9 months and explain how we expect provisioning to roll off for the rest of this year and into next. Our cost of risk in 9 months '20 stood at 81 basis points. Within this, 33 basis points were accounted for by specific LLPs for loans that were in stage 3 or moved to stage 3 during the first 9 months. This is better than what we have reported in the past, and this aligned with the cost of risk guidance that we gave in last December's Capital Markets Day.

Despite a third quarter '20 cost of risk of 63 basis points, we expect a significant quarter-on-quarter increase in LLP in fourth quarter '20, driven by a number of factors, as well as the usual seasonality, this including anticipation of future impact for increased overlays, proactive classification and regulatory headwinds. The latter mainly connected to the new definition of default are estimated at around 10 basis points, forming the bulk of the expected regulatory headwind LLPs in full year '20.

Our stated cost of risk guidance for full year '20 is confirmed at 100 to 120 basis points, with lower specific provision of 40 to 50 basis points and higher 50 to 60 basis points overlays as well as 10 basis points of regulatory headwinds. The higher level of overlay provisions we are taking this year underlines the credibility of our full year '21 cost of risk guidance, as some of these overlay provisions will be used next year when higher defaults should materialize. Full year '21 stated cost of risk guidance is confirmed at the bottom end of the 70 to 90 basis point range, with the underlying cost of risk close to 60 basis points.

Let's turn to the balance sheet, starting with asset quality on Slide 15. In the third quarter, our gross NPE ratio for the group, excluding noncore, was stable at 3.5%. Using the EBA's definition, the group NPE ratio, excluding noncore, at 2.7% continues to be better than the average of other European banks. The reduction in the coverage ratio of 0.8 percentage points in the quarter compared to second quarter '20 was driven by 3 factors. First, disposal of bad loans. Excluding such disposal, the coverage ratio of bad loans would have been higher than in second quarter '20, above 71%. Second, the classification into UTP of a single named government-guaranteed loan where LLPs apply only to the uncovered part. And the coverage duration on the full loan up -- below the portfolio average. Excluding such impact, the coverage ratio of UTPs would have been well above second quarter '20 at over 50%. And third, an increase in unlikely-to-pay loans from precautionary classification, leading to a different mix effect.

Let's turn to Slide 16. We continue to work on the noncore run-down, and the process remains well on track. We confirm our target of gross NPE below EUR 4.3 billion by year-end as well as a full rundown of the noncore in 2021. In the third quarter, we carried out a successful transaction with Illimity selling Italian SME secure nonperforming loan portfolio, a testament to our ability to execute deals in the current economic environment. As a result, gross NPEs in the noncore were down EUR 1.1 billion in the quarter to EUR 5.9 billion.

The CMD '19 P&L guidance is confirmed, and we also confirm that the overall noncore portfolio is provisioned to sell. The remaining financial impact of noncore on group performance for full year '20 and full year '21 is minimal. And the net economic risk embedded in noncore run-down is close to 0.

Let's turn to Slide 17. Our CET1 capital fully loaded is at 538 basis points buffer over our MDA level. To put this into context, our MDA buffer is now significantly larger than our current market cap. The 58 basis point increase in the MDA buffer over the quarter was thanks to a reduction in risk-weighted assets of more than EUR 10 billion, repeating the pattern we saw in the first quarter.

Lower risk-weighted assets were driven mainly by lower overall loan volumes in CIB and changes in the [indiscernible] our overall loan book. The latter was mainly driven by changes in the mix in CIB and increase in guaranteed loans in Commercial Banking Italy. In line with the economic recovery anticipated in 2021, we expect a loan growth of at least EUR 10 billion for the next year. As a result of this and further procyclicality, a large part of the positive risk-weighted asset dynamics this quarter should reverse next year.

Please note that the procyclicality effect in the quarter came mainly from PD rating migration. We continue to approve a cash dividend in the third quarter equivalent to 30% of underlying net profit.

Note that the planned share buyback, which makes up the balance of the 50% capital distribution in full year '20 can only be deducted from capital once we have the approval from the regulator and the AGM. The change in the regulatory treatment of software assets, introducing the so-called CRR Quick Fix will take effect in fourth quarter. The benefit is expected to be around the mid-teens in terms of basis points.

Regulatory headwinds are expected to be less than 0.2 percentage points in full year '20 net of the change of software treatment and less than 1.4 percentage points in full year '21. This [indiscernible] and PD rating migration. The latter totaled 0.7 percentage points in full year '20 and full year '21 combined, of which 0.40 percentage points were taken in 9 months '20. Please remember that this rating migration will revert over time as GDP recoveries in the cycle.

Looking forward, we expect our MDA buffer in full year '20 and full year '21 to be well above 300 basis points, which is above our target range of 200 to 250 basis points. We remain committed to gradually returning excess capital once regulators allow. This will be the base on the sustained excess capital over our target MDA buffer.

Let's turn to Slide 18. In line with the strong increase of our CET1 MDA buffer, our TLAC MDA buffer has increased to 648 basis points, well above our target range. The prefunding carried out for our 2021 subordinated TLAC units contributed positively as well.

Despite the tough environment, we executed EUR 1.25 billion of senior nonpreferred in July and another $1 billion in September, raising money at attractive price. For the rest of the year, we are not planning any further public issuance other than MREL-eligible products.

Let's turn to Slide 19. And finally, a quick look at our tangible equity, which was stable quarter-on-quarter at EUR 50.9 billion. Retained earnings were offset by a decline in the FX valuation reserves of EUR 0.5 billion, mainly due to depreciation of the Russian ruble, Czech koruna and Turkish lira.

Let's turn to Slide 21. Jean-Pierre, next to you.

[Jean-Pierre Mustier, executive]

Thank you, Stefano, and well done for your first quarter quarterly presentation.

As I said at the start, this quarter was characterized by a pronounced recovery in underlying net profit, driven by lower loan loss provisions as well as a rebound in revenues as customer activity picked up. The robust performance of investment fees was noteworthy.

Thanks to our strong balance sheet and commitment of our team members, we are very well placed to keep supporting our clients, whatever the environment. As always, we will continue to run and manage the bank in a conservative and disciplined way and prepare for all eventualities. And as always, the health and safety of our employees and customers comes first.

While mindful of the potential impact of the second COVID-19 wave, we confirm our underlying net profit target of above [ EUR 8.3 million ] for financial year '20 and up EUR 3 billion to EUR 3.5 billion for financial year [ '25 ] (sic) [ '21 ] as well as our 2023 underlying return on tangible equity of 8%. We have also improved our gross cost savings target for the plan by 25% to EUR 1.25 billion.

We also confirm our stated financial '20 cost of risk guidance of 100 to 120 basis points as well as our stated financial year '21 guidance at the bottom end of the 70 to 90 basis point range. Both figures include around 10 basis points of regulatory headwind. This is why we confirm our 2021 underlying cost of risk at close to 60 basis points. Remember, this regulatory headwind need to be deducted when calculating the underlying net profit that is the basis for capital distribution.

Our balance sheet remains very strong, with our fully loaded CET1 MDA buffer at 538 basis points. And we expect this buffer to remain well above 300 basis points in both financial year '20 and financial year '21, and plus, above our target range of 200 to 250 basis points.

We remain fully committed to reinstating our Team 23 distribution policy, a cornerstone of the plan. Subject to the regulatory green light, we expect to resume distribution from calendar year '21 onwards. Our policy remains a combination of an ordinary distribution of 50% of underlying net profit, and in addition, an extraordinary distribution of excess capital. These distributions will be a mixture of cash dividends and share buyback, acknowledging the divergent wishes of our shareholders.

For the return of excess capital, share buybacks are the preferred option, and they make the most financial sense at current share price levels. We have also been very clear on what we mean by excess capital. This is the sustained excess over our 200 to 250 basis points CET1 MDA buffer. As such, we will pay careful attention to all the expected regulatory headwinds, and we will update this at our Capital Markets Day to be held in the first half of 2021, the day to be confirmed. We want to [indiscernible] pandemic and show the concrete progress of the acceleration towards more remote banking.

It also means any excess capital will be returned gradually. However, while maintaining a very strong balance sheet is important, we will not keep excess capital for the sake of it. The efficient allocation of capital is at the heart of how we run the bank.

Before we finish, let me extend my sincere thanks and appreciation to all UniCredit team members whose commitment, resilience and continuing hard work in this unique and continually developing situation has allowed UniCredit to prosper and to do the right thing for all our stakeholders.

One final housekeeping item before taking your question is to note that our virtual team this quarter will be complemented with Wouter Devriendt, our Head of Finance & Controls. We very much look forward to seeing you all and continuing our dialogue.

Now Stefano, the rest of the team and I are ready to take your questions. [Operator Instructions] Many thanks. Operator?

[Operator]

[Operator Instructions] The first question is from Antonio Reale with Morgan Stanley.

[Antonio Reale, analyst]

Before that, I also wanted to wish my best to the Prof. Padoan for his new role. I'm sure and confident it will be a great addition for the bank.

So 2 questions. First one on net interest income. I understand you're confirming the guidance of EUR 9.5 billion next year. However, some of the headwinds you've mentioned seem that likely to stay. I think Euribor, which has now hit new lows in Q4; and Central and Eastern Europe activity, which was probably affected more than any other region by the second wave. Now how do you expect to cover for the difference? If I annualize your Q3, Q4, you are at EUR 9.2 billion versus the EUR 9.5 billion. That's my first question.

And my second question is on dividends. You've always been open and transparent on regulatory matters. UniCredit has an MDA buffer now of more than double your target. That leaves obviously a significant excess. You've talked about it, some of the excess. If I look at it today, it's EUR 10 billion, almost will cover for regulatory headwinds, as you said. But some of it will go to shareholders gradually. And if I understand correctly, I think you've said already in 2021, of course, if ECB allows it. That's on top of the 50% ordinary dividend. Now I appreciate it's [indiscernible], but can you help us understand what you think are the key criteria for the ECB to assess the bank's distribution capacity? And how much of that excess you think you could realistically pay in 2021? So that's my second question.

And if I may, just very quickly on the -- on a clarification on the sub-holding project. Because if I understood correctly, the project came up first as part of your Capital Markets Day last year, which was very consistent with your de-risking efforts at the bank. The idea of this sub-holding was not much to see improvement on funding cost, correct me if I'm wrong, but related to sort of limit the capital volatility and reduce the debut of the Italian sovereign. Now this was also in line with target to reduce the [indiscernible]. Since then, things have changed quite a lot. I mean, ECB has a strong commitment to QE. It could be extended in December. The sovereign bank nexus is probably stronger than it's ever been, I mean, with all the government support measures in place. So maybe just to help understand what would be the rationale of [indiscernible] company in this environment?

[Jean-Pierre Mustier, executive]

Thank you very much. Just let me take your questions one by one, and I will let Stefano, if necessary, comment with more detail. On the NII side, we confirm our guidance for EUR 9.5 billion in 2021. And the main reason is the same across all our main markets, which is the strong rebound of the economies and the resulting growth in loan volume. We have said during the presentation that we expect a EUR 10 billion increase of loan volume, which will be supporting more fixed investment by our clients next year. But all these crises have one thing in common that they all end actually. And our economists are forecasting a 5% rebound in the European economies next year. And this will mean more volume, more fixed investment and that we will be supporting our clients for that. So that's important, because the higher loan volume will be, of course, one of the drivers in terms of improvement of the NII versus the trend that you can see in Q2 and Q3 basically.

Second thing is that we expect base rate to stay at the current level. On the CEE side, we expect a rate stabilization on the loan side in the course of the year. And we will see a still positive, even diminishing contribution from deposit repricing. We had a very strong deposit repricing this quarter, as you have seen. As a result, on the CEE side, the NII will trough in the end of the first quarter, second quarter '21. And then we expect the NII for the CEE side in FY '21 to be up year-on-year.

And in Western Europe, we have a higher loan volume, as I said, which will compensate the tighter client rates and because of the increased government guarantee loans. And we will as well as the economy rebound normalize the underwriting guidelines for the loans to individuals, mostly consumer and mortgage. We have taken so far a conservative risk approach, which is important when we have such a sharp fall in the GDP. And we are ready as soon as the economy turns to actually increase our loan volume, as I said, and resume more normal underwriting for consumers mortgage. So all this will mean that we expect our NII for 2021 to be very equivalent to what we have in 2020 of EUR 9.5 billion.

As far as the dividend is concerned, we have, as we said, an excess capital. This excess capital allows us on the one side to finance the economy. And Stefano mentioned that the improvement we've seen in the CET1 ratio this quarter of 58 basis points is mostly due to the fact that we have the clients paying back the revolvers -- their revolving facilities. And we will have, I mean, this benefit being returned next year as we have increased loan volume, for instance. So you have to look at the CET1 buffer in light of risk-weighted asset inflation, and we should have increase of loans, as I just said.

In terms of regulatory headwinds, we have told the market that we should have next year less than 140 basis points of regulatory headwind. We have had a translation of regulatory headwind from 2020 to 2021. We're planning to have 100 basis point combined regulatory headwind between '20 and '21 before we add the rating migration before the crisis. These regulatory headwinds transfer to 2021. On top of that, there's the rating migration of 70 basis points, as mentioned by Stefano, between '20 and '21, 45 basis points taken in 2020 and the balance in 2021. This rating migration will reverse over time when the rating improve basically.

So we have a rating migration, which we will, I mean, if I take FY 2020 and 2021 and regulatory headwinds of less than 140 basis points, including rating migration, regulatory headwind and TRIM next year. And beyond that, we communicated at the Capital Markets Day in 2019 the different rating migration.

So when we take into account the projection of the regulatory headwind of the risk-weighted asset inflation because of higher loans, we can look at the excess capital we have well above 200 to 250 basis points, basically target. And we intend over time to return all our excess capital above our target to our shareholders. We will update all this projection at our Capital Markets Day, but we have substantial excess capital when you look at it over time in the way I just described.

The ECB will look probably, and I cannot speak on behalf of the ECB. But when we apply, for instance, for share buyback, we can look at the projection of capital over time to define what is the excess capital above the MDA. So we expect that the ECB will apply exactly the same policy basically. And we will apply for share buyback next year, not only coming from our regulatory dividend payment from the net income, but also for our excess capital. But we expect the ECB to only allow banks to gradually pay the excess capital next year. This is why we said that we will pay our excess capital gradually next year and over the coming years basically. But I think what is important is to look at the excess buffer above our 200 to 250 basis points over time or duration of the plan in the end. Sorry for this long explanation, but I think it's important for everybody to understand the way we look at our excess capital projection.

As far as the international holding is concerned, we announced last year that we are looking at the creation of an international holding in order to see if we could improve our cost of funding and/or our MREL and TLAC constraints, with the ECB extending quantitative bidding and the client and sovereign [indiscernible] this project, which has always been a project, it's still a project. And because of the macro environment and the ECB action, we don't intend to move on the project, because there's no reason to do it with the credit and sovereign [indiscernible] being very tight.

[Operator]

The next question is from Adrian Cighi with Crédit Suisse.

[Adrian Cighi, analyst]

Adrian Cighi from Crédit Suisse. I have a question on M&A and a follow-up on capital. On the M&A front, we've seen continued noise around potential M&A sort of opportunities in Italy. And we've seen other banks provide a different stance on their intention, noting that shareholder value creation is their only criteria. Should they judge M&A as value accretive, they'll pursue it. You've previously ruled out M&A outright. Would there be any conditions where that would make sense?

And on the capital, sorry, just a clarification from your previous sort of answer. Can I just make sure that I fully understand the headwinds next year? So you mentioned 20 basis points headwind on a net basis, including the software intangible this year; and next year, 140 basis points between TRIM and credit risk migration. Is that [Technical Difficulty] sort of outside of that headwind? This is sort of above and beyond what's already happened. Is that correct?

[Jean-Pierre Mustier, executive]

Thank you very much. I will let Stefano confirm the regulatory headwinds. On the M&A side, let me reiterate the fact that our Team 23 plan is based on no M&A assumptions, only organic growth. And it is even more true, let me say, with the current environment where our clients are shifting to more remote banking. So while in Team 23 we had a transformation plan, which is one of our 4 pillar, what we are doing today is to accelerate the transformation to more remote banking to do what we were planning to do in 4 years in 2 years.

For instance, today in Italy, thanks to the transformation we did in the acceleration and to have a paperless branch and ability of the clients to sign digitally, I mean, most of our product can be signed by our client remotely, which allows us to handle much more remote banking. And so we will debrief everybody at the Capital Markets Day next year on the acceleration of the transformation. So we prepare to transform rather than integrate, and this is driven in large part by the behavior of our clients.

And the second reason why we have no M&A stance is that we want to use our excess capital, as mentioned before, in order, on one side, to finance the economy. We see a rebound of the loan and the financing activity next year with a strong rebound of GDP to be expected. On the other side, to return capital to our shareholders. So no M&A assumptions for Team 23.

Stefano, I'll let you confirm the figures of regulatory headwind for this year and next year.

[Stefano Porro, executive]

Thanks, Jean-Pierre. So your summary is correct. So minus 20 basis point from a common equity Tier 1 ratio basis point impact from regulatory headwinds in the full year '20 and less than 1.4, so 140 basis points in '21. Important to mention that in definition of regulatory headwinds, we're including both the effect that are from models, change in regulation and PD [indiscernible] as well. So we are including all the related effects.

[Jean-Pierre Mustier, executive]

I mean the 70 basis points impact of [indiscernible] coming from the rating migrations are included in these figures, and clearly, were not included in our initial projection when we presented the plan as we didn't plan for the COVID [indiscernible] basically. And once again, the rating migration impact, the 70 basis points, will afterwards be compensated when the GDP rebounds, the rating will improve, and we will get back most of it over time. We also said, Adrian, that the 70 for the 2 years, 0.4 that we've already taken year-to-date. Next question, please.

[Operator]

The next question is from Giovanni Razzoli with Equita.

[Giovanni Razzoli, analyst]

A clarification on the regulatory headwind, specifically on the PD migration, the 70 basis points. Can you share with us what geographies are mostly hit by this migration? Question number one.

Question number two regards the cost of risk guidance for 2021. If I'm not mistaken, the guidance for Italy should be in the region of 100 basis points for next year, if I'm not mistaken, if you can clarify this.

And I was wondering whether you are not recording any improvement in the risk profile because of the increased contribution from the state guaranteed loans. So I was wondering whether you've kept a margin of safety vis-à-vis the improvement in the risk profile because of the contribution of state guaranteed loans.

[Jean-Pierre Mustier, executive]

Thank you very much. I will let Wouter give the breakdown of the projection for the cost of risk next year. Please give the breakdown afterwards by country and the PD migration. So -- but on the evolution of our cost of risk this year breakdown of between specifically over next year.

[Wouter J. M. Devriendt, executive]

Okay. Thank you. First of all, important to repeat that we confirm the forecast that we have given for this year and next year. So I clarify that for this year, we confirm the cost of -- stated cost of risk guidance of 100 to 120 basis points. And for '21, we confirm the underlying cost of risk close to 60 basis points.

The composition of our cost of risk or stated cost of risk for this year is composed of 3 components: it's overlays, its specifics and regulatory headwinds. The specific cost of risk for the year 2020 is 40 to 50 basis points, overlays 50 to 60 basis points, and 10 basis points for regulatory headwinds.

It's important to clarify that the 50 to 60 basis points overlays, that is in anticipation of future impacts. We have explained [indiscernible] before, but it is important to highlight that it is very different from the specifics.

When we go to next year, what we do is we confirm our stated cost of risk between 70 and 90 basis points. And when we correct that for the regulatory headwinds, that is the underlying cost of risk, which we confirm close to 60 basis points. That is a very important number, because that is also what we use to calculate our underlying net profit for 2021 that has been confirmed in the range of EUR 3 billion to EUR 3.5 billion. And that is also the number that we use for our dividend policy.

[Jean-Pierre Mustier, executive]

Thank you very much, Wouter. So Tj, breakdown of cost of risk for Italy in 2021 projection and PD migration by geography.

[Thiam Lim, executive]

For 2021, we confirm our cost of risk overall at the bottom end of the range of 70 to 90, and close to 60 basis point for the entire group. We have not given the breakdown by division.

In terms of the so called PD migration for the group, already mentioned by Jean-Pierre, 45 basis points is taken in 2020 and the remainder of the 25 in 2021. Most of it is in Italy and as well as in Germany, and Germany primarily because we have a lot of the CIB businesses and you expect a rating migration drift from the -- with some in Austria and very little in CEE at this point in time.

[Jean-Pierre Mustier, executive]

Thank you. Next question.

[Stefano Porro, executive]

Sorry, Jean-Pierre. There was one question in relation to the state guarantee.

[Jean-Pierre Mustier, executive]

Yes. Go ahead, go ahead, go ahead, Stefano.

[Stefano Porro, executive]

In relation to this, as a matter of fact, already in this quarter, we had -- if we look at the dynamic of the risk-weighted assets, a positive contribution of around EUR 4.2 billion, they are in from the state guaranteed exposure. And we have a positive impact on the expected loss perspective as well.

So you can see at Page 41 of the presentation that our expected loss on the new business is moving down of a couple of basis points. This is also due to the benefit related to the state guaranteed contribution that it is 2 basis points when we look at the contribution to the stock, expected loss. If we look to the new business expected loss -- when we look, the contribution for Italy is even higher because it's 13 positive effect, 13 basis points to the expected loss of the new business of Commercial Banking Italy.

[Jean-Pierre Mustier, executive]

And also, Giovanni, the number, as Stefano mentioned, on the state currencies and RWAs on Page 51.

[Operator]

The next question is from Andrea Filtri with Mediobanca.

[Andrea Filtri, analyst]

Two questions, 1 on asset quality and 1 on capital. On asset quality, we continue to hear banks in Q3 experiencing very benign asset quality trends and no worrying signs from expiring moratoria, while economies are getting back into some sort of lockdown and GDP expectations are deteriorating. Can you share with us your latest thoughts and anecdotal evidence on what's happening on the ground on expiring moratoria, and what are really the forward-looking signs that we should be careful about that you're seeing to gauge what real NPL creation is going to be next year? And how will the ECB look at this in conjunction with capital return for 2021?

And the second on capital return. As has been said before, your MDA buffer is 2x your target at the moment. If the ECB maintains the handbrake on capital return, how could you accelerate the usage of excess capital to boost your share price in a sluggish macroeconomic environment where loan growth is limited, also given your no M&A policy? And have you considered the possibility of buying back some of your JVs or other businesses within the group?

[Jean-Pierre Mustier, executive]

Thank you very much, Andrea. Firstly, on asset quality. If we go to Slide 13 of the presentation, you can see that for the 9 months to date, our specific cost of risk is at 33 basis points, which is below the specific cost offering that we had last year. So clearly, in the current figures, there is no sign of worsening of the credit environment, and that's for a large part because of the moratoria and the fact that the different countries and governments have extended a very massive government-guaranteed loans.

If you go to Slide 44 of the presentation, we give the breakdown of our moratoria exposure and of the expired volume of moratoria. So we have today, EUR 29 billion of loans under moratoria, EUR 22.4 billion in Italy, with EUR 1.6 billion, which have just expired. The loans in Italy have just expired. So it's way too early to say there could be any impact. At this stage, on the loan expiring in Italy, we have 0 NPE reclassification. So I would say that's a very positive impact. But I mean, it's way too early to draw any conclusion.

We had a EUR 3.8 billion of loans expire in the moratoria in the CEE side, where now we have a total amount of EUR 5.8 billion. They have expired a little bit earlier in Italy. And there, we have seen a default rate, which is bigger than what we were expecting, I mean, let's say, on the 2%, 2% to 3%, depending on the countries. But it's here as well, too early to draw a conclusion about where will be the default rate of the loans and the moratoria be lending, basically.

So I think it's -- let's look at the situation step-by-step and not draw early conclusions about what can happen. But nevertheless, the early indications are more positive than negative, basically.

And you asked a question about what would the ECB do, and how would the ECB look at the evolution of capital? I'm not the ECB, and I cannot comment on their behalf. The only thing I can say is that when the ECB looks, for instance, a share buyback, they look at the projection of capital under adverse scenario. And on our side, we are always conservative. This is why we want to take additional provision in the fourth quarter to reach the 100 to 100 basis points cost of risk. So if you do the math and the calculation, it's an additional EUR 2 billion of provision in the fourth quarter to reach this amount, which is in anticipation, as we said, of regulatory headwinds as well as future defaults that this overlay provision can be used against the set provision next year. And I'm convinced that the regulator will do exactly the same. They will look at what should be the impact of banks. And if banks are properly provisioned or not, their future regulatory headwinds or their future specific cost of risk. So for that, we are very well prepared as we have a conservative approach, and you can absolutely project what should be our capital evolution.

On the MDA buffer, it is high. That's very clear. It has never been so high at 538 basis points. As we said, to project the excess capital above our 200 to 250 basis points, you have to take into account risk weighted asset inflation, we plan to have our loans increasing by EUR 10 billion next year, which will support our NII and allow us to deliver EUR 9.5 billion NII. We have to take into account the regulatory headwinds. Next year, 140 basis points basically as well, and you have to project that. We know the ECB will allow banks to pay dividends. So it's not a question of if, it's a question of when. So it will happen. We are convinced it will happen next year for the dividend on the 2020 net income, but also for excess capital. But for excess capital, we think that the ECB will only allow for a gradual return of excess capital, this is why we plan only a gradual return on excess capital.

We are not looking to do anything else. As we said, our business plan is based on organic assumptions, [indiscernible] in that the [ nominee ] includes not doing anything on some of the joint ventures.

[Operator]

The next question is from Domenico Santoro with HSBC.

[Domenico Santoro, analyst]

Just a couple of clarifications. First of all, my understanding, if my calculation is correct, is that your guidance on net profit for this year, the EUR 800 million, which is 100 for Q4, implies a level of provision that is probably in the mid of your range, 100, 120 or even less, around 100, if we have to take some seasonality on cost, which is usual in the fourth quarter. So I just wonder whether something can be better actually in terms of revenues or if you might consider looking at any capital gain in the case of a level of provision of 120.

The second question is on the NII in Italy. Nobody asked, but it's down more than 10%, if we have to include absolute TLTRO3 impact. So caught on the business evolution on which you commented very well. I just wonder whether there is any one-off here because the decline is significant. And then a clarification on capital. Can you just mention what is left to book in the fourth quarter in terms of regulatory headwinds or positive in the case of the software intangible, anything which is not business related?

[Jean-Pierre Mustier, executive]

Thank you very much. So just on your first question for the EUR 800 million guidance for the full year, I mean that's the guidance, looking at our 100 to 120 basis points cost of risk for the year. And we should land around the middle of the range, basically. So that's the, let's say, first assumptions you could have. That does include regulatory headwinds, basically, of 10 basis points, okay? So as such, the 100 and 120 includes 10 basis points of regulatory headwinds, which are not included into the underlying cost of risk. So if we land on the middle of the range for the stated cost of risk, the underlying one should be at the bottom of the range of 100 basis points. It's exactly the same way that you have to use when you look at the 2021 cost of risk. You said the stated EBIT at the lower end of the 70 to 90, which includes 10 basis points of headwind. So obviously why we confirm the underlying cost of risk of close to 60 basis points for 2021. And once again is the underlying net income, we confirm for 2021 of EUR 3 billion to EUR 3.5 billion, which is the base for our dividend calculation.

For NII in Italy, we have some regular impact and one-off impact. I will let Stefano give you the detail of that. And afterwards, Tj can comment on the last question on the regulatory headwind and capital. But Stefano for the NII in Italy.

[Stefano Porro, executive]

Okay. In Italy, so Commercial Banking Italy were mainly 3 elements to be taken into consideration. So we experienced an overall customer rate reduction on the lending stock of 12 basis points quarter-on-quarter, down to 226 basis points. It is the average client rate on all the stock. This was due to effect. One was connected with Euribor that was affecting all the Euribor-linked asset. And second is a substitution effect because we have a higher share of term-guaranteed loans. The term-guaranteed loans, on average, has a client rate above 100, which we're substituting the higher-yielding short-term loans during this quarter.

The second effect was a lower internal remuneration to the deposit due to the movement of Euribor that was negative in the quarter for 17 basis points on the average. The sum of these 2 effects is explaining the delta of the net interest income of Commercial Banking Italy during the quarter.

[Jean-Pierre Mustier, executive]

And then more or less, the [indiscernible] [ contributed ] for half of the impact, basically.

[Stefano Porro, executive]

Yes. The first one, yes. The first one is equal to EUR 38 million. So the sum of the clients' rate effect, so deriving from both Euribor and the mix. And the second one is explaining the other delta.

[Jean-Pierre Mustier, executive]

Okay. Tj, on the question on the regulatory headwinds.

[Thiam Lim, executive]

On the regulatory headwinds, as we have mentioned sort of earlier, for 2020 is 20 basis points. And for next year, it's 140 basis points, no worse than that. And that includes PD scenarios, trends and all of the effect in terms of models and procyclicality. So this is already everything that is factored in that was mentioned sort of earlier.

[Stefano Porro, executive]

I think on this, you are asking for some more detailed explanation to the 4Q. The most relevant item, as I was highlighting before, is the software treatment. So the change of the software treatment is going to be in the fourth quarter. And we are estimating the impact in -- the team's positive impact in relation to the common equity in our ratio. While the other one that is a negative is going to be some other effects from PD procyclicality perspective. The sum of all the effect, as highlighted before, will bring the overall impact full year to less than 20 basis points.

[Operator]

The next question is from Britta Schmidt with Autonomous Research.

[Britta Schmidt, analyst]

Two questions, please. The first one, just picking your brain again on the wording regarding M&A. The statement that Team 23 does not include M&A is not necessarily the same as not being interested in M&A. Under what conditions would you be interested? Are there deals to be struck where you could maintain your payout policy, for example?

And then the second one would be just on the stage 2 loans. It sounded like there were some single names in there. Can you just explain a little bit more of the Q-on-Q increase and maybe also the single name? What sort of factor it was in and what division it was in?

[Jean-Pierre Mustier, executive]

So I will let Tj answer for the second question. On the first one, I just want to repeat what we said and we always said is Team 23 is based on no M&A assumptions. We prefer to transform rather than integrate, and we use our excess capital to finance the economy and to return capital to shareholders. Difficult for me to be clearer than that, basically, and don't try to find any certainty in any of the wording. And we never comment on [ reimbursement ] speculation. It's not today that I will start to do that. And no M&A assumptions. We prefer to transform, then integrate, and we use excess capital to finance the economy and to return capital to shareholders.

On the second question, Tj?

[Thiam Lim, executive]

Thank you, Jean-Pierre. On the stage 2 increase, this is primarily driven by a proactive classification, headed more toward expiration in 2021. We have basically gone through the portfolio, assess the riskiness of the specific industry on a forward-looking basis as well as the early portfolio warning.

So in Italy, we have roughly about EUR 5 billion increase. Overall, stage 2 for the group is about 14%. And Italy is still 9.3%. So we are already looking at forward-looking anticipating just to avoid the cliff effect of the moratoria.

[Stefano Porro, executive]

You were mentioning a single ticket. During the presentation, we were highlighting a single ticket contribution in relation to the coverage of the NPE. So from this perspective, the effect was on the UTP. So we experienced a shift of a position, on the state-guaranteed position in Germany that we moved to -- from performing to nonperforming that is explaining the majority of the delta of the NPE related to UTP during this quarter. This is what I was referring to during the presentation. And this is why we need to adjust the coverage of the third quarter to take into consideration the fact that the contribution of this classification is diluting the coverage of the UTP.

[Jean-Pierre Mustier, executive]

But there would be a feature going forward for all banks. It's absolutely not uniquely specific, which means that when you have a state guarantee loan, which is reclassified under stage 3, basically, we were going to provision only for the part which is nonguaranteed. But because of the way the ratio -- coverage ratio is calculated, you take the full nominal of the loan, so it mechanically lowers the coverage ratio.

So this is why we said that if we were not looking, excluding this German credit, which was reclassified in UTP, our coverage for UTP would actually be above 50%, so higher than the coverage of the second quarter. And we will give the 2 figures going forward for analysts to understand what is the true evolution of the coverage ratio. And maybe just a more clarification as well or detail on the stage 2.

On the stage 2, we have a group coverage of 4.1%. And where for Italy, the coverage of the stage 2 loan of 6.8%. So stage 2 loan in Italy represents 9.3%, as Tj mentioned, of our portfolio in Italy and are covered at 6.8%. So the reclassification of EUR 5 billion of loan in Italy from stage 1 to stage 2 includes an additional LLP of around EUR [ 200 million ].

[Operator]

The next question is from Jean Neuez with Goldman Sachs.

[Jean-Francois Neuez, analyst]

I had a question on business development. You mentioned you felt that you prefer to transform and you have a high priority to remote banking, paperless, et cetera. I just wanted to know whether you could -- or you had anecdotes or evidence on how that has so far or not differentiate yourselves from your competitors in the various geographies where you operate, either in terms of volume, speed or pricing advantage.

And my second question was, again, maybe on some of the regulatory developments, which was subquestion one, whether there is any correlation between the cost of risk that you anticipate and the procyclicality impact on risk-weighted assets that you anticipate. Meaning that, if your early read on the anecdotal evidence on asset quality developments, which you said yourself have been so far behind, even though it's very early, would have also an impact on procyclicality if they ended up having a positive impact on assets on loan loss rates. And secondly, whether you're TLAC excess, but whether in your NII projection, there was -- what assumption were there on your excess of TLAC and whether you plan to maintain such a buffer over and above your TLAC requirement, which is quite costly, obviously, and good, perhaps.

[Jean-Pierre Mustier, executive]

Thank you very much, Jean-Francois. Just on the remote banking side or transformation, we'll give much more detail at the Capital Markets Day to be held next year. And we actually -- the reason why we want to have it in the first half of the year, not early in the year, is to show concrete acceleration of the remote banking measures that we have been taking. So the teams are working very hard on that.

I'd just give you one example. We have many but -- we told the market that we wanted to be paperless in Italy from the beginning of the third quarter, which we are actually. But to do that, we have put in place what we call the digital mailbox, which allows the client to receive all the information on their UniCredit mailbox. And using the digital mailbox, we can have the client today sign in for, remotely, for most of the contract they can transact with us. So basically, moving from paperless in the branch, using digital mailbox, allows us to accelerate the remote banking activity by putting a lot of the contract into remote signing, for instance. And so that's very important, specifically when we do the second wave, and we roll out the paperless process and digital mailbox in all our geographies. More detail at the Capital Markets Day.

On your second question, [ continue ] to have gotten everything, but the procyclicality impact that we are seeing, it's something which will impact all the banks, because the ready migration the current environment when you have GDP going down that much is mechanical, basically. So it's not UniCredit-specific. You know that we are always anticipating regulatory impact to put them behind us. So this is why we are targeting an overall impact of procyclicality of around 70 basis points. We are getting 45 basis points of that this year, and the balance next year, basically. And as I said, this procyclicality will reverse in -- starting from '22, '23 and beyond, and will be almost fully offset when the economy rebounds, basically.

On your next question, Francois, do you want to clarify? Was it about the correlation between the cost of risk, impact for rate headwinds and the capital input for rate headwinds? Or have we answered your question with what we just said?

[Jean-Francois Neuez, analyst]

That's right. So for example, you said 70 bps, for example, next year of provisions at the bottom end of the range. If you see, for example, 10 bps less of cost of risk for argument's sake, is there a mechanical effect on the rate headwinds with regards to procyclicality there? I was trying to see whether there was -- what was embedded in [indiscernible] or if there was any?

[Jean-Pierre Mustier, executive]

Just -- I will let Stefano give you the details, but the procyclicality is a risk-weighted asset. Inflation is not a provision or LMP. But Stefano will give you more detail there. And afterwards, I will comment on the TLAC issuance, what we pre-funded this year and how we manage the [indiscernible].

[Stefano Porro, executive]

Yes. So in this moment, we have effect from PD procyclicality impacting the risk-weighted asset and clearly also the expected loss. This is deriving from the application of the internal models, where we have 2 components, a qualitative one and then a quantitative one. Looking to the qualitative one, we need to take into consideration the evolution, not only of the macroeconomic situation, but also the single value. This is not translating in the same approach that we are doing from the cost of this perspective. And as a matter of fact, we are not highlighting to you a relevant effect on the cost of risk deriving from regulatory headwinds because, as we have communicated, the effect deriving from regulatory headwinds in guarantee is going to be around 10 basis points for the full year then in fourth quarter, and another 10 basis points in the next year.

So as a matter of fact, there is no direct correlation between the calculation of the risk-weighted asset effect due to PD procyclicality and the cost of risk. For sure, the expected loss is going to be impacted accordingly. As a matter of fact, the vast majority of the cost of risk that we are having this year is due to overlay that are then looking to the specific sector and the specific position, especially one under moratoria.

[Jean-Pierre Mustier, executive]

If you look -- if you go to Slide 51 of the presentation, you have the risk-weighted asset work basically. And you have on the regulation, a EUR 3.3 billion increase of risk-weighted asset. This is for EUR 3.8 billion coming from procyclicality. We have of course some benefit from SME currency. But -- so the procyclicality impact, the risk-weighted asset and, as I said, will be reversed over time when the economy rebound and the rating of the clients improve.

Of course, I mean, some of these clients might default in the future as part of the probability of default, which is a component of the expected loss. But procyclicality, the 70 basis points are purely risk-weighted-asset driven. Stefano on TLAC?

[Stefano Porro, executive]

Yes. On TLAC, currently, as we can see on Page 18, we do have an important buffer on TLAC at 648 basis points due to different reasons. So primarily is the common equity Tier 1 ratio level that we have already commented is very high. Second, the delta between the fully loaded and transitional that is equal to 74 basis points. A portion of this is going to be fading away over time in the next year. Further, we've anticipated the 2021 TLAC funding plan for a couple of billion already due in 2020.

So what we are expecting in the next years is an increase of the risk-weighted assets also deriving from the regulatory headwinds that is either what we were commenting before, to the increase also of the requirement because nowadays, the requirement is 19.5 when we are going to move to 21.5%. So as a concept of that, we are expecting to have a reduction over time of the buffer. The buffer will be higher and our target one that is a range between 50 and 100 during 2021, will move more to the upper part of the range, 50, 100 in 2022 and 2023.

[Jean-Pierre Mustier, executive]

So it's a combination, if you want, for compression of the buffer of the fact that we have regulatory headwinds to a certain extent, towards the transitional phase, which is fading in. And so we lend towards the target, end of the target. And we have been prefunding, as we always look for windows in order to prefund when we are doing those.

[Operator]

The next question is from Delphine Lee with JPMorgan.

[Delphine Lee, analyst]

So just 2 questions as follow-up. First of all, I mean, actually, I wanted to ask on fees. Your guidance basically for full year implies an increase in the fourth quarter. So I heard your comment on the financing fee seasonality. But if you just wouldn't mind giving us a little bit more color on the other components. And also for next year because your EUR 6.4 billion implies an increase, which is actually larger than the GDP assumption that you have of 5%. So just wondering if there are any drivers that we should be looking for.

The second question is, just sorry to come back on capital and distribution. But -- so your comment is very clear on the 50% total distribution. But I was just wondering, are you concerned that the excess capital potential buybacks that you could do next year could be at risk because of what's going on, on the lockdowns and the macro in Q4?

[Jean-Pierre Mustier, executive]

Thank you, Delphine. Just on the fees, we had -- for Q4, we had an extremely good October, basically, and so we are very comfortable that we'll deliver the fees for basically being able to reach the guidance, which is around EUR 6 billion this year, slightly below EUR 6 billion. So a level of fees for the fourth quarter, which will not be very different from what we had in the third quarter, basically. A very good October and as you know, I mean the new lockdown that we could have a more, let's say, pragmatic, and so we don't expect the dramatic impact we had during the second quarter. And Stefano will give more detail.

[Stefano Porro, executive]

Yes. In relation to 2021, we are guiding EUR 6.4 billion. I think it's important to have a look at full year '19 as well because 2020 is a [indiscernible] year. So if you look at 2019, our absolute level of fees was EUR 6.3 billion. We are guiding EUR 6.4 billion. It is an increase of just below 1 percentage point. Within split of the fees, we are expecting to have, in comparison to 2019 at a rated [indiscernible] growth on investment and transactional fees that are then on financing fees are also due to the fact that the financing fees are connected to the growth rate of the lending that we think is going to follow the rebound on the economy and, as a matter of fact, is going to be pronounced starting from the second quarter next year.

[Jean-Pierre Mustier, executive]

On the capital side, your question on, is the distribution of excess capital at risk? As I said, I'm convinced that the ECB policy of allowing banks to return capital to shareholders in mix of dividend or share buyback is not an if, but when. So we are comfortable that the ECB will allow bank and to pay back capital basically to shareholders. And the timing will have to be fine tuned. We are very confident that it will start in 2021.

[Operator]

The next question is from Patrick Lee with Santander.

[Patrick Lee, analyst]

I just had a couple of follow-up on your cost of risk guidance. I think for the full year guidance, as you mentioned, you are expecting a sharp increase in the fourth quarter. But if I just look at the specific component of it, I think on a year-to-date basis, you are running around 33 basis points. And if I arithmetically putting it together with your 40 to 50 basis point specific charge for the full year, we are talking about a specific risk of maybe 60 to 80 basis points in the fourth quarter. Now in the context of second lockdown but also extension of moratorium, is there any other specific miss you see already that will see such a sharp increase from 1 quarter to another? And on the other hand, if the specific is the lower, out of prudence, is it right that you're still topping up to around 100 basis points for the group basis?

And I think relating to that, looking into 2021, your current overlay, let's say, is around EUR 1.7 billion, probably more than EUR 2 billion by the end of the year. What is the actual mechanics of turning this overlay provisions into specific release? I mean do you take it on a loan -- specific loan-by-loan basis? Or do you take a more portfolio approach or strategically tapping into it? And within the 60 to 70 basis points, are you penciling in any further overlays in that guidance?

[Jean-Pierre Mustier, executive]

Thank you very much. I will let Stefano comment on the accounting methodology to be used on the overlay.

On your first question, in -- as what I mentioned earlier, we target for the full year 2020, the level of specific cost of risk from the 100 to 120 of 40 to 50 basis points, and for the overlay of 50 to 60, where we have a 10 basis points of regulatory headwinds.

For the specific cost of risk, we have a proactive reclassification on a certain number of loans on which we will work in order to anticipate potential degradation of the credit. So the increase you will have on this specific will be coming from a proactive reclassification into, let's say, to pay. And mostly, as we did, for instance, this quarter, on the CEE side, we have the proactive reclassification under UTP of a certain number of credit as we want to be conservative and anticipate effect on the future. So we always take conservative assumptions, and we always want to anticipate the pain. And so that's what we will be doing in the fourth quarter in order to have quarter-on-quarter a cleaner, if you want, 2021.

On the reclassification, Stefano, on the mechanics to move from overlay to specific.

[Stefano Porro, executive]

Yes. First of all, in the overlay, as highlighted, we are including all the effect connected with capturing the forward-looking dynamic of our portfolios. So we are including the change in the macroeconomic assumption that we already did in the first quarter. It is 20 basis points out of the 48 basis points overlay that was in the 9 months. And then we have a movement to stage 2 portfolios deriving from analysis in relation to riskier sectors than others, taking in consideration the impact deriving from COVID-19 and a single obligor analysis, especially the one under moratoria. As a consequence of these 2 analysis, we are moving position from stage 1 to stage 2.

To give you the flavor of the magnitude of the provision, if you look at the slide at Page 48, where there is the breakdown by stages, you can also see that the overall provision that we have in relation to performing portfolio, stage 1 to stage 2, is EUR 3.8 billion. And if you look at 1 year ago, it was EUR 2.6 billion. So it's EUR 1.2 billion more in a year.

How it's going to work? It's going to work that a portion of the stage 2 portfolio is going to migrate to stage 3, not all the portfolio, but a portion of the portfolio. When the portfolio is going to immigrate, clearly, a portion of this is already provisioned. Another portion has to be brought to the leverage of coverage at our UTP or bad loans. We are going to have also the other way around. So a portion of the portfolio can also migrate to stage 1. The combination among the 2 is going to let us arrive to the guidance of 2021 cost of risk that it is close to 60 basis points underlying cost of risk.

[Jean-Pierre Mustier, executive]

Okay. Thank you, Stefano. And just to maybe summarizing the overlay provisions are not a black hole. So that is why we are extremely careful to make sure that we can write them back if we want to reassign the freed up amount into specific provision, and that requires a very fine accounting approach, as Stefano has outlined. If you want more detail, I mean, feel free to call the IR team or have a direct discussion with Stefano. But as far as an anticipation, and then you can be [indiscernible].

[Operator]

The next question is from Alberto Cordara with Bank of America.

[Alberto Cordara, analyst]

My question is, first of all, on the cost of risk. We talked about the fact that this new state guarantee loans have a negative impact on NII. But clearly, they will have a positive impact on loan losses. So my question is, what would be your cost of risk next year without the state guarantee loans, particularly in Italy? And connected to that, what rate of default on a multiyear basis should we assume on these loans?

And then I'm going back to a question that was very much discussed in the quarter, this 140 bps regulatory headwinds in 2021. This is not new news because it is the same guidance that you gave in Q2. So we've been talking a lot about it, but you basically confirm previous guidance. So the question to you would be, provided that you have a very high MDA buffer, you may not necessarily need to take any action, but is there anything that you can do to mitigate this negative value? And then connected to that, I remember that you also mentioned a 60 bps negative headwind for 2022. And if I remember correctly, around 30 bps for '23. So is this still in place in terms of your guidance or not?

And then the very final question is that you remind us what is the impact on NII from your replicating portfolio in the quarter? And how should we expect this to evolve?

[Jean-Pierre Mustier, executive]

So I mean, I think that the IR team will need to come back to you for some of the details you're requesting because we can't deal with it in too much detail with everybody, but I will try to just comment on a more qualitative basis. I don't know if Tj can have -- can give more detail. Otherwise, we'll let you call the IR team later.

On the state-guaranteed loans, you're absolutely correct. It's NII negative to a large extent as these loans are at a tight spread. But as outlined by Stefano during the presentation, we have seen in Italy, for instance, that the client taking the term loans, state-guaranteed, have been paying back some of their short-term borrowings. And so there has been a substitution effect, which is [ mainly negative ] in the sense that the short-term borrowings were at a spread, which was almost twice higher than the spread of the long-term loans, basically.

So if it could improve the loan loss provision, I would say that -- and that's a qualitative comment I wanted to make. If you had listened to Finance Minister Gualtieri earlier this week, I think, over the weekend, he mentioned that it was likely that the moratoria in Italy will be extended from the end of January to the end of June this year as well as the state guarantee. So we might have more state-guaranteed loan. And clearly, there could be more substitution effect between the bank loan and the state-guaranteed loan, specifically for the sectors, which are the most impacted by COVID-19. And we gave you the breakdown of the sectors of the segmentation for high impact to low impact.

And so if we have more time, basically, some of these clients in the high-impact sector might go for more state-guaranteed loan, which will, in fact, reduce a potential loan loss provision for the bank. So that should be a positive. Difficult to quantify, but I will hand over to Tj, if he can give you a bit more detail on that.

[Thiam Lim, executive]

Yes. On the state guarantee, clearly, the impact -- IR will get back, but our expectation for this year is quite -- not a lot, a few basis points. But clearly, we have assumed in the default rate assumption, this is artificially suppressed. As I said before, in Q2, that it was roughly 3.5%, but is shown in -- our observation is 2.2 sort of percentage artificially suppressed. So we expect that all of this future impact for a cliff effect has really been articulated earlier, and Stefano has mentioned in terms of the overlay, the macro assumption and also the proactive classification.

[Stefano Porro, executive]

Yes. In relation to the replicating portfolio. In the quarter, we had a net benefit contribution to the NII from the replicating portfolio. We have an equity on deposits or EUR 350 million. This is EUR 10 million better than the previous quarter, reason being the dynamic of the rates, so especially floating rates because this is a net benefit. So it's a difference between the fixed rate and the floating rate. In future, especially in '21, we are expecting a lower contribution because they're expecting that default in rates are going to remain the same, while doing the rolling. When we do the rolling, we are going to achieve lower fixed rate. The margin of the effect in 2021 could be ranging between EUR 80 million and EUR 100 million in comparison to the assumption of Team 23. However, such a delta is going to be reduced over time in '22 and '23, following the dynamic of the value invested and the rates. And we are not expecting a significant difference in comparable with the assumption of the contribution in 2023 versus Team 23 plan.

[Jörg Pietzner, executive]

Alberto, we have given the exact details on Page 55. That's the footnote 1 to Page 9. So there you have the replicating portfolio Stefano just mentioned. On the other ones, so the remaining open points on the guarantees, we'll come back to you. And that's a promise, matter of fact.

[Jean-Pierre Mustier, executive]

Just on -- we'll update at the Capital Market Day next year, the regulatory headwinds. But as you said, we're planning in the communication we gave in December last year, more than 60 basis points of reg headwind in '22, 139 in '23. And we will have afterwards -- you have to take into account the mitigating impact of the rating migration, which will be a positive in '22 and '23. We'll give you the detail, whichever, which will mitigate basically the planned regulatory headwind as the rating of the portfolio will improve. And so the procyclicality will play positively starting from '22. But we'll give you that later next year during the Capital Market Day.

[Operator]

The next question is from Jackie Ineke with Morgan Stanley.

[Jacqueline Ineke, analyst]

I have a question from the credit side. First, thank you for your comments about treating stakeholders fairly earlier on. And bondholders certainly appreciated you paying the coupon on the cashes this year. I got a question on these bonds. The EBA recently came out with guidance from aspects of legacy instruments. And at the moment, nearly EUR 3 billion of those cashes have a value of 80% as core equity. But the EBA guidance might suggest that after 2021, the other 20% might have a limited regulatory value. I think even if we take the worst case and assigned 0 value to that 20%, I think the other 80% appears to be still very cost-effective core equity compared to traditional equity.

I was just wondering if the EBA opinion has prompted a review of the cashes? Or if you're now thinking about them differently in any way?

[Jean-Pierre Mustier, executive]

No. We don't think, but then -- definitely, Stefano can comment about it. Just to say that the cashes when the grants and will be considered as Tier 2 for EUR 600 million. And I mean, that's it, basically. And there is no question mark. I repeat, no question mark about the regulatory treatment of the cashes at Tier 2 when the grandfathering ends.

[Jörg Pietzner, executive]

I think the only point for clarification. You mentioned EUR 3 billion, that was the original issued volume. So we're talking now only about the EUR 600 million that has not been converted with the restructuring in 2011 into equity. So there's currently EUR 600 million, grandfathered 81 that [ in some periods ] will turn into Tier 2.

[Jacqueline Ineke, analyst]

Sorry, just in terms of what the EBA gave us an opinion, it would suggest that, that cannot count as Tier 2 after the end of 2021. That was really...

[Jean-Pierre Mustier, executive]

No. But I said, there's no question mark. I cannot comment publicly about the regulatory pressures. But if I'm telling you, there's no question mark, there's no question mark, and all the cashes will be converted into Tier 2. And there is a -- and we've got -- I mean, we are absolutely certain of the regulatory treatment.

[Operator]

The next question is from Ignacio Cerezo with UBS.

[Ignacio Cerezo Olmos, analyst]

A couple of ones for me. One on NII, if you can give us the calendar of maturities with your treasury portfolio in the next couple of years and if possible the [indiscernible] of those loans expiring. And the second one on the capital return. Sorry to come back to that. There's been some chatter around the possibility of a payout cap imposed by regulators. That's something actually reconciled with your conversations with them?

[Jean-Pierre Mustier, executive]

Well, we never comment on rumors and speculation about UniCredit. I will certainly not comment about rumors and speculation about the regulator. The only thing I can say on the last question is that we are highly confident that the ECB will allow banks to return capital to shareholders. It's not an if, it's a when, and we're highly confident that it will happen sometime in 2021.

And so on the NII...

[Stefano Porro, executive]

On the portfolio.

[Jean-Pierre Mustier, executive]

Maturities in the portfolio, I'll Stefano answer.

[Stefano Porro, executive]

Yes. The overall liquidity portfolio is at EUR 136 billion at the end of the quarter. The duration of the portfolio is around 3.5, if we look the overall portfolio. If you look at the Italian component of the portfolio, the exposure is around EUR 43 billion, has a duration of EUR 3.3 billion.

In relation to the maturities of these exposure, so the Italian one are expecting to have maturity around EUR 9 billion in the next year, and another EUR 14 billion in the year 2 and year 3, coherent with the average duration I was highlighting to you that it is a 3.3 year of the overall Italian average portfolio.

[Jean-Pierre Mustier, executive]

And just this Italian portfolio, EUR 43 billion, we have EUR 22 billion in the held to collect basically in the balance in the fair value of CI.

[Operator]

[Operator Instructions]

[Jean-Pierre Mustier, executive]

Okay. Looks like there is no more questions. I would like to thank you very much for your questions. We will meet digitally with many of you in the next few days, but let me summarize some of the key points that we've been mentioning during this presentation.

First, UniCredit is in a very strong position to face the future with confidence. Our management philosophy is very simple. We run the bank with a conservative approach maintaining a tight control of cost and a strict underwriting discipline with a priority to long-term sustainable outcome over short-term solution. So it does in practice that in terms of net interest income, we will not compromise our future asset quality for short-term net interest income [indiscernible]. We, therefore, will not do volume lending, nor will we do carry trade.

In terms of cost, controlling cost is in our DNA. As Stefano pointed out, Team 23 is based on substantial and additional cost-cutting over and above what we successfully delivered in Transform '19, including further reduction of both FTE and branches. Less than a year ago into the plan, we have taken decisive actions on costs and have first been able to improve our cost guidance by a further 2% in financial year '20 and '21. And as a result, we have improved our Team 23 gross cost-cutting reduction target by 25% to EUR 1.25 billion.

In risk, we have a conservative provisioning and a strict underwriting discipline, which are the group trademark. Our cost of risk guidance is based on realistic and not optimistic assumption and we always anticipate future impact. As a consequence, we are not changing our target because of the second wave. Instead, we confirm our financial year '20 stated cost of risk guidance at 100 to 120 basis points, thanks to this anticipation of future impact as well as seasonality next quarter. So this puts us in a very strong position to face the uncertainty created by the second wave. We have an extremely strong capital position, adopting by a record 538 basis points CET1 in the above and a very strong liquidity position with a point in time liquidity coverage ratio of 183%.

We have de-risked our balance sheet, having materially run down our gross NP, sold non-strategic asset and reduced our BTP exposure. As the successful execution of Transform '19 showed, we have confirmed track record of delivering on our commitment to invest, whatever the environment. And we confirm our 2021 underlying net income of EUR 3 billion to EUR 3.5 billion in our 2023 underlying return on tangible equity of 8%. So from this position of strength, we will continue to support the economy and distribute capital to our shareholders. We confirm the reinstatement of our capital distribution policy based on an ordinary distribution of 50% of underlying net profit and a gradual distribution of excess capital when the regulator will give its green light. It will comprise a mixture of cash and share buyback. And we plan to make both ordinary and extraordinary distribution from calendar year 2021 onwards.

This concludes our third quarter results presentation. So I look forward to talking digitally with you all again in 3 months' time, if not before. Stay safe, and thank you very much. Bye-bye then.

[Operator]

Ladies and gentlemen, thank you for joining. The conference is now over. You may disconnect your telephones.