Deutsche Pfandbriefbank AG

XETRA:PBB

Earnings Call Transcript 2018-Q2

[Operator]

The conference is now being recorded.Ladies and gentlemen, welcome to the PBB Deutsche Pfandbriefbank conference call regarding the Q2 results 2018. [Operator Instructions] Let me now hand over to Walter Allwicher, Head of Communications.

[Walter Allwicher]

Good morning from Unterschleissheim. Thank you very much for making yourself available. Here with me is Andreas Arndt. Andreas will lead you through the presentation and, of course, be available for your questions afterwards. Andreas, please go ahead.

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

Yes, thank you. Good morning, and welcome to our second quarter and half year results for 2018. Key messages for the first half were already communicated on the 4th of July when we released our revised and increased guidance, now standing at EUR 175 million to EUR 195 million. And I must say we managed the last 4 weeks without producing any other new guidance or news, and, therefore, I think we have good time today to concentrate and to focus on details and updates. But before I come to that, let me sum up the state of affairs, as we find it in first half 2018.First, we are modestly optimistic for the entire 2018 as reflected in our new guidance and good underlying operative development on the P&L. As you will not be surprised, we continue to stick to our conservative and selective business approach to keep portfolio quality high, as we already are far advanced in the cycle. The third point is, we remain well capitalized to be prepared for the regulatory challenges which we see coming.We call it the regulatory triathlon of [indiscernible] TRIM, EBA and Basel IV. And last point, we constantly push forward our strategic initiatives to support profitability and to keep ourselves well-positioned for the future. The key word here is building optionalities, optionalities for our future, building careful -- carefully and consistently [ under your prudence ] and also building rigorously and consistently our digital agenda. All in all, and despite significant headwinds, we continue to show good operating performance.Let me turn to Page 4 with a few details to the numbers. PBT for the second quarter came in EUR 74 million, resulting in EUR 122 million for the entire half year, which was up 33% over the first quarter and 18% on the first half 2017, and as I said, reflects nicely and solidly underlying operative trends as well as some -- to some minor degree, benefits from an one-off gain. NII is up plus 6% quarter-over-quarter and 12% or EUR 24 million year-over-year, amounting to net interest income of EUR 220 million, which is mainly driven by significant reduction in funding cost, but also by higher average strategic funding volumes or business volumes.Operating costs remain at EUR 88 million in the first half here, slightly below previous year's levels. And risk provisions contributed by a release, EUR 7 million to the bottom line. While the majority of improved performance stems from operating trends, we also benefit from a one-off gain from a purchase price adjustment on Heta, which came in early July, where we had the opportunity to set a debt -- debtor warrant attached to the original Heta settlement to a third party. While PBT is EUR 120 million, the net income after tax spends at EUR 99 million, which taking into account the AT1 coupon translates into earnings per share of EUR 0.72 for the half year and return on equity after tax of 6.7%. The new business is in line with planned guidance and expectations on lower levels than 2017. And as I said, we stick to our conservative approach and that's mainly and predominant the reason for the development. Public sector remains somewhat behind due to the fact that already signed transactions were pushed down the line and closing is expected to take place at a later point in time. However, for both Real Estate Finance as well as Public Investment Finance goes, the pipeline looks very much okay, despite difficult markets. As I told you, the average cost margin -- the average gross margin in the first quarter was nice, but probably not quite sustainable affair and that sort of is reflected also by the second quarter results on gross margins, which is down from a relatively strong EUR 170-plus million in Q1 to EUR 160 million for the half year. But I may also point out, it's still well above the 2017 full year level of 155 basis points.Net margins, including fees, so-called net revenue margins, which we do not specify, were, by the way, remarkably resilient. And here we see that there is a different trend between gross margins on one hand and net margins due to funding cost -- favorable funding costs on the other. We remain -- as far as new business is concerned, we remain specifically cautious in the U.K. as well as on the retail asset class. In other words, while we cautiously expand on the U.S. business, we also cautiously keep back on the U.K. business. U.S., by the way, makes up 13% for new business and brings the portfolio share in Real Estate Finance now to 5%. The strategic financing volume in Real Estate Finance is up almost EUR 1 billion, while Public Investment Finance is down by EUR 300 million and so is Value Portfolio.On funding, a few words. In summary, we collected EUR 3 billion in new long-term funding in the first 6 months, plus to be added a EUR 300 million in AT1. We do this at lower costs than last year, but also on lower levels in terms of overall funding volume. I will come back to that. The key and the most important thing is that new funding costs have come down significantly, which overall impacts our levels of funding costs, both on stock as well as on new business.The capitalization improved further with a fully loaded CET1 now at 19.4%. The increase mainly reflects, first of all, the positive IFRS 9 effect on capital, which we already communicated last quarter, plus the AT1, which now kicks in for the total capital and the Tier 1 as well as RWA reductions from maturities and PD and LGD parameter changes.I would skip details on page 5, which is a graphical summary of what I just commented on. Just to point out one thing, I think you will find nicely compared the IFRS figures, IFRS 9 figures and IAS 39, so you see how figures also accounting-wise and accounting standard-wise have developed over time.On financials, and I'm turning to Page 7, a couple of smaller points which I want to highlight here, with NII and cost -- and risk cost being specified in separate pages. NII came in strongly, up EUR 24 million or 12% to EUR 220 million, and as I indicated, the main drivers were funding costs, which have come down significantly year-over-year as well as the increase in strategic financing volume, as I said, details in a minute.Net income from fair value measurement is up EUR 4 million, including the one-off gain from Heta purchase project adjustment or debt warrant -- debtor warrant or, in German, Besserungsschein. That, just as an explanation, comes in as a fair value item not in realizations, where usually it normally should be, that simply has to do with the fact that offers for a sale of that Besserungsschein came in, in June and did force us to rethink valuation of our book in that particular aspect. And so we included that into June figures on the valuation side rather than the realization side. And by the way, the value which you found on the valuation side is identical with the one you would have found later on, on the realization side. Is not a transaction with Heta resolution, asset resolution entity or with the [Foreign Language] but a third-party market transaction where we received a number of offers and transacted on one of them. With that, we have sold out completely and unconditionally on that title. Again, and to make that very clear and to preempt any possible questions, while we've achieved a very satisfactory result on that item, it's still a very minor item on -- in the context of overall P&L business development for the first half of 2018.In other words, onto Page 7, net income from realizations is mainly driven by prepayment fees and is down minus EUR 7 million against previous year. The reason is lower repayment volumes. They came down according to plan, and it's good that they're coming down because we're looking at more stable flows, NII flows in the coming quarters. But -- and that's the second effect, which we also have to notice is, and that's part of the overall pressure on the asset pricing side. It's not only gross margins which are under pressure, but also other fees and other commission income, which comes with that and prepayment fees goes into that, is under pressure and is less than we have looked at in 2017.Net operating -- net other operating income is now without the cost of deposit issues, that goes into separate line but is including, again, reserves for any other items and provisions, is down by EUR 12 million as last year's figure benefited from some off -- some one-off gains from asset sales out of the Value Portfolio. The current half year figures are affected by some FX translation losses and reserve building for legal costs, all in relatively small numbers.Turning to Page 8 on net interest income. And when I speak to the figures, I always refer to the half year over half year figures. Now 12% up, or EUR 24 million plus in terms of margin pressure and reducing overall business volumes, and all that is no small achievement and justifies some explanations. The development which we saw in first half is driven mainly -- mostly by 4, 5 factors, which I want to explain to you. First of all, and that's sort of the outgoing point, and as mentioned, gross asset margin are coming down further, the pressure is unabated and that goes for new business as well as for the portfolio as such.But, and that's the second point, it's balanced by the fact that net -- sorry, new business margin is being influenced favorably by the reduction of funding cost and to a degree, which more than compensates the decrease which we see on the asset side. And the overall, and that's the second point, the overall portfolio margin benefits from the expiry of vintage funding of higher margins from previous years, which we do not replace to the full extent, because of lower new business figures and the tighter management of excess liquidity or liquidity overhangs. And the third point is that we see half year over half year, an increase of average Real Estate Finance, strategic financing volume by EUR 1.2 billion all in all, and that also did help the overall margin.This being said, reducing volumes in Public Investment Finance and Value Portfolio and still lower trending yields in equity and liquidity books work against these positive factors. And there are 2 other factors which presently support the positive NII development but will be sort of only points in time for the next quarters to come is, first of all, the [ Tier 2 ] was drawn in the second quarter 2017. So in a half year -- over half year comparison, there will be still some positive impact to chime in, in the next half year to come. But there's another one, there was a special senior funding tranche, which expired also first half of 2017, which did carry a very high coupon and that expired, as I said, and that effect, that positive effect of funding cost will not repeat itself in the later end of 2018 and 2019.Looking forward, the NII prediction for second half and beyond will be influenced by, what I call, the only creeping positive impact of the bank's overall funding as long as we fund ourselves below the levels which we have on our books just now. We do so and we continue to do so also going forward. I'll come back to the perspective in a minute when we talk about funding. And the second thing what needs to be recalled and to be taken into account, the positive impact from reduced funding volumes will also be limited as we cannot reduce or will not reduce our liquidity profiles without end. So there is a certain backstop to that development as well. With that, or having said that, we tend to be cautious on the second half predictions on NII.So much for NII and then turning to Page 9 on risk provisions. Now despite the change of impairment occurred from incurred loss models, our IAS 39 to expected credit loss model to IFRS 9. In beginning of 2018, we did not see any essential changes, which we can report. So structurally, the portfolio behaves in a very stable manner. Portfolio structure with parameters are trending stable. The risk parameters are still influenced by sound base of real estate markets reflected in occupancy rates, prices and new developments, and is also reflected in higher property prices and continuously higher equity stakes resulting in further improvements, especially in the LGD structure of our book. But you see that likewise, on the other hand, also the development of risk-weighted assets later on when we talk about capital because as LGDs are being positively influenced, RWA also tend to trend southwards.So hence, there's very little movement in rating classes and almost no migrations between levels 1, 2 and 3. That results in a EUR 7 million net release in first half here, which was driven by maturities effects and expiries in stage 1 and 2, mostly sort of reflecting shorter vaults or below 12-months vaults and expiries on southern periphery countries. In stage 3, we had 2 million additions, the small roundings on existing exposure, nothing serious to report about.With that, stage 3 coverage is around 21%, 22%, which we deem as an [ LGD/PD ] level always taking into account that, together with collateral which we hold on these positions, the real coverage ratio is 100% plus.Now that all in a result is certainly the effect of a benign, still benign market development in terms of pricing parameters, value parameters and supports our risk provisionings, but I also may remind you, the low levels of risk cost are also reflection of our conservative risk positioning.Few words on general and administrative expenses and depreciations. Depreciations are now in a separate line. Not much to report about that. They're rolling according to plan. The -- now it's sort of newly phrased general and admin expenses, slightly -- as I said, slightly below the levels of 2017, showing that for one, I think we still keep tight control on costs. We also see that 2017 did encapsulate a couple of project costs which did not recur and did not repeat itself in the first half of 2018. And even, more so, important is we keep FTE levels relatively stable, and therefore, the cost of the personnel -- the personnel costs are flat as well. Now we do expect that we'll see some catch-up on these positions in the second half to come. That is partially due to the fact that we will increase FTEs on strategic projects. That goes for the United States business as much as it goes for the digital or CAPVERIANT business, we'll start further staffing on both of the projects. We are, timewise, slightly behind the plan, not in terms of overall development, but in terms of staffing coming on board. But we will see that second half. And the other point is on the other administrative expenses, we'll see more regulatory projects leaving their traces on cost in the second half and also in 2019.On that place, let me remark -- or give you some general remarks on investing and cost development as a precursor to the developments in second half 2018 and 2019. What is this all about is building optionalities. And one of the optionalities, as I said, is the U.S. business, which is on track, where I think we got the sequencing right, we started doing some business there, stretching out our reach towards the U.S. markets with clear intention to have cost infrastructure coming in later and that pays off because we have revenues out of that business before the costs really chiming in. And we are now in the position to start do primary origination business as we did intend to. Remind you that primary origination is something we always only do if we have people on ground who are familiar with -- intimately familiar with the market. Now that's the one thing, the one building optionality. The other building of optionalities is our digitalization of business. We have no guarantee that a platform business will be the way public sector or real estate asset -- Real Estate Financing assets will be transacted in future. But not to be there, not to do it, not to move into these optionalities is also no option. In addition, digitalization and building new platform or products has an eminent impact on the rest of the organization. We learn something, we learn something about leaner organization, about more efficient organization and higher degree of client focus, which we take on board for the existing bank, while we work on new projects and new products such as CAPVERIANT.So you will see more investments to come through. And you will see its respective impact on G&A line in the second half and even the more so 2019, but that is important to leave as a message here, that's predominantly strategic. And we will be more specific about these items when we come to the regular and usual forecasting of 2019 figures together with full year figures 2018. And whatever we foresee for 2018, of course, we have built into our guidance.Now with that, with the general overlook -- overview on the bank, on the bank's P&L, let me add a few words about segmental reporting. Real Estate Finance is doing fine. As now said and repeated many times, also here, we stick to our risk conservative approach, remain selective in what kind of new business we take on board, given the fact that the real estate cycle has far advanced and that the markets are highly competitive. Good properties have become quite rare, and as I have explained to you the previous quarters, we have to run around many more times to find the right business than in the past.So the new business volume, not very surprisingly, is down from last year, but within our plans, within expectations and within our full year guidance.Second half year pipeline looks remarkably well filled at the present and that goes both for Real Estate Finance and Public Investment Finance. Also there's one thing quite clear, which I would like to underline here. At the end, I prefer to write the right business instead of fulfilling any volume targets. Quality comes before quantity if it comes to the crunch. Average LTV, as you can see here, is down 59%. So we are approaching the LTV figure, which we have on stock, and the average gross margin, I mentioned already, so we can leave that. Regionally, you see that we continued to focus on German business there with almost 50%, which helps us in terms of anchor rating with Standard & Poor's, which also helps us in terms of margin stability. Levels are low, but levels are much more stable than in other adjacent European countries and, therefore, I think it is good to be invested in Germany, stock as well as new business. Where you see major changes is the levels of U.K. business and the United States. United States, I did mention, portfolio-wise, it's now up to 5% and the U.K. is the reflection of our being continuously cautious on Brexit and the macroeconomic results, which we may face in 2019. The interesting thing is that transaction volumes and margin hold nicely in the U.K. But we do believe that the risk return is not exactly where we would like to see it.The other countries, such as France, the regions, Nordics and CEE are in line with the portfolio shares and in line with our investment strategy. So not much to report on that. Property-wise, the actual figures also reflect our strategy. We have substantially more business on the office side with 51 against 40. Partially, that's something which also reflects the situation in the first half, but partially, it's strategic and is a way we want to see the business going. Likewise, retail, we are much more subdued and reduced in the approach. And on the residential side, we continue to do business there. We like to do business there as long as it is not high-end and as long as the margins, which we can realize on this business, somewhat fit our profile.We had a slightly higher share in new developments -- development versus investment loans, but all within the guidelines or the portfolio guidelines and limits which we had. Pity with that business is that, usually, it sort of runs down much faster than we would like to see it going down. So -- and as I mentioned, the Real Estate Financing volume is up EUR 1.2 billion year-over-year.So that's what I wanted to leave with you on Real Estate Finance. Public Investment Finance, not much new in addition to what I already said.To underpin again, we expect a higher pipeline for the second half, and therefore, some rebounding also of the portfolio figures as we go along. The margin reflects the higher share in [ supplement ] financing, that shouldn't -- will hopefully adjust second half with more regional exposure to come. NII development on the segment is in line with the overall development and the main rationale of doing this business, i.e., this being a contribution business, we have approximately EUR 28 million to EUR 30 million forecast in revenue line, stands against direct cost allocation of EUR 5 million to EUR 6 million, and is important as a sort of low-risk, high-contribution-margin business.Value Portfolio, not much to say there. The rundown according to plan. One word might be of interest regarding the 13% Italy exposure. That is just to remind you that the vast majority of that sits in -- they see portfolio at cost -- value-added cost. The rest, 10%, is OCI, so any movement, spread movement is bound to go through equity, that's about 10% of the EUR 2 billion exposure which we have on this portfolio, and another 5% actually is the rest which impacts potentially the P&L when it comes to spread movements. But also keep in mind spread movement is not the only valuation item which impacts the fair value and the P&L movement at the end.So it's not that we can say we are relaxed about Italian spread movements, but in terms of being able to digest movements and volatility there, I think we are well-positioned. And should -- and did see that in the fair value development over the last quarter as well.Now portfolio profile, I think, is a fairly straightforward affair. I would skip that page, because there are no changes over the last quarter. And what I can leave with you on Page 17, if and when there might be somebody having questions about Estate UK-3, there is no changes which I can report on these dates.With that, we're turning to funding. I've detailed pages, on funding, #19 and #20. As I mentioned, we had EUR 4 billion originated from markets in the first half 2017 compared with EUR 3 billion this year. The key change being the spreads, as they have developed over 3 months. Euribor, I think, is very gratifying to see that spreads of 80 basis points on senior unsecured have come down to 48. They have gone up a little bit slightly. That was still moving in a territory which is significantly below the spreads which we look at when we look at the portfolio, the funding portfolio, which we have on our books.The other point to mention is, and I think I did that already at the beginning, the advantage of significantly lower funding costs, something which rolls in over time. So the average vault which we have on our liability side on these liabilities is between 4 to 6 years depending on what kind of liability you look at. And if we have sort of a 10 or 20 basis points funding advantage, divided by 4 or 6 years gives you sort of the creeping or the rolling impact as we see the advantage of funding cost growing into the portfolio over time. The other point I want to mention is that on the 21st of July, German parliament did adjust the funding rules for preferred senior unsecured, which basically gives free road for senior unsecured now also for German banks to be issued. We will see after the summer break how we will make use of that. I'll come back to that point in a minute when we talk about MREL on page 21.Now Page 20, not much new to report there. The figures as of July still very low. Good development all over the place. And as I said, with the average levels which we have on our books, significantly above the levels which we transact on these days.Now Page 21 gives you sort of a short overview on a new KPI, which has finally materialized, at least for us, in terms of official announcement what our MREL ratio should be. We are not supposed to disclose that. What we can say is that the ratio comes to be below the 8% TLOF-MREL requirement and that translated into RWA based on 2016 and 2017 figures, basically translates into an RWA requirement of approximately 28%. Now the interesting point which you see here is, or the 2 interesting points which you see here is, that most of the requirement, which we have to fulfill some 90% or so is already fulfilled with our own funds. So the amount which eats into bail-in-able debt -- senior unsecured nonpreferred debt is relatively small. That's the first point. It actually what comes in as bail-in-able debt makes up 78% of the RWA. That's the first message. And the second message is, as we go along, we could wait until time in to -- 10 years from here that we need to, given present figures, until that time that we may have to issue nonpreferred material again, meaning that we can take full advantage of senior preferred issuances going forward from here.I would say from all what I see in the market these days, 78 MREL ratio is probably one of the best you can find in European markets these days, which is reflection of the fact that we do have senior unsecured wholesale funding on our books, which, in this case, is a big support in fulfilling regulatory ratios.On capital, Page 23. The key message is RWA have come down again because of LGD movements. That is partially due to improved LGDs over the last 6 months, partially improved LGDs because of sort of faster enrollment of collateral, partially because we see property prices still going strong or going up.There's no change in methods of calculating LGDs and PDs. We adhere to the same methodology as we did a year ago. So it is a reflection of the macroeconomics of the Real Estate Finance markets. That results in a 19.4% CET1 and 20.6 -- 26.3% in own funds, and own funds, of course, including the EUR 300 million AT1. As I said at the beginning, we have to see the ratios in the light of the 3 components, targeted review, EBA guidelines draft and Basel IV to come, which I did explain last time, I think extensively, we are holding onto 12.5% communicated minimum management level for CET1, but I also said that given the times which we are in, we feel more comfortable with something around 13.5% to 14%. That's in itself indicates to you the delta which we deem as a requirement or as a cautious and prudent buffer against the regulatory developments which we see coming.Now with that, let me conclude. The strong performance -- the strong financial performance and business performance in the first half 2018 gives us a good and sound base for good results in 2018, full year results 2018, as indicated by the adjusted guidance. We remain cautious, as you would expect, as we see the markets being strongly competitive with further pressure on margins and NII. We do believe that the cycle is fairly well advanced. And we will continue to focus on our strategic initiatives, which together with further regulatory project will weigh on our cost levels in 2018. Our strategic initiatives remain well underway. We continue to build optionalities, both in the U.S. and in the field of digitalization; U.S. business gradually, cautiously but nicely growing in line with expectations. Back office being established and closer to the market. And with that and the digitalization well on track, I think we are well prepared for '18, '19.In April, as communicated, we launched our portal for Real Estate Finance clients, providing payment information and documental exchange, which we intend to further build out in terms of functionalities and processes. And I should mention that in May, we went live with the public sector portal, CAPVERIANT, which you may call a fintech within the bank. We'll build out and continue to build out functionalities, and we will look into the French markets end of this year, beginning of next years. With all that, I think we have set out and build out new structures and additional resources to push forward digitalization within the bank, and that will give us, I think, more competitive edge on the side of proximity to the client and efficiency in the credit process.Digitalization is not a fashion but is a need, and having that in mind, we will continue to invest on that side. Those are the points I wanted to leave with you. That's my presentation, and I'm now happy to take questions, if you have any.

[Walter Allwicher]

[Operator Instructions] Our first question comes from Tobias Lukesch from Kepler Cheuvreux.

[Tobias Lukesch, Equity Research Analyst]

Couple of questions on my side. So first, if we look at the cost basis, and you talked a lot about what's going on, on regulatory issues and also with regards to strategic things. And we have discussed that in the past Q1, et cetera. But could you give a bit more of a flavor, just like how that will develop now compared to the first half year in 2018? And what your outlook is? I think it has sharpened a bit for 2019. So that would be the first one. Secondly, on the legal costs, you mentioned that there were some additional legal costs, not that much, however, I would assume that, yes, I mean, you are looking what could happen around UK-3. You mentioned nothing has changed, however it would be interesting if there was anything connected to that. And thirdly, with regards to the CAPVERIANT, public sector platform that went live. So could you maybe give some figures around that? So how much was at the end of the day invested? How much further investment needs do you see for that project? Where do you see a breakeven? When will it happen?

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

Okay. I would start with the questions in the order you gave us. On the cost basis to start with. I think you have to bear with me around to 2019. I think I can give you just a sort of general outlook where we see things developing into as a precursor to things which we see coming. And on 2018, as I said, we have built a certain increase in cost into the second half 2018, and therefore, into the guidance which we see in 2018.The point is relatively easy without, say, being too specific on the details. We'll have a couple of requirements trigger through regulatory requirements, which will bear on additional build-out of IT, which we have coming through now in the second half of 2018. That's the -- predominantly the regulatory side. And we also will build out the U.S. presence and the staffing for the digital initiatives. We are bit shy on giving exact figures because we will see how that rolls in. But in terms of forecasting, we will see that the cost will trend upwards to some degree. I can sort of give an indication to that degree that -- and to the same degree as I did in the past. We do not foresee that the level of cost for 2018 will exceed the level of cost which we saw in 2017.Now on legal cost, for the -- as I said, those are smaller items. It is partially triggered by the fact that there's a new court ruling in Germany from the BGH regarding derivatives within a client contract -- client loan contract. That's something which was predicated on private clients, but it goes into the same category -- in our view, same category as it goes with previous decisions of the BGH regarding the Aberdeen's [indiscernible] commission and other commissions and fees being charged to customers, which finally were also translated from private clients into commercial clients by the BGH in the past. And as this is a new verdict coming in and coming down, we did provide for that. The U.K. figures are not being affected, because as far as I can remember, we did not have anything of size and significance to add during the second quarter.We are still sort of in expectation of things to happen. Now the usual thing is during summer time, July, August, there's a sort of quiet period also on the legal side, on the lawyers' side, and we will see how things continue to develop thereafter. But there is really nothing significant to explain.Now CAPVERIANT is -- and that's the third point, is sort of a child, which has to start to learn walking. We are not the only platform out in the market. It's also there quite a competitive field. We are technically where we want to be in terms of basic functionalities. I would say, the real sort of forecasting is something which we start doing next year. I don't think it's an exercise where we would go into giving breakeven figures or concrete and precise business forecasts, simply because that's new technology, that's a technology approach, which is also driven by the fact that partially, we will take learnings and experience into the bank as matters of supporting further development of efficiency. In that respect, we'll not share specific figures, at least not in 2018. We'll see how we lend and where we lend in 2019.Mr. Lukesch, that's all from my side to your points. Maybe not points actually, but that's what that can be on that side.

[Tobias Lukesch, Equity Research Analyst]

If I may follow up on one further question. On your funding and on the spreads we have seen. So looking at the increase in spreads by the end of March, on the one hand, the AT1 issuance, on the other hand, compared to your closest competitors, so to say, here in Wiesbaden. With regards to the liability structure, how would you expect that kind of funding or the funding spread between the 2 of you to develop over time? Since you mentioned it before, you have this 50% of loan book allocated to Germany do you feel comfortable with it? S&P is looking at it, and if I understand you correctly, is kind of valuing this approach. So also you have a very low share of deposits. So how do you say? Or how would you access that kind of funding spread gap?

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

No, I don't want to sort of engage myself in comparables or comparative interpretation of developments here. There are 2 or 3 things which drive our spreads presently is: a, we dispose of a good rating with a A-, and that is something which is helping in 2 ways. First of all, it pulls -- so all rating categories across the board. The second point is, it helps us also on senior preferred. You always have to keep in mind the capacity to issue senior preferred is also determined -- while, of course, it's determined by the MREL capacity, which we have and that is relatively high, because we have relatively low deposit base. And that is sort of "the advantage" which we had through the capital markets funding. And the third point is -- and that's also an advantage of capital markets funding. We actually can reduce that. If you have a deposit base, that's something which is relatively solid and that's why you want to have it. But the adjustment to the requirements on the asset side is very limited, and what you can see from the development over the last 6 or 12 or 18 months is, we were actually quite nimble and flexible on that side to adjust to our funding needs and thereby to reduce our funding cost. So all these points together and perhaps a fourth one, which I already mentioned. As long as we stay below the funding levels or the spread levels which we have on our book, sort of revenue issuance which we bring to market lowers the average of funding costs on our book. And that is something which I still look very much look to, because historically, you know on the senior unsecured side, you know where we're coming from. I mean 4, 5 years from here, we did have funding levels of EUR 200 million at this point. We came down to EUR 140 million, EUR 130 million. We came down to EUR 90 million, EUR 80 million. And we are now around EUR 40 million to EUR 60 million.Now all that legacy still sticks in our books and is rolling off and is to be replaced by lower funding cost levels. So even if that goes up another 10, 20, 30 basis points, it still works positively against the average. So there is some ammunition left in the gun. Although, as I said, it's rolling in slowly and it's not a big lever but it is a lever, which gives us confidence that at least on the funding cost side, we are doing fine. The question at the end of the day is, how much pressure market will exert on the asset side, yes? So far, we can say -- and we can say that for a couple of months now that we've kept net margins stable. And if you look around, not many other banks can actually claim that.

[Walter Allwicher]

[Operator Instructions] Next question comes from Nicholas Herman from Citi.

[Nicholas Herman, Assistant Vice President and Analyst]

I have 3 questions, please. Just -- so you've got your guidance for the full year, it remains unchanged. Just want to get better sense of your underlying assumptions there, please.

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

Nick, can I interrupt you? Sorry, can you speak a little bit slower because it comes over very fast and I can't really understand you.

[Nicholas Herman, Assistant Vice President and Analyst]

I will start again, okay. Apologies. So I just want to get a better sense of your underlying assumptions for NII for the full year or for the end of the year, just given your guidance on PBT for 2018. So the first part of that is, it sounds like given a strong pipeline that you expect new business volumes to still be more than EUR 10 billion? And then as part of -- and then similarly on NII, do you expect -- or when you are making your guidance, do you factor in an increase in funding costs? And if so, could you give an indication of how much? First question. That's the first question.My second question -- my second and third question is on capital. So we have seen, you've had your ECB review your models, and now we are also seeing LGD changes coming through. Are there any changes that you are currently working through? And equally, does this also imply that Basel IV impact, when it comes through, ultimately be less than what was previously guided? And finally on capital return. I think it's fair to say that capital is better than what you expected it to be when you gave your -- when you provided payout ratio of guidance for this year. In the past, you have paid special dividends when capital was better than expected. Do you continue to prefer special dividends to buybacks?

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

Okay. Now with the last one to start with, because that's the easy one. Well, we all like special dividends, but we'll have to wait until the end of the year before we can say something about that. That's the usual thing and the usual game. And I take your questions in reverse order, please. On ECB models, LGD changes, if I got that correctly, what are we working on and do we expect any lesser impact from Basel IV? No, we do not -- we have no changed assumptions around Basel IV. And we are not specifically working on different LGD methods or models other than the ones which we discuss with the regulator these days. And part of the [ talk of ] review of internal models, part of the individual review of models, as part of the ongoing regular review of the supervisory bodies, we would expect that risk weights out of those changes will be higher, risk weights will be higher rather than lower in times to come. So -- but that's -- as I said before, that's a process which is ongoing, which takes quite some time. And the targeted review of internal models, as you probably also know, is something which has been extended as an exercise towards probably middle of '19 or potentially even a little bit later. So we have no change in assumptions other than the ones communicated a quarter ago or 2 quarters ago.Now second point, I wouldn't call it a strong pipeline. I would call it a pipeline somewhat better than we expected, pipeline which potentially gives us the opportunity to reach targets. But as I've said, we put quality before quantity. We have not sort of resolved to abandon the volume target, because the pipeline is good. But I also make it a very clear point that quality comes for -- before quantity. In terms of funding cost, would we expect funding costs to increase? I would put that more into relative terms. I would say, the funding benefit which we had relative to previous periods will be less, yes. And that's -- how that works on net interest income, on net interest margin is a matter of which is faster and which is quicker. The deterioration of -- on the asset side or hopefully be keeping margins in place there and, say, new funding levels which we may see in second half to come. Now -- and your first point, if I got that right, was what are the underlying assumptions on the full year NII forecast? It is exactly what I just said. We would believe that the, say -- the overall change in funding levels and funding cost levels between first half '17 and first half '18 will not reoccur. So we do not expect another EUR 24 million improvement or EUR 7.5 million improvement. I think we would be happy if we keep the levels stable. We're building a margin of conservatism there, that we say fourth quarter, probably somewhat less because of the market environment, as I just described it.

[Nicholas Herman, Assistant Vice President and Analyst]

Just one follow-up if I may, please. I completely get that you are prioritizing quality of new business over quantity. I think I agree. That makes sense in these markets. The LTV on your Real Estate Finance business fell from 62% in the first quarter down to, it looks like, about 55%, give or take, in the second quarter given the first half average LTV of 59%. Are these the kind of LTV assumptions we should be working with going forward? Or will it fluctuate a bit more? [indiscernible] do you think?

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

We have -- I mean, we have to say -- and you know that as well as I do, the actual LTV, whether we land in a quarter, whether we land on the 61% or 59% depends very much on, say, the different shape and form of business which we get in. We are not, sort of, thousands transactions business, but in a year, we do, at the end of the day, 220, 200, 220 transactions in a year and that might well be that we're trending a little bit higher one quarter and little bit lower the other. So I think what is important is the trending channel or the trending perspective, and I do not foresee any reasons why we should be much higher than the 60% we usually sort of have as a midpoint in LTVs for the second -- sorry, for the second half to come. So we don't guide and we don't forecast on LTV, but I mean, you have seen it's been relatively stable over the last quarters. And for me, there's no reason why we should significantly deviate from that.

[Walter Allwicher]

At that point in time, we have 1 further question registered, which is Philipp Häßler from equinet.

[Philipp Häßler, Director of Research]

I've 2 questions, please. Firstly, more or less a number question. The Heta impact, am I right in assuming that the -- that this is the EUR 4 million you show on the net income from fair value measurement? And secondly, as you are very successfully expanding into the U.S., could you imagine expanding into other countries as well? I mean, Italy is probably currently not very attractive, but are there other countries where you could think of expanding into?

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

I'm not quite clear on your first question, sorry. You said where does Heta materialize in terms of P&L? Or what was the question?

[Philipp Häßler, Director of Research]

No, no, no. I mean, because you said that it materializes under net income from fair value measurement.

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

Yes.

[Philipp Häßler, Director of Research]

So the EUR 4 million, is it more or less the positive Heta impact in Q2?

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

There is a Q2 positive impact from Heta, yes. But we have also -- we have pull to par effects -- the use of pull to par effects and valuation effects which stand against that. So the delta figure which you see is the delta of both positives as negatives.

[Philipp Häßler, Director of Research]

So the Heta effect is bigger than the EUR 4 million?

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

Well, I tried cautiously and carefully to -- try to avoid any indications to size and form. There might be some indication to that effect, yes [Audio Gap] other countries. The U.S., you already sort of answered yourself. I think that's a place to be in. Now Italy, of course, is not. I think what is important is to see what kind of exposure we have there. It is, going back to the page on the Value Portfolio, is 13% of Value Portfolio, which compares against an absolute figure of roughly EUR 2 billion, which we have outstanding. It is -- if I remember correctly, it is -- 2/3 or 3/4 of that is southern exposure and the rest is more regional. And the other thing what is important, it is being accounted for at cost to the tune of 85% of the EUR 2 billion, meaning that spread movements will not immediately sort of come through in the P&L. That only comes if the risk parameters, LGD and PD, change due to rating changes attached to Italy. That's something which we do not foresee for the time being. And the rest is either OCI, so through capital or is through P&L, which is 5% of the entire exposure, and even that 5%, you have to keep in mind that spread movements do not consist of -- yes, the P&L impact of spread movements do not just exist -- not just consist of the pure country spread movement, but the interest rate movements and other things to be included. The spread movement, the significant spread movements which we saw throughout the last 3, 4, 5 months did only very modestly and moderately reflect into P&L. Otherwise, in terms of other countries to explore from a Real Estate Finance side, we're happy with the places where we are in. We still do very good business in CEE. France, as I explained, last [indiscernible] is a very competitive place to be in. So the overall analysis of markets which I gave last time is more or less stable and holding true as of today. That's also the reason why we did not have an additional slide on the Real Estate Finance markets development. That's something being relegated to the appendix, where you can also see how we look at markets going forward. I hope I've sort of touched upon your question. If not -- yes, okay.

[Walter Allwicher]

We have no further questions registered. We take this as we have answered all possible questions. So at that point, then, thank you very much for joining us. Thank you for making yourselves available. We appreciate your interest in PBB. And we look forward to Q3 results in mid-November. Thanks. Have a great summer break. Bye.

[Andreas Arndt, Chairman of Management Board, CEO & CFO]

Thank you. Bye.

[Operator]

The conference is no longer being recorded.