KBC Groep NV

XBRU:KBC

Earnings Call Transcript 2022-Q2

[Operator]

Good day, everyone, and welcome to the KBC Group Earnings Release for the Second Quarter of 2022, hosted by Kurt De Baenst, Head of Investor Relations. My name is Ben, and I'm your event manager. [Operator Instructions] I'd like to advise all parties that this conference is being recorded.

And now I would like to hand it over to your host, Kurt, the word is yours.

[Kurt De Baenst, executive]

Thank you, operator. From my side, a very good morning to all of you from the headquarters of KBC in Brussels, and welcome to the KBC conference call. Today is Thursday, the 11th of August 2022, and we are hosting the conference call on the second quarter results of KBC.

As usual, we have Johan Thijs, Group CEO, with us; as well as the Group CFO, Luc Popelier, and they will both elaborate on the results and add some additional insights. As such, it's my pleasure to give the floor to Johan Thijs, who will quickly run you through the presentation.

[Johan Thijs, executive]

Thank you very much, Kurt. And also from my side, a warm welcome to the announcement of the second quarter results. And as usual, we start with the key takeaways, and that always starts with the final number of the second quarter profit, and that was a very excellent EUR 811 million. As a matter of fact, despite difficult circumstances, we all regret what's happening in Ukraine. The impact of that on the economy and on inflation is becoming quite obvious. But nevertheless, we were able to indeed post an excellent EUR 811 million, which was actually supported by all our activities in all our countries. As a matter of fact our bank insurance machine has been firing on all its cylinders. The customer loans were up significantly. I'll come back to that later on in detail, but I can already say 9% is a stellar performance.

Same can be said about customer deposits, which also grew on a yearly basis by 9%. We were able to have more net inflows on the asset management side despite the fact that, of course, the financial markets had a negative impact on our assets under management. We were able to sell more insurance contracts than originally budgeted because we have a growth of 9%. With an excellent combined ratio, we were able to maintain our costs at a very decent level despite a very high inflation, and we have hardly any impairment charges.

This is indeed also quite extraordinary given the circumstances. No big surprise that our solvency and our liquidity position have even further improved and now stand at a solid 15.9% and a solid margin upon the regulatory requirements of more or less 50 points percent on the liquidity side. On the back of that, we are happy to announce that we are also going to pay out an interim dividend of EUR 1 per share in November of this year. And that also the return on equity of this first half of year, when we spread out the bank taxes over the entire year stands at 15%. Coming back, bank taxes, they have increased further and very significantly, and they are now a whopping 659% (sic) [ EUR 659 million ] for the full year estimate.

Let me also highlight that also on the sustainability front we made further achievements. Actually, as a matter of fact, we have achieved all our targets, which were quite ambitious when we set them a year or 2 ago, but we have achieved the majority of our targets, which were forecasted for 2030 already now, and therefore we will review them in the course of September. Also in that perspective, reviewing targets, we are also updating our financial guidance on all the numbers which we have put forward in the first quarter, given the changed market circumstances, given the uncertainty which is there. I'll come back to that at the very last part of the presentation.

In terms of sustainability, you'll find more details on Page 4. On Page 5, you find the traditional overview of the building blocks, but that's not waste time there. On Page 6, you can find the exceptionals in the second quarter results. And once again, we have a list of exceptionals, which are totaling EUR 32 million negative. This is mainly influenced by the bank taxes in -- the extra bank taxes in Hungary. As you know, the Hungarian government decided to implement what they call a kind of a windfall tax on certain sectors, energy sector was part of them, but also the financial business, including banks and insurance companies was part of that windfall tax, and that will -- that cost in KBC Group EUR 78 million in Hungary.

Now positive one-off was EUR 68 million, which is this -- which is linked to the sale of a real estate subsidiary of KBC Insurance Belgium, and that is totaling EUR 68 million. All the other stuff is mentioned on the page. For the sake of time, I suggest to skip that because there's minorly jumps up and down, and it results ultimately in the EUR 32 million, as I referred to.

If I look at the split up between the bank and insurance activity, then it is a bit better for the insurance company this quarter, of course, influenced by the -- sorry, the taxes, bank taxes in the banking side. The split up is 80-20, which is more or less in line with the 85-15 average long-term average.

Okay. Now the serious stuff, the different P&L lines, we go into net interest income. And the good news is that net interest income once again increased this time with 4% on the quarter, 14% on the year, which is very good. And this is driven by 2 things. First of all, it is driven by, of course, the change in the interest rate environment. We all know what happens in Czech Republic, where the interest was pushed up by Czech -- the deposit rate, sorry, was pushed up by the Czech National Bank to 7% in a very short time period. And also have a similar trend in the Hungarian area where also the national bank has pushed up their interest rate. It contributes obviously positive on the transformation result in these countries, but also in the Eurozone, because of the shift in the interest rate, long-term interest rates, that has had a positive effect on our transformation result, which has increased quarter-on-quarter with EUR 36 million.

In terms of the lending business, we have a very good result on the sales side. We have been able to grow our mortgage book, our commercial book, both on the SME side and on the corporate side in a significant manner, 9% year-on-year, 3% on the quarter. And is an excellent result without any doubt. And also on the mortgage book, 7% growth. It's quite significant. So in that perspective, indeed the sales machine has been doing its utmost in this second quarter. And actually is a reflection of what has happened in the full year up so far.

Also on the deposit side, we were able to increase our positions with 9%, which is also given the fact that interest rates are now shifting, becoming beneficial and no longer detrimental, as you know. And negative interest rates are changing to the positive side. In terms of the net interest margin, net interest margin is increasing. You don't see it at first glance. And this has to do with the fact that in Ireland, which is where we are waiting approval by the Minister of Finance for the sale transactions agree upon with Bank of Ireland. Of course, the book there is shrinking and also the margin is coming down a little bit there. If you would take out Ireland in this comparison in the net interest margin, then the net interest margin would have been 3 basis points higher. So actually, also on the net interest margin, we were able to manage this in a positive manner.

All other things are components which are more or less growing, not necessarily in bigger numbers. So dealing room results, short-term cash management, all that had a positive performance. Our ALM result was -- our net interest income generated through ALM results significantly up, has to do, of course, with amongst others, the transformation result, but also in the inflation-linked bonds which are located in that book -- in that part of the P&L line. So in this perspective, positive elements to mention. This also triggers us to reassess the net interest income guidance, and therefore we also increased and the net interest income guidance for full year 2022 to ballpark EUR 5.05 billion.

In terms of the fee and commission business, next page, the story is actually a bit different. As a matter of fact, we were able to increase our sales, again also in the second quarter, despite the very turbulent financial markets and despite the very difficult circumstances, we were able to create a net inflow of roughly EUR 0.5 billion. That brings actually the total net inflow for the 6 months in this year to EUR 2.2 billion. To just give you an idea and to make a comparison possible, last year, same -- last year, full year, we had a net inflow of EUR 2.4 billion. So in this perspective, positive net inflows. You don't see it in the fee which are generated by asset management business because of the deterioration on our assets under management because of the performance of the financial market. Assets under management, down EUR 17 billion because of that performance, and that obviously reflects itself in the management fees, you know how it works.

In terms of the entry fees, we saw lower entry fees than previous quarter, but that's obviously to do with a record quarter which was noted in the first quarter of this year. All other parts of the fee and commission business, you know that the split up between asset management, banking services, securities businesses, 65 asset management with 35% all the rest. We do see in the financial services business good performance and stronger growth on the traditional business like credit-linked fees, like payment-linked fees. We have a slight decrease on the securities business, EUR 3 million. It's not tremendously high, but it is only to do with the fact that we make a comparison between 2 top quarters, namely second quarter last year and the first quarter this year, which were record quarters in our securities business in Belgium and Czech Republic. And therefore, we do see a 3% -- EUR 3 million decline in the revenues. Just to give you an idea on the securities business, we have 10% more new customers year-to-date compared to the record year 2021.

In terms of assets under management, already mentioned that, that stands at an 8% decline. Going to the insurance business. We have a stellar performance on the insurance business, definitely on the nonlife side. We had a 9% growth year-on-year, which is indeed very strong, is driven by and Belgium, but also, of course, by the Central European countries, Belgium is about 7% growth. Central Europe is more than 10% on average. So it is indeed strong performance. What is also excellent news there is the fact that the combined ratio stands at 85%, which is excellent because, let's remember, we had a windstorm which was very significant, about EUR 90 million payment and reserves for the first quarters are included in that 85%. But despite that windstorm, we're still at a very low level, 85%, which gives you an indication how sound the portfolio and how sound the underwriting policy in KBC Group is. To give you an idea, the combined ratio stands below 90% in all countries, 85% Belgium, 85% Czech Republic, 89% in Slovakia, 90% in Hungary and 79% in Bulgaria.

In the life business side, on Page 13, the situation is a bit different. We see an increase on the interest-guaranteed products, is a slight increase, year-on-year 1% up, always have to take into account seasonal effects. So let's be careful when making any comparison quarter-on-quarter. But what is clear that unit-linked was having a decline of 22% on the quarter, and that is of course, it has to do with the very difficult market circumstances we are currently in, and people then shift in KBC. It obviously doesn't make any difference if you shift from life insurance to investment products where we had the net inflow. So customers buy their products and take into account the circumstances and the availability of products at hand.

On Page 14, you have the comparison of the financial instruments fair value over the different quarters. At first glance, you would say there is a significant drop. This is fully related to the dealing room activities. As a matter of fact, the dealing rooms had a good performance with EUR 34 million profit, which is perfectly in line with normal quarters over the last couple of years. The comparison quarter-on-quarter is distorted by the fact that in quarter 1 of this year the dealing rooms had an extremely good result. And therefore, that is a difference of roughly EUR 80 million.

In terms of all the other building blocks, so equity, we realized less equity than in previous quarter, which was a voluntary choice, by the way. And in terms of our mark-to-market of our ALM derivatives, this is of course positively be influenced because of the increasing euro rates. We had a significant increase of EUR 50 million. XVAs, which stands for the funding value, just count of party value adjustment, the market value adjustment situation is pretty stable. Net other income is in principle pretty normal, but is heavily distorted by the one-off I already referred to, the EUR 68 million of realized gains on the real estate subsidiary of KBC Insurance which we more or less offset it by a sale of bonds where we use the momentum of cutting the losses and investing those proceeds in higher-yielding bonds going forward. So it's actually good for the nearby future.

In terms of -- on the OpEx side, well, the situation, cut the long story short, 47%, excluding all bank taxes. Cost/income ratio is better than what we budgeted for, significantly better than we budgeted for. This is due to the fact that we are able to maintain our cost at a very low level. If you exclude the bank taxes, if you exclude the one-offs, amongst others, mainly influenced by Ireland and so the pending sales, if you would exclude those, the cost increase is 5% year-on-year and only 3% on the quarter. This is obviously heavily influenced by inflation, which, as you know, is 8.9% in Belgium and more than 10% in the Central European countries, roughly 15% to 17% in Czech Republic and in Hungary. So with an increase of 5%, this is pretty low compared to that, and that is due to the fact that we were able to decrease our FTEs in the second quarter again.

So cost income ratio is 53%, if you spread out all the bank taxes across the year in a uniform manner, and also that is substantially better than what it was last year. Remember, '21 was still a year which was, in terms of profit and expenses, positively influenced by COVID.

Going forward, of course inflation will further kick in. We are of the belief that inflation is not going to undergo to normal levels in -- for sure not this year, and also next year probably is pretty high. So in that perspective, we expect that our costs will further increase, will go beyond the guidance which we gave. And costs will therefore go from EUR 4 billion guided earlier to EUR 4.15 billion going forward. Now as a matter of fact, cost increases are lower than the income increases. And as a consequence, the costs, the jaws are reviewed as well. We have now a jaw of 4% going forward for the year 2022.

In terms of the bank taxes, already mentioned that they increased as well. So we are estimating a EUR 659 million bank tax for full year 2022, and that is more or less 14% of our total OpEx, and that is indeed a lot of money. Going into the credit impairments. As a matter of fact, we had no credit impairments. We had EUR 1 million to be precise of credit impairments. We had EUR 13 million, which is related to the pending sales in Ireland, and we had to review according to the sales transactions and the current stance of that sales transaction. As you know, we received the approval of the antitrust authorities of CCPC of Ireland on that sale. And therefore we reviewed a couple of things and that brought in certain impairments, an accounting impairment of EUR 13 million. But the real underlying impairments net were only EUR 1 million for the entire book. So in essence, we do have for the year-to-date release of impairments, and that means that the credit loss ratio stands at minus 0.1%. That's one thing.

The other thing is also that we have -- as we have no impairments, we don't have impairments which are related to COVID. We still had a covered buffer, which is released in the quarter, EUR 55 million, but we use that buffer to further assess our book and take into account potential negative impact of the Ukraine crisis combining with all its additional impacts like inflation, like energy prices going through the roof and so on and so forth and therefore a potential negative impact on our lending book. That impact was analyzed further. We have all that detail on the pages following, and that is coming to a EUR 50 million -- EUR 50 million increase of our buffer for emerging and geographical risks, which now stands at EUR 268 million.

For good understanding, I repeat it again, this buffer is not used whatsoever. As a matter of fact, we got some recoveries from earlier positioned buffers. We have recoveries on 2 assets which were called direct exposure. We had a buffer put in there, or provision put in there of EUR 50 million. We recovered EUR 20 million because of the current situation. So as a matter of fact, in total, no impairments buffer for emerging risk, EUR 268 million, and our impaired loan loss ratio now stands at 2.2%.

In terms of Page 18, where you can see how it worked with the covet buffer and the buffer for emerging risks. The detail is there explained. On Page 19 you see the full detail where you do see that indeed it is built up taking into account several elements. For good understanding I repeat this again, we don't take into account only risks which are generated by, for instance, disruption of gas or oil or disruption because of business activities, which are linked to Ukraine and Russia, but we also take into account impact because of the change of economic circumstances, high inflation and so forth on our book.

We have there now an outstanding exposure of EUR 6.3 billion. So we increased that up from EUR 5.9 billion. And the total charge we set aside for that emerging risk on those portfolios, which I repeat are not directly related to the Russian and Ukraine business is EUR 168 million. We also changed our macroeconomic scenarios and that macroeconomic scenario is expressed in the column or in the line E which added an additional EUR 32 million in the second quarter. For good understanding, this was an assessment made by the end of quarter 2. We are reviewing that again because since end of June, the world has changed again and the world has not changed for the positive. So we will review that probability 65%, 35% downwards more to the negative than what it is here. So probably we'll go to 55%, 44% and 1% for the positive scenario.

EUR 268 million estimate for the total buffer at the end of second quarter. And we also confirm the guidance for the credit cost ratio, which was set to be somewhere in between 10 and 25 basis points. Yes, indeed you could say that given where we are today at minus 1 basis point is pretty conservative, but we consider this to be an expression of further deterioration of the economic situation and therefore a conservative stance going forward. So if you take into account the scenarios of the economic forecast, which we predict that is, we will go in -- we are in a fundamental slowdown of our economic growth, we have a high inflation.

The base scenario which we use is a scenario whereby the European institutions are able to potential gas cuts, full gas cuts of the Russians to mitigate those to the level that we don't have an energy deficit. So it will be a kind of a speculation scenario. If you take that into account, we do estimate that there is a negative impact on our lending book, and that negative impact is then buffered with 10 to 25 basis points of guidance. In a no-recession scenario, we will be, for sure, at the short end of the range, so close to 10 bps. If we go into a recession for 2022, we are 100% confident that given the EUR 268 million buffer on top, we are very confident that we will not overshoot the 25 basis points end-of-range target for 2022.

All the other pages which are following, 20, 21 are indicating further detail, but I will skip those. If any questions, obviously, we will answer them happily. And on all the other countries, Belgium and so on, the detail is further in the next following pages, but let me skip immediately to Page 42, where you actually see the summary of all those countries. You see that all countries have been contributing and they have ROACs which go beyond 20%, the national market business unit, is therefore negatively influenced by the EUR 78 million of taxes in Hungary otherwise that would have reached easily that target as well.

In terms of our balance sheet, Page 43, you see the growth levels and there indeed also all growth levels exceeds the original guidance which we have given. So we gave a guidance of 45% on the growth side. We are now increasing. We are now having 9% on average. We are changing our guidance to 7% in that area. And therefore, that has also a positive impact of course on the guidance of our net interest income, which I was referring to earlier.

Let me go into capital now on Page 45. You can see the evolution of our capital position. We are at 15.9%, which is substantially higher than the MDA and the OCR. So we have a very sufficient -- we have a very interesting buffer compared to the OCR. Let me also highlight again that this 15.9% is positively influenced by the fact that the Belgian National Bank has decided that the one-off which was added for mortgage loans is cut and has been replaced by an increase of the requirements in the OCR of 33 basis points. So we have a drop of the risk-weighted assets with EUR 3.3 billion, and that is replaced by an increase of the systemic buffer of 33 bps in -- which is part of the OCR. Also, we have some changes in the OCR because of countercyclical buffers in Slovakia and in Hungary. That is 10 bps. So we are substantially above the target with 50.9% and then also giving the profitability allows us to say that we give -- we are announcing an interim dividend of EUR 1.

The detail of the capital ratio, how it is built up, you can see on Page 47. And on Page 48 you see the leverage ratios of KBC, which stands solid at 51% -- not at 51%, that would be a lot, at 5.1%, part of the thresholds which are indicated by the supervisors. The insurance company has a solvency ratio of 242%. That is significantly up compared to previous quarter. And that is obviously to do with the fact that higher interest rates play a role. Also the increasing corporate spreads and the lower equity markets have an impact. At first instance, you would say that must have a negative impact for sure, but that is obviously in the Solvency II methodology compensated by the symmetric adjustment factor and the volatility adjustment ratio. So both have a positive effect on this result. And therefore it stands at a solid 242%.

In terms of liquidity, also there, a further improvement of our positions. We are at 142% and 158% respectively in the long term and the short term. So rock solid 70% of that is customer-driven. And in that perspective also we have a TLTRO which is still part of that liquidity ratio, EUR 24 billion.

Let me end with 2 things. First of all, the wrap up. I'm not going to develop on the numbers you already know, but I just want to highlight one thing that is Kate was launched 1.5 years ago, and Kate is now rolled out in all our countries. We launched at the end of July in Hungary, which was the last country to catch up. So now it's officially launched in all countries. And what we see in the 2 countries where it was launched first, Belgium and Czech Republic, it goes much faster than we anticipated. We have 2.1 million users of Kate, which have been interacting with Kate at 11 million times.

And why is the number here different on the slide? That is because the -- these interactions are interactions straight through until the end of the issue which they asked to Kate. 7.7 million interactions, which means that we are interacting with our customers in a more and more Kate way. What is also fundamentally is that the autonomy of Kate, which means Kate can answer and give a solution to the customer without any kind of help of a human being in KBC Group that, that autonomy is rising. Currently it stands at 50% in Belgium, and it stands at 45% in Czech Republic as we speak. So it means that 1 out of 2 questions can be answered by Kate, can be solved by Kate, which means that the NPS by our customer is increasing and is becoming extremely positive.

In that perspective also, I would like to highlight that Kate has been also launching a digital coin. It's called obviously the Kate Coin, it's blockchain-based and it is launched and tested already in Belgium, and it will be set -- will be launched to our customers in September, October. By the way, for those who, say, listen, on the slide you have an autonomy of 40% in Czech Republic, that was end of second quarter. In the meanwhile, it's 45%, which I mentioned.

So looking forward, well, the economy is going to shift massively. It's having the impact on what's happening in Ukraine. We already know the impact on inflation. We do see a slowdown indeed in the growth levels. Our forecast is that number-wise we will be not in a recession yet by year-end, 0.4% growth in European level, which intrinsically means if you cut out the spillover effects, that you are having a negative growth in quarter 3 and quarter 4. That's one thing. The other thing is that interest rates grew further take into account the high inflation. We do not believe that the national banks will get inflation under control by year-end, and we do not believe that inflation will be at the expected levels of 2% in 2023 either.

And as a consequence, central banks are going to use interest rates to put more control on that inflation to bring it down. I think this is a narrative which is in the meanwhile accepted by most central banks, including the ECB, and therefore, we expect interest rates to go up in the next coming period. And the expectation is that they should go to what is called a neutral interest rate that is inflation of 2% plus 0.5% real interest rate. So in total, ultimately, they should go to 2.5%. The question is by when, and the question is by how many rate hikes. So the expectation is that the 2.5% will only be reached in the course of '23, '24.

And the short term -- so the deposit rate will go up by year-end to the tune of EUR 125 million, EUR 150 million. That is taken into account in all our guidance, which I already spoke about. I want just to mention one extra thing. We are guiding the total income for the full year 2022 as well. That is EUR 8.4 billion now. That compares to EUR 8 billion, if you do comparison like-for-like. Be aware that in the previous guidance which we have given Ireland was included. So the deal transaction was included as well. Given the fact that we're still awaiting the approval of the Ministry of Finance in Ireland, we do not expect this to happen this year anymore, the closing, and therefore it's shifted to 2023. The EUR 8.2 billion guidance included EUR 0.2 billion. Therefore, the guidance has brought down like-for-like from EUR 8 billion taking into account what I just said on the economic evolution to EUR 8.4 billion ballpark going forward.

All the assumptions which we have used in those guidances, all of the net interest income, total income OpEx and the credit cost ratio are mentioned on Page 53 in the footnotes and are part of that guidance. Also on the long-term guidance, we also reviewed that one. And the most important thing there is to mention that we do expect the jaws to be at 4% rather than on the earlier guided 3%. So also there a slight positive impact. We do have reviewed our interest sensitivity that now stands at first year 7%, second year 14%, and the third year 17%.

I would like to keep it there. I think that's it. And I hand over the floor to Kurt who will guide us through your questions.

[Kurt De Baenst, executive]

Thank you, Johan. We will open the floor now for questions. Please restrict the number of questions to 2 to allow for a maximum number of people to raise questions. Thank you.

[Operator]

[Operator Instructions] And our first question is coming from Tarik El Mejjad from BofA.

[Tarik El Mejjad, analyst]

2 questions, please. I mean the first obvious one, I would say, is your -- and this is your latest comment, is your assumptions for, rate assumptions for your new guidance, especially on the NII. I mean you -- it sounds to me quite punchy especially for 2023 as because you seem to have a high conviction that inflation will continue to be very high and ECB has to act through much higher rates than -- but this is actually much higher than the forward rates and what most economists expect especially for '23. So maybe you can, I mean, tell us why you've been so optimistic there, especially we are used to you being generally quite conservative? And maybe you can shed the light on what would be your jaws or your NII, your revenue, sorry, CAGR, if we assume rates going to 1.5%, and that will be like the neutral level. And then the second question is on the assumptions on volume growth. You -- when you look at your -- for 2022, you expect a 7% growth, given what you achieved in the first half. So naturally expect some slowdown in second half this year. What about 2023, what kind of volume growth you're assuming?

[Luc Popelier, executive]

Yes, an obvious question, many thanks. Luc here. Obvious question, the assumptions that we've taken in our forecasts, I think the most important ones are the euro yields. And for the short term, the ECB deposit rate. We've taken an assumption that the ECB deposit rate would still increase quite strongly given the fact that the inflation is still very high in Europe and the inflation is driven by a supply shock, not by demand pool. Therefore, we believe that by the end of the year the ECB rate will be about 1.25% to 1.5%. ECB deposit rates.

On the longer term, we will be around by the end of the year, we believe, given that the short-term rates will go up, but also the long term will further improve, to around 2.5 or a bit higher perhaps. These are the most important ones. If we then look at the Czech deposit rates, we assume there will still be another hike of 50 basis points, somewhere in September. And then it will stay at that level for the full year. And in '23, '24, it will come down again gradually. For the Czech Republic, the long-term rates will be more or less around these levels, a bit above 4% and stay at way around above 4% in '23, but then coming down slightly the next years. I think it's the most important ones. You take the second question, Johan? Okay.

[Johan Thijs, executive]

So Tarik, thank you for your second question. So on the loan growth. So first of all, I mean actually your question was loan growth in 2023. But I mean, you know that we don't predict now or don't give the numbers now for loan growth of next year or for any other detailed number for next year, we will do that as always at the beginning of the year with a bit of detail, which you are used of us. But let me give a comment on the expectation for the second quarter, the 2 quarters to come, sorry. So yes, indeed, we do have a 9% growth of loans in the first half this year. We bring down the guidance to 7%. The reason why, it is obvious, that is we do see the fundamental slowdown of the economy. As I said, we predict at the European level a growth of 0.4%, which is a bit different for Belgium and the Central European countries. And Belgium is forecasted at 0.3%, which is de facto, actually a recession because you know how it works, how it is calculated. You always have a spillover effect of the previous quarter.

And Czech Republic and other Central European countries is 1.5% full year, and all the other countries are around 2.2%. So it is indeed a slowdown. Now the fact is that the third quarter, obviously the production in the third quarter obviously is already realized. Let me give you an example. When you look at the Belgian situation, mortgages are having a throughput time because of legal requirements of 3 months. So the production of the third quarter is already produced. That will no longer suffer from further deterioration of the economic growth. We only start to see that in the first -- in the fourth quarter and then obviously in the first quarter next year. So that will be reflected in the numbers of 2023 for sure. And the same can be said about the credits on the SME and on the corporate side. You have already a big chunk of what this produces already invested, and therefore is a given. We will see the slowdown in quarter 4 and for sure in quarter 1 and quarter 2 next year. So that's the reason why we went down from 97%, and that's what we are going to see further going down in 2023.

[Luc Popelier, executive]

Maybe just as additional information, the 9% that Johan is referring to is the year-on-year growth. It does not mean that there is a deceleration, that there is a negative growth in the second quarter. If you look year-to-date, the growth is 6%. We think there will be an additional 1% growth for the full year, so it will go to 7% coming from 6% year-to-date. So you cannot compare the 7% Johan mentioned with the 9% year-on-year number, just additional information.

[Operator]

Our second question comes from Giulia Miotto from Morgan Stanley.

[Giulia Miotto, analyst]

My first question is on costs. So if I take the 3% CAGR, and then I compare 2024 excluding bank taxes with what consensus has for 2022, it looks like the increase in costs is only EUR 160 million, more or less, which would be a 2% CAGR from 2022. And I was wondering, given your comments on inflation, how can you keep costs growth so low? And then perhaps another question was related on costs around bank taxes. And what do you expect there? Some of your peers seem to suggest that we could have bank taxes everywhere in CE pretty much. There is a very lively debate in Czech Republic. Yes, what is your sense there? Thank you.

[Luc Popelier, executive]

So on the cost side, I'll take that question. First of all, our guidance is excluding bank tax. So that's an important element. And secondly, for 2022, you're talking about 2022, I believe. The costs -- yes. Okay. There we think that the -- well, first of all, the inflation impact in this year will not be much greater than what was included already in our guidance back in February. The reason is, I mentioned before that in the SG&A costs, the -- most of the contracts we have are fixed. So we have to, of course have vendors who are trying to get -- to increase their prices, but most of them are fixed costs. Then look at salary levels in Central and Eastern Europe, there is normally an annual negotiation around increase in wages.

Of course there will be some further discussions with unions. But given that we're already 6 months in the year or maybe actually almost 8 months in the year, the effect of any discussions would be limited for this year. The only important factor of course is the increased inflation on salaries that we have in Belgium. And that is an important factor because automatic salaries are automatically indexed. That increase will be absorbed by further savings or to a large extent absorbed by further savings identified in the organization, both in numbers of FTE but also a number of other savings in the SG&A. As an example, travel expenses, we've been able to keep it at less than half of the budget. So that is -- these are the main explanations.

[Giulia Miotto, analyst]

But, sorry, can I just follow up on costs. What I meant is that the CAGR that you're giving, the 2%, starts from '21. But if you take what -- the implied cost for '24 is and you compare it to '22, then the reminder, between '22 and '24, the increase seems very small considering that, as you mentioned, inflation implies it to stay quite high. So I'm just asking how the years, what offsetting factors do you see? I'm sorry if I…

[Luc Popelier, executive]

Yes, for that guidance, you should make sure -- yes, I should exclude Ireland in '21 because Ireland was in for the full year. That's about EUR 200 million of costs that Ireland has. That of course is no longer there in 2024. On the other hand, of course we have [ Raizen ], which we included as of this year, will also be there in '24. But the cost base of Raizen is half of that of Ireland. So that's one important correction that should be made to look at the underlying elements. And then the rest is explained by already the factors I mentioned before on the savings that we identified. And yes, the reduction of FTEs that we see going forward as we've been doing the last few years.

[Johan Thijs, executive]

And then going back to -- Hi, Giulia, going back to your last question regarding taxes and bank taxes. So yes, indeed you said like everywhere in the Central Europe, there are conversations in some other countries, but it is not yet the case. And then you're specifically referring to Czech Republic. Yes, indeed in most countries where we are present, we already have bank taxes and the only exception until further notice is Czech Republic. You are right. There are conversations ongoing. There is a discussion ongoing between the authorities and the banking sector in Czech Republic. It's far too early to conclude that there will be bank taxes. I think that's an early shot because the discussions are ongoing.

As a matter of fact, yesterday evening there was a discussion. And earlier this week there was an other discussion with the bank sector and the authorities. What is clearly true is 2 things. First of all, the Czech authorities really understand that they need to have a strong banking sector to underpin their economic growth and to underpin the stability of their country. That is for sure. And that is also well-appreciated. And the second thing is, that is what we need to understand is of course that the budgetary deficit in the Czech Republic is given as well, and they currently don't have bank taxes. But are you going to combine the 2, then you do not necessarily come to a solution where there are bank taxes.

You can have also alternatives. One of those alternatives is, which is currently being discussed, is how we can integrate the banks more in the, for instance, the financing of the public spending of government, for instance, in infrastructure, and I can give other example if you want to. So that debate is currently ongoing. And what is for sure, I think that's a guarantee, that is the banking sector will be interfering in that funding in one way or the other, which is requested by the Czech government. If it will be bank taxes, we'll see soon. If it will be something else, then it will be something, for instance, which is I don't remember of if you -- I don't know if you remember the nationally -- the national, what's the name again?

The National Development Fund, which was a setup where also banks were interfering in financing. This can be done in another way where you use instead of funding capital and so on and so forth. Those ideas currently are on the table. And I think it's too early days to make a bold statement about taxes as a given or taxes as not a given. So in the next coming weeks will be continued. I think the deadline is within 3 weeks.

[Operator]

Our next question comes from Johan Ekblom from UBS.

[Johan Ekblom, analyst]

Can we come back a little bit to the interest rate assumptions? Because I'm trying to pick up on what Tarik said before that we've been used to you being very conservative. And when the market was pricing in very material hikes in the Czech Republic, you were always presenting a picture that was based on much more modest hikes? And now we kind of ended up in the opposite situation where you're talking about 75 to 100 basis points more hike than the market is pricing in for the Eurozone. What has driven this, I guess, very different view on the inflationary pressure and incorporating this in your guidance. And I just want to also maybe tie it in with Julia's question. Is that consistent with the kind of 2% cost CAGR for the next 2 years if inflation really is sticky enough to force the ECB to go to 2.5% plus by next year?

[Johan Thijs, executive]

So thanks, Johan, for your question. Indeed, we mostly the time are indeed conservative on our assumptions and mostly of the time are also -- as a consequence modest in our predictions. We were indeed, when we were giving the original guidance extremely careful. We did not take into account any rate hikes in the eurozone which is indeed very conservative. Now what has made the change? First of all, inflation is much higher than what was originally the case when we were giving the guidance, much higher. And then also the lessons learned in Czech Republic are quite straightforward. I come back to what Luc just said a second ago, mind you, this inflation is not a demand-driven inflation. This is a supply-driven inflation. And that makes also things different. It's also not true that this inflation is purely linked to only energy prices. It is a combination of what is called core and noncore inflation.

So that is quite important to understand. Now the return of national banks or central banks have changed fundamentally since we gave the first guidance. That is, we want -- originally, they were saying we are not convinced that the guidance is -- that inflation is sustainable. And therefore we actually wait what we're going to do. The fact was, in that perspective, more assertive than what we have seen on the European continent, and there were 2 exceptions, and that was Czech Republic and Hungary. What we have learned in those 2 countries is that the rate hikes which were taken and which were quite substantial, have not led to a decrease of inflation on the contrary. But still, the national banks or the central banks, in this case, have continued the further rate hike. Now the rhetoric of the European Central Bank, and in that perspective, we make indeed or we at least try to perceive what they are saying, is changing and said we want to tailor the inflation.

Therefore they made the first rate hike. Now if you combine the 2 things, then it's quite clear that if the Central Bank is serious, European Central Bank is serious about they say, they said, listen, we want to return to a normal inflation, which is 2%. Therefore we will adjust -- we will use the instrument of interest rates. They have to continue to a level which is now depicted by us. And for that reason, we have increased the assumptions on interest rates short term to 125, 150. And also as a consequence, the interest rates on the longer term are increasing as well. So it's actually a combination of the 2. If the European authorities leave that position.

So if the European Center Bank leaves that position and do not return to a normal, let's say a normal policy, that is 2% inflation and a real interest rate of 50 basis points, which in the combination is 250, if they leave that position and they let inflation go, let it lose because I don't know -- I mean, the traditional economic solutions for curtailing a high inflation is interest rate increase. If they leave that philosophy, then of course our assumption is too aggressive. But if not, then it's perfectly in line with what is said by the European Central Bank and by the other central banks in Europe. That's also the reason why we think that the Central Bank of Czech Republic is going to further hike 50 bps in the course of September, probably towards the end of September because inflation is still rising. Despite 7% short-term interest rate, it is now at 15%.

[Johan Ekblom, analyst]

But maybe just to follow up then on the inflation. So what inflation should we think of as an input into the automatic wage increases in Belgium, right? We're looking at Central and Eastern Europe, double-digit wage inflation, and it sounds like Belgium should be mid-single digits for the next 12 to 18 months then in terms of the lags of that getting priced in, which makes it even harder to see the kind of 2% CAGR, '22 to '24 cost being -- that implies very, very substantial cost savings, right?

[Johan Thijs, executive]

Let me answer your question. You're right, and there is a fundamental difference between Central Europe and between Belgium, namely Belgium, you have an automatic indexation of your wages. Correct. We do expect inflation to be roughly around 4% in the year to come. And that will be automatically put into the wages. That's correct. But the reference you made to Center Europe. Indeed you refer to double-digit wage increases. This is perhaps true for the Central European market, but this is not true for KBC Group at all. So we have been able to manage our wage increases in such a way.

And that's one of the reasons why the earlier question asked by Julian, how come your cost is not increasing according to the inflation. That's one of the reasons. We do have the savings. By the way, this is amongst others triggered by the increased productivity which is generated through Kate and the way of using AI applications. So the investments start indeed to pay off, but also because of the fact that we are able to manage the wage inflation down compared to the double digits you were referring to, and down is a significant down. So in that perspective, indeed there is inflation, but it is not correct to state that in Central Europe we have a double-digit wage inflation in our group.

[Operator]

The following question comes from Benoit Petrarque from Kepler Cheuvreux.

[Benoit Petrarque, analyst]

Yes. So I'd like to shift a bit the discussion away of this 2024 level and maybe look into 2023 and the more immediate sensitivity to eurozone rates. I think you provide plus 7%, plus 12%, plus 17%, your 1-year, 2-year, 3, 400 bps. I just wanted to reconfirm with you that it is netted of TLTRO tiering exiting negative charging and also addressing the margin flow. Because if I do the math, that could be actually a plus 25% NII sensitivity 400 bps, which if I plug that on the NII, the eurozone NII will leave -- well, will bring me to roughly EUR 700 million for 400 bps.

So just speaking about just -- talking about 100 bps interest rate hike, I mean we got already 50. Is that fair to assume that in the kind of next couple of years these 100 bps interest rates, higher interest rates will result into roughly EUR 700 million additional NII, will be useful to get a bit of sensitivity on that. Second question is on costs. Yes, sorry to come back on that, but if -- so if I do the math, I think you expect EUR 4.25 billion of costs in 2024. You've got EUR 4.15 billion in 2022. You've got this EUR 200 million of M&A effects. So it's a delta of EUR 300 million for 2022-2024. So that's roughly plus 3.5% cost growth in 2023-2024. Is that broadly what you have in your assumptions? Is that the kind of expected cost inflation you have in mind. And I think you were talking about Belgium at 4%, see a bit higher. So it means that there will be a bit of cost savings around that figure. So that's the second question. And just maybe finally, I see a Solvency II ratio on the insurance at 240% end of Q2, up massively. And I just wanted to ask a question on potential dividends upstream from KBC Insurance.

[Luc Popelier, executive]

Benoit, the questions you asked are very detailed, to be honest. And going through that will require a lot of explanation, but the only thing I can confirm is the sensitivity, the 1% -- the 1% parallel shift for the group as a whole will be 7% on the NII of 2022, yes. And we should remember 2022. And you can look at our guidance for the group as a whole. So that means that for year 1, if you take it from here onwards, you take 1 year going forward, that's EUR 330 million, approximately extra. And of course the next year, because of replication of the portfolio, it will be increasing to 17% by year 3, which is almost EUR 900 million. But for the rest, what exactly will be in '23 and so on, that's quite detailed.

We can have an off-line discussion on how the mechanics work. But I don't think this is the purpose of this call at the moment. On the cost growth, it's also, yes, very detailed that you want, and we don't give any guidance, as you know, for '23. We've given the guidance for everyone for 2022 and '24. But I can always stress what Johan was saying, that we do see a relatively high inflation also continuing in '23, but we have significant productivity improvement projects within the group, which will reduce the cost. And if you then look at what the cost growth will be for '24, adjusting for the fact that Ireland will be out and Raiffeisen Bulgaria will be in, you can see what the actually the productivity gain is against inflation. It's actually quite easy to calculate over that period. But exactly for '23 versus '24, we don't give that detail.

[Johan Thijs, executive]

And Benoit, good morning also from my side. And then coming back to your question on the solvency position of the insurance company, indeed it's with 242% quite high. What about the dividend and going forward. So that's in principle the same as we always do. The insurance company will stream up 100% of its profit to the group. As always, and definitely with the combined -- sorry, with the Solvency II ratio of 242%, there is no issue whatsoever to be expected from the regulatory side. By the way, we didn't get any questions from the regulatory side, neither on our dividend upstreams in the last 2 years. So full upstreaming to the group.

[Operator]

The next question comes from Kiri Vijayarajah from HSBC.

[Kirishanthan Vijayarajah, analyst]

Just a couple of questions on my side. So firstly, with the elimination of that mortgage risk weight add-on in Belgium, I just wonder, does that have any impact on mortgage pricing in Belgium. It looks like spreads are already under pressure year-to-date, but is there more to come through in the second half with capital requirements on writing Belgium mortgages is now more generous. And then on the loan impairments, you've given guidance, upper end of the 25 bps if there is a recession and that applies to 2022. And obviously that comes after a very benign first half outcome. But my question is more, can you keep to within 25 bps in 2023 in that same kind of adverse recessionary scenario you talked about earlier?

[Johan Thijs, executive]

Hi, Kiri, let me answer your first question. So the impact was indeed minus EUR 3.3 billion on the risk-weighted -- the impact of the decision of the Belgium National Bank to get away of the add-on on the mortgages has an impact of minus EUR 3.3 billion on the risk-weighted assets, fully correct. And then they replaced that with an increase of the buffer of, the OC buffer. So the systemic buffer of 33 bps. So that's the mechanics. For them, it's a kind shifted from one pocket to the other, but that's not how it works. I do agree with you. And because you put it into the capital requirements in a requirement as a buffer, in principle you should put that into your pricing. I fully agree with you. How it will be in practice, we'll see. It is indeed well-spotted that the Belgian market is very competitive and that the margins have been coming down in general in the market and also with us to what it is today. So it is competitive pressure. There is a declining margin and with what they decided now in principle you should price that through.

We will do, as always, we try to optimize our margin. So that is indeed looking for a higher margin is the red line in the way how we deal with our business, but we will not push up the margin at further dispense of market share. For good understanding, KBC has been increasing market share in the mortgage business to more than 21% in the first year half. So in that perspective, we have been having a good trajectory. On the guidance of the loan impairments, so let me repeat what I said earlier. So we do have, as we speak, a buffer of EUR 268 million. Let me now do the math a bit differently. We have -- let me round the numbers. We have roughly EUR 200 billion of credit portfolio, 10 basis points, low end of the range, 25 high end of the range means EUR 200 million low-end, and EUR 500 million low-end guidance for this year, full year.

So it means that intrinsically, we can absorb if we use all between roughly EUR 470 million and EUR 770 million for this year. So this includes a very adverse scenario. If we do the numbers, if we do our assessment and we stress our numbers, we will be actually even in a stress scenario around 15 bps. So it really needs to go really sour this year to get at that high end of the range reached. Now your question was about what happens in 2023 when we go into an adverse scenario. Kiri, we gave guidance on 2023 always at the beginning of the year. I can only indicate that if it really goes sour, we will not use the entire 25 bps, which we have today and the full buffer which we have today, yes. So it probably will shift into 2023. But what it precisely will be? I give a very clear idea about what I expect this to be for 2022, 15 bps. If you want to have that number, you have to wait a couple of quarters. We will give that in the beginning of next year.

[Operator]

Moving on to Anke Reingen.

[Anke Reingen, analyst]

The first one is just you were suggesting that you think the environment has been deteriorating a bit, which might lead to you visiting the shifting in your expected credit loss assumptions. But I also want, just confirming that this more conservative view is also already being taken into account in your revenue guidance. And then just secondly on your client behavior. As you said, you have a number of products like deposits, insurance, mutual funds. If you can talk a bit about, do you see more clients shifting into deposits given the not-so supportive markets? And I know you said you're not going to talk about the assumptions on your interest rate sensitivity. But if you can maybe give an indication of your assumption on the deposit beta, that will be welcome.

[Johan Thijs, executive]

Anke, I'm sorry, we had a very bad line. And we understood your second question, and I will take that answer for sure, but can you repeat briefly your first question because we -- none of us could understand what you just said.

[Anke Reingen, analyst]

No problem. When you talked about the expected credit loss and how you do the percentages or the weighting of the different pessimistic optimistic scenario, you suggested that you might shift that more towards a conservative view given recent developments. And I was wondering if you have taken, just confirming that more conservative view has already informed your revenue guidance for 2022 as well. But just to make sure that it's consistent. I hope that came clear.

[Johan Thijs, executive]

Okay. Now it's everything clear. So first of all, the -- so numbers which are on Slide 53 on the credit cost ratio and that guidance that -- and also on the slide where we have the buildup of the EUR 268 million, that was at the end of second quarter, and that is still the old scenario. Now if we shift to the new scenario, which is 55% positive 44% negative and 1% -- sorry, 55% base, 44% negative and 1% positive. Why 1% positive, because of accounting rules, we have to have 3 scenarios. We actually don't believe in a positive scenario anymore, but that's something else. Then this goes up. But that goes up and is still within the guidance of the 10, 25 bps. So it is what -- I just come back to the question I answered, Kiri's question I answered the second ago. That still holds in that scenario because that has been taken into account when we set the guidance at 10, 25 bps.

So if there is no real issue then the 10 25 range will be low end if everything goes well, being speculation, if you go into a recession, then we move up to the higher end of the range then, 25 bps. That has been taken into account, and that includes as well the change of the probabilities of the different scenarios. Now has had an impact on our revenues. The guidance which we have given in net interest income and in total income takes into account the economic circumstances as we have depicted on Page 53. So therefore we indeed include there what was set on the probabilities of the scenarios as well. Coming back on your second question on client behavior, do we see a change of client behavior? Well, the answer is yes and no at the same time. Let me explain what that means.

First of all, if you compare the client behavior in terms of investment products and then the usage of saving accounts versus investment products, then I mean let's be aware we have never had a better quarter than quarter 1 in that perspective of investment products. So it was literally top quarter. So every comparison made for the first quarter is a change of behavior. Okay. This is on the basis of numbers. Now on basis of behavior without looking at the numbers, there is a slowdown indeed in the shift to investment products. For good understanding, we had net inflows in the second quarter as well. And the net inflow is 1/3 of what it was in the first quarter, just to express how extremely good the first quarter was. The expectation going forward, that is if the situation on the financial market keeps as volatile as it will be if we go into the scenario whereby the Russian authorities decided to put a full cut on the gas supply to Europe. And therefore Europe -- and Europe is not able to manage that energy cut in an appropriate way.

So we will have an energy deficit that will have a negative impact on the behavior of our customers. There is no doubt that this will be the case. And for that reason, we do not, we do not guide. We don't -- we never give guidance on fee and commission, as you know. But we do not guide to multiply the first half year by 2 for getting the numbers of the second year half. There's no way an option. We do see that slowdown already happening. Do we shift -- do you see more shift towards deposits? The answer is no. We do not see that happening. What we do see is that we have a lot of inflow from other institutions.

And for that reason, deposits increased with 9%, but we do not see more shift from investment products, for instance, to saving accounts. What we do see is a shift, of course, within the products, and that is true for Central European countries. So from traditional saving deposits, more to term deposits, that is indeed giving high interest rates and the pass-through to our customers in Central European countries. But in Europe, the eurozone, we don't see this yet. If the interest rates are going to increase on the saving deposits, then things might change, but at this instance we don't see it.

[Operator]

Our next question comes from Andreas Scheriau.

[Andreas Scheriau, analyst]

I want to come back to the rate assumptions, and apologies in case I missed the answer to this particular question. Market pricing is for an ECB terminal rate of around 1.3% at the end of 2023, whereas your revenue CAGR assumes 2.5% terminal rate from 2023 onwards, my understanding. And given there's such a big difference between the 2, I think it would be very helpful to understand the downside risk to your revenue guidance. Would you be able to quantify where this revenue CAGR could be if you put through, let's say, 1.5% terminal rate? And if not, could you talk about it more qualitatively?

[Luc Popelier, executive]

Yes. No, that's indeed a very valid question, and we do have the answer to that question. Obviously we make our own sensitivity calculations. But unfortunately, we've decided here not to give any guidance on such a scenario. We just stick to the 1% sensitivity, which is a impact on the full curve of 1%. In reality, obviously, that is not the case. If you would say the deposit rate will be lower by, say, about 100 basis points, you don't necessarily have also a shift of the long term. So we unfortunately can't give that guidance.

[Operator]

[Operator Instructions]

[Raul Sinha, analyst]

It's Raul Sinha here from JPMorgan. I've got 2 questions, if I may. Just firstly, on your targets, am I right in thinking that the IFRS 17 impact is kind of excluded from targets on revenue and cost CAGR? And just to understand that in a little bit more detail, is that because it's not very material for you in terms of the impact from a cost-to-income ratio perspective? And then secondly, if I can just ask about Czech Republic where you're assuming gradually declining rates. Have you changed your hedging policies recently in Czech Republic in order to perhaps protect the NII from rate cuts? I'm just trying to understand if the sensitivity of NII when rates start falling is going to be similar to the sensitivity it was more recently when rates were going up.

[Johan Thijs, executive]

Thank you for your questions. Regarding the target setting in IFRS 17. So IFRS 17 has not been included in the guidance which we have given for obvious reasons. Obviously IFRS 17 is going to change completely the way how we are going to report numbers, and we will give you some insights in the quarters to come. And for good understanding and also in that perspective, a clear cut, what is for sure is that IFRS 17 has no impact on our solvency ratio, has no impact on our common equity ratio as a consequence of the way how we validate -- value the KBC Insurance into the KBC Group, and has no impact on our dividend policy. I think that is one of the main important conclusions we already have. Further detail provided in the next coming quarters on specifically IFRS 17.

[Luc Popelier, executive]

And maybe on the way we hedge our positions in particularly the Czech current accounts and savings accounts. We have indeed, are shifting our strategy already for more than a year, by the way. So we are reducing, we had reduced, the duration was already quite short versus our benchmark, and we've been extending or lengthening the duration on the replication portfolio since a while already. That is the reason why our sensitivity to a 25 basis point Czech rate hike has decreased from -- in the middle of last year EUR 30 million to EUR 25 million in the third quarter and by -- to EUR 20 million in the fourth quarter. And we gave new guidance in the first quarter of this year. That sensitivity has further reduced to 15. And that will remain around 15 because it was the full year guidance that we have 2022 versus 2021. That included everything. But you can see that the sensitivity has come down quarter by quarter by quarter. And that means that we're lengthening the duration and therefore protecting our interest income for further downward -- well, for a reduction in the [ sub ] deposit rates which we expect as of 2023-'24.

[Operator]

We have currently no further questions in the queue. [Operator Instructions]

[Kurt De Baenst, executive]

If no further questions, then it is time to wrap up this call. I would like to thank you for your attendance and hope you remain healthy. Take care and enjoy the rest of the day. Cheers.

[Operator]

Thank you for joining, everyone. That concludes your conference. You may now disconnect. Please enjoy the rest of your day. Goodbye.