Deutsche Pfandbriefbank AG

XETRA:PBB

Earnings Call Transcript 2018-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to the Deutsche Pfandbriefbank AG Conference Call Regarding the Q3 Results 2018. [Operator Instructions] Let me now turn the floor over to Walter Allwicher, Head of Communications.

[Walter Allwicher, Head of Communications]

Good morning, and a very warm welcome to our Q3 results call. We appreciate that you take the time to dial in. And nevertheless, we preempted some of the good news already last week, but I think, we still have some very good news to tell you. Andreas Arndt will give the presentation and be also available for your questions afterwards. Andreas, please.

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

Yes, good morning, also from my side. Thank you very much for joining. As Walter Allwicher mentioned the news value today for the overall picture is somewhat limited. Nevertheless, I think, we have couple of points which would like to comment on further. Key messages have already been communicated in our talk last Thursday regarding the outlook for 2018. The key drivers for the increase in our guidance were better than prognosticated in our development and lower than anticipated cost. The new guidance, therefore, is around EUR 205 million to EUR 215 million after EUR 175 million to EUR 195 million previously. And the key figures for Q3 are EUR 49 million profit before tax for the isolated quarter and EUR 171 million against EUR 154 million for 3 quarter year-to-date figures, which is an 11% increase in profit before tax. NII stands at EUR 334 million after EUR 298 million, which is a 12% increase. Costs are slightly down with EUR 136 million after EUR 141 million [ over the ] -- excluding write-downs according to IFRS 9, which were stable quarter-over-quarter. And risk provisions up from minus EUR 3 million to minus EUR 10 million including EUR 17 million specific provision on U.K. exposure. The new business lagged behind plan because of the more selective screening and picking up those exposures which fit into our risk profile and into our ROE profile, but we also have to point out there is still a strong margin -- sorry, strong pipeline into the fourth quarter. Last year's fourth quarter may serve as a guidance there. The portfolio in real estate finance still grows slowly, but steadily. We are end of year figures against now 3% up against last year or if you take average volumes on a 12-month basis, it's 5%. ROE pretax 5 months to date is around 7%, 6.94% isolated quarter and 7.6% for the entire 3 quarters 2018.CET1 is strong at 19.7% after IFRS first time application and generally lower RWA, we're coming back to that. But not much of a change against the figures, which we communicated last quarter or half year. In our release last week, we made it a point that we see 2019 cautious. Those who have sort of seasonal deja vu regarding our warning might be right. But because we have said something similar same time last year that we are of the firm opinion that some concerns, which we had last year, may even be more valid this year regarding 2019 as markets on one hand may perform or have performed strongly. In 2018, the macroeconomic seems to be holding, but on the other hand, we see first rumblings in some of the subsegments, notably the U.K. shopping area. The cycle is dragging on, interests are likely to raise to increase and spreads already on the rise. So all in all, I think, good reasons to be cautious about 2019. How much more cautious, we will have to be -- we think we have to be as a matter of the next analyst call, we think about full year figures and our perspective into 2019 in more details. Before we go on with the figures, let me make a few general remarks on commercial real estate markets, where we stand and where we see the main risks coming forth. As mentioned, macroeconomic forecasts for most of the markets which we are in is holding fine despite some recent rectifications. GDP growth in eurozone is around 2%, with some being below, some being above that figure. [ Use ] were above 2% -- about 3%. And the demand for office and residential is still going strong while supply is increasingly difficult. So is the office take up is going strong, rents are stable and vacancies are remaining low. We look at transaction volumes in the first half 2018, which are more or less of the same levels at 2017. And the consensus in the market is, for most of the asset categories, going [ sidewards ] in terms of valuation and yield, with one notable exception and that pertains to the retail segment.The risks which we see and, which we closely observe, is yields are on all-time lows, low levels and in some markets raising, rising. The valuation impact, which comes from increased yield is significant. As always, my standard example, if you have a prime yield in a prime market of 3%, which is something which you observe in prime locations in major cities for office, for instance. And that increases by -- to 3.5% or 4%, that 1% increase is 25% decrease in valuation. And that sort of may pose some questions or may pose some difficulties when there is an LTV covenant in between. So valuation is the piece to watch. We don't have that much concerns or we don't have concerns about the business cases, the cash flows and the interest in debt service coverage, but we look closely how valuations develop over time. Some of the asset classes do already see some weakening, as I said, such as retail shopping centers. The problem just now in some of the corners of the business is that very little transactions going on, it's difficult to find a good price. The other element is, besides yields and subsegment developments, is structural changes in the market as a whole. The -- sort of the best word is flexible working, which becomes more and more dominant. If you look at the London office market, you will see that in the first half 2018, 18% of the office take-up is being affected by WeWork type tenants. And WeWork and the likes are now largest tenants in town. The same development, although on a much lower level has been seen in other cities like Frankfurt, Paris and so on. What it does risk wise is it shortens the weighted average lifetime of the rental periods and the formal term of committed rental cash flows, while duration of loans stays broadly the same, and thereby, increasing the re-letting risk.There is, as I mentioned, there is still strong demand, strong liquidity and lot of equity in markets and in supporting prices. However, the risk comes in when interest rates go up further. It's interest related and change in interest rate regime may divert equity away from commercial real estate markets. And the other 2 risk categories, which should be on the list to be watched, is construction risk and construction cost. They have increased notably over the last 12 to 18 months. And last but not least, clients become more demanding, not only in terms of lending conditions or credit conditions, but also in terms of their own investment decisions and investment selections. There are many cases where a B location is being tried to sell as A locations and we have to watch out for that. So are we overly cautious? No. I have been scolded by 1 or 2 of you lately that I have a tendency to sort of work on the negative sides of the business. I would put it this way, we are not pessimistic, but we are cautious and that is the subtle, but very important difference and we should not forget despite all the warnings and the cautioning, which I make, we should not forget there is more equity cushion in the markets today than ever before. And that in any case should help going forward. With that precursor to markets in general, I come back to the London market and the retail component of that later on when we talk about risk cost. But let's focus on the P&L side first. Page 5 gives a good overview on the recent developments. I'll go into more details in a couple of minutes.Three remarks I want to leave with you on this page is we are close to EUR 6 billion in terms of new business. Our guidance still holds EUR 10 billion to EUR 11 billion as the official guidance with the qualification that it's most likely and probably at the lower end of the figure, which I just named. And to be very clear with you and I said that before already, I'm not sorry if it's below that. We put quality before quantity. We do have volume targets as well but never ever at the expense of the quality of the business which we want to write. And I'd like to make that very clear. The other point is, we did work on cost and we did work on cost income ratio saying that we have increased our forecast for the entire year also implies cost increase on 2 elements, one is risk cost and the other one is on general and admin expenses. Now not to the tune, which might be insinuated here by the figures of EUR 60 million plus as a difference between EUR 199 million and EUR 136 million will be certainly lower, but it will be higher than the EUR 48 million, which we indicated for the third quarter. On risk provisioning, the relevant figure to compare against 9 months '18 result is minus EUR 3 million. I'll come back to that. And that leaves us with year-to-date ROE before tax of 7.6%. I will use the Page 7 to comment on a couple of points, which are not being followed up by [ thicker ] pages thereafter. So it starts with the NII line EUR 298 million to EUR 334 million, which is a 12% increase. I'll come back to some drivers of that in a minute. Let me comment briefly on the fair value results in Q3, which are being driven on one hand by negative impact from Italy -- valuation of our -- fair valuation of our Italian exposure. And a negative pull to par on one hand and a positive impact on derivatives evaluation driven by slightly higher interest rates. A cautioning remark on the Italian exposure, you know that we have in Value Portfolio approximately EUR 1.6 billion in terms of nominal values. Now the piece which goes through profit and loss is a small fraction of that is an EUR 80 million underlying nominal, which shows some variations of fair value, but in a very limited manner. So the fluctuation impact from that is rather encapsulated or rather small. The year-to-date figure is again influenced as we had already in second quarter, influenced by the pull-to-par, of course, and by the heat of recovery in Q2. Realizations I'll come back to later and the operating income as another point to comment. 2017 picture is being positively influenced by shares from legacy portfolio in 2017. 2018 figures result from precautionary build up for reserves or legal costs notably for potential derecognition of upfront lending fees, which are being put in jeopardy by high court verdict some time ago, I think it's 2 years now, which we reported on and there was another verdict coming in this year, similar verdict on cap and floor fees and client derivatives being -- having been to be derecognized. We reported on that. We built some provisions for that. I think we are cushioned for any claims which may come home. There's a number of small items in that position on outstanding taxes provision for moving cost and so on. So that's it, that closes with EUR 171 million pretax after expenses on bank levies and write-downs, which I think don't warrant further comments. With that, I turn to Page 8 and some comments on the NII developments. Now first point, as I mentioned, average balances on real estate filings up by 3% year-end and 5% year-to-date on weighted average base. That's been supported on the asset side by resilient margins and gross interest margins around 160 basis points. That's been further bolstered by fee income incorporated into the lending margins, so not to be mistaken with provisions and commissions such as agency fees, which are shown in the provision line. But also, what we sort of take along as [ upfront ], which is leveled out the lifetime of loan has increased and has supported margin so that the gross revenue margin, we report on gross interest margin, but let's keep that to the gross revenue margin has hold resilience stance and has been developing actually quite nicely. That's it, on the decline side on the asset side of the business. Against that, we have a number of developments, which we also have to keep in mind. And that is the flows, the revenues from flows, realization of flows has been lower. The [ spec ] which we received from the equity book is lower. And the same goes for the liquidity book. And the contribution, because of reducing volumes and contribution from Value Portfolio in public investment finance portfolio, is also lower. These are negative effects on the asset side, which counterbalance the positive client-based outcome of the NII development as we go forward. Now while all that in itself balances as a asset contribution to margins, the funding side has been definitely positive in terms of bringing up negative, bring up net revenue margins due to low funding cost for new business, lower funding cost were to replace existing high cost debts further reduction of funding as a gross figure. And that all in all, did work on positive NII development and positive net margin development as we have discussed it. Net income from realizations, it's somewhat slower because we see less prepayments in 2018, which is good or which sort of preserves run rate for the future. The prepayments are at EUR 3 billion versus EUR 3.7 billion last year. Now the figures for fourth are quarter still open. Typically and traditionally we see more prepayments coming in at the end of the year. So we have to watch out for that as well. The other point is risk provisioning, which I want to comment in a bit more detail. Now first of all, the provisioning which we show is well within guidance forecast plan and so on. We talk about increase from minus EUR 3 million to minus EUR 10 million, with gross EUR 17 million being baked into that figure. In principle, what you see and what your observe is -- the risk provisioning is driven by 2 counterbalancing effects. First of all, the general loan loss provisions according to IFRS 9 in Stage 1 and 2, which are still very much driven by favorable LGD and PD developments. That's the result of still benign markets and the conservative risk profile, which we hold. And it does not work as a good predictor for coming trends, but it presents the present market situation.Against that, we see specific provisions reflecting specific developments in subsegments. And having said that, and having given a general overview of commercial real estate market, let me insert some observations on U.K. markets and U.K. retail markets. While the overall sentiment still holds reasonably and remarkably firm, despite Brexit, I'm talking about U.K. markets now, retail is going weaker. [ ROE ] is going up across all sub-segments. The London market as much as the rest of the country is still holding remarkably well. The prime west end and city developments are still favorable, office take-up is slowing down or is not growing. But on a high-level still good absorption and occupancy is good. The prime rents are stabilize; rent-free period is stable. So all the perks and some factors which you normally take as precursor to price changes, are holding up remarkably well. 50% of the developments are pre-let. A large chunk of investments are being represented by large global investors, which go into the market with a lot of demand, with a lot of equity and facing lack of product. So what we observe is that for these markets, more or less stable prime yields for West End around EUR 375 million and for city, EUR 425 million with higher values -- sorry with higher yields for the rest of the country. Against all that, retail take-up is thin and investment activity has slowed down. We see [ little ] transactions there and we see impact on price as you could observe. So there is some concern about retail expenditure of private households in the wake of Brexit and concerns around that. And we also see some renegotiation of rents. What is important in this context here is not all retail is alike. There are different dynamics in retail markets and we have to carefully segment and distinguish these different dynamics. The other retail classes besides shopping centers, which we look at and, which we are invested in, is retail parks, Hyde Street. Hyde Street comes with offices, [ normally ] that's the usual Oxford Street, Brompton Road, Fifth Avenue or Park Avenue kind of offices with Hyde Street retail attached to it. Neighboring shopping, which is food and things like that and factory outlets. Those are categories where the basics and the fundamentals still works the right direction as opposed to shopping centers, hypermarkets, department stores, which we consider by and large no-go or strictly caution areas. Closing remark on that. We have managed down the retail exposure in the U.K. over the last 3 years from EUR 2.5 billion to EUR 1.5 billion. So the overall exposure has been already significantly reduced. The overall portfolio holds roughly 40% -- sorry, 54%, 55% LTV with a 300% interest service coverage ratio where retail U.K. is more or less broadly in line with slightly lower values behind that. And the shopping centers I have been talking about is a smaller fraction of the entire retail business which we write and which we have on our books in the United Kingdom. The coverage ratio, which you also find on the same page, sort of reflects the 11% on the affected U.K. exposure, which we deem to be a sufficient figure for the time being and which affects the overall figures for the risk provision. Now with that, I will turn to Page 10. A quick view on general and administrator expenses and depreciation. Personnel costs were remarkably stable and flat during the entire year so far, with a stable FTE number behind it. We will see more personnel costs coming through in the wake of filling positions for New York and [ digital ] projects in the fourth quarter and the same goes for 2019. The other thing is after finishing some of the regulatory projects, largely in 2017, end of 2017 or to a large extent also in the beginning of 2018, such as we discussed it various times and [ a credit ], the FRITZ project, harmonization of regulatory and risk management data, warehouse and so on. We did see some relief in cost. And we did release some provisions against that. But now as you can see -- sorry, third quarter increasing run rate from EUR 44 million to EUR 48 million. That will also stretch into fourth quarter with some further increase to come. That again is driven by the digitalization by U.S. business and by working on ECB as stipulated projects on writing models and IT. The overall outlook on cost, I would say, for 2018, so third and fourth quarter higher than the first half, but probably not reaching the 2017 figures. Let me now turn to the client page, which is Page #12, I think, most of the points I have mentioned. First of all, the 1:8 rule still holds or 8:1, however you want to take it. We have to work on 8 deals in order to book 1. We have discussed that couple of times, many times with you, that used to be 4:1 in the past. Now that's time bygone. Selection is the task of the day, proper selection in terms of ROE, proper selection in terms of risk. And that's the dynamics, which we have behind that business. Evidently, the United States business plays a larger role by design. If you look into the regional chart, United States, new business was a 14% against share in portfolio of 6% shows where we're heading at. While the German piece holds relatively stable at 45% or 49% in portfolio, which is slightly down against last quarter, but still a significant portion of our business. U.K. new business has come down to 12%. You may remember we had 9% by half year, according to our internal forecast on new business and the business mix, which we would expect from total business. Total business share of U.K. business will probably drop somewhere around 10%. So that also shows how we drive the business there, given the [ how much ] we see in these markets against the 15%, which we hold in portfolio and again, 17%, 18%, which was in the usual new business run rate for the U.K. in the past. Now switching to property charts. Not as an incidental or accidental matter, but as a matter of consciously steering our portfolio, office has become by far the largest asset class or property class, which we look at. You can also compare this nicely against the portfolio, which we hold. Retail is less and is becoming less also in terms of new business contribution. Residential slightly up, could be or should be more. But as explained already, it is a business, which carries significantly lower margin, due to less oscillations in terms of value. The small surprise here is really the logistics portfolio of the share of logistics in the entire portfolio and new business, which I would personally -- would have expected to come out higher. There is more on the pipeline to see. And it's a business, which is very much in demand where we see still possibilities to expand further. On margin side, I've commented on LTV, total LTV as you can read from the footnote on extensions at 57%, a total of 59%, 60% for the new business only and margins hovering around 160 basis points, slightly above 2017 levels. If you would ask me for a forecast for the fourth quarter, we'd probably trend a little bit lower than the 160 basis points because we have a number of larger transactions in the pipeline, as low LTVs, more residential related and consequently, also with lower margins attached to it. In terms of risk return profile, I think very doable, very acceptable deals. And fitting exactly into the risk of strategy as we run it just now. A few words on public investment finance. Now to put it in a nutshell, it's an non-satisfactory development. There's significant lack of supply or suitable transactions. The pricing is not satisfying and to make this story short, we are looking to this business where we assess this business in the context of planning 2019, and we'll come back to that as we will speak about full year results and planning 2019 results. With that, brief mentioning of the Value Portfolio. And first of all, it's a slow run down in 2018 due to maturities. We did do a small transaction with an Italian exposure where we also spent some money on, which is EUR 1 million on the cost side on the P&L in order to offload low double-digit figure and nominal value, so not much to say. Rather than saying we look at smaller opportunities to optimize the portfolio. The next 3 years look at rundown further rundown of roughly 20% in terms of nominal value and 30% in terms of risk-weighted assets. With that, let me turn to funding -- sorry to portfolio profile before we come to funding. Not much news here. I think a very constant and straightforward development. We held on to conservative risk profiles both in terms of LTVs of all for the portfolio as well as country wise with 95% total investment grade on the entire portfolio. The changes you can see on Page 17 where the NPL ratio goes up due to the effects, which I have described, to from 0.4% to 0.7%. Now the increase in restructuring loans of approximately [ 150 ] is attributable to the already mentioned U.K. exposure. And let me reiterate that business is still performing exposure in terms of debt service. What we look at is the valuation topic and we are in the process of remedying that shortcoming in terms of talking to clients for [indiscernible] injection for cash-strapped organizations, accelerated amortization and things like that. The last word on that page is UK-3. No news to share. The process drags on longer than I did expect. We look at that closely. We submitted to regular assessment whether our risk assessment changes or not. And the firm message, which you receive here, is there is no change in our risk assessment plan. Now on funding, I think, what is to be mentioned here is, I think, 2018, we've managed an interesting funding mix. First of all, you see and that is also something, which reflects in overall funding cost for the bank, higher share in mortgage Pfandbriefe. Mortgage Pfandbriefe basically make up 69%, almost 70% of the entire funding with a EUR 4.2 billion or EUR 4.3 billion whereas senior lending -- senior benchmarks and so on come in at 30%. The mortgage Pfandbrief, basically, if you sub-segment that, we launched 2 billion in benchmarks in dollars plus taps, 600 went into foreign currency issues, 400 for the pound sterling and 200 for the Swedish krona and 300 were private placements. I think overwhelming majority of that again in euros. Why do I mentioned that? I think we have a broad issuing platform for the benchmarks that's working nicely. We take much -- we pay much attention to having a decent share of foreign currency -- foreign currency issuances because it comes somewhat cheaper and reflects the local situation which we have in these markets, both in pounds as well as in Swedish krona and therefore, it shows us the placement power, which we have. Now senior unsecured with EUR 1.3 billion quite a bit less than we had last year. Still the vast majority of that goes into senior unsecured nonpreferred. That is due to the fact that change in legislation was only effected in July this year. We did roughly EUR 200 million -- a bit over EUR 200 million in private placements on the preferred side, testing markets, smaller private placements. And also to be honest, a limited need on our side. There is upside potential in that field because ALM wise, we are well placed, we have a significant cushion we come back to that figure on the last page, we have a significant cushion and seeing the unsecured nonpreferred. And we have free hand and enough space to continue senior unsecured preferred issuances for 2019 and following years in order to realize larger market potential there, in order to realize more advantageous pricing. Pricing, as you can see on that Page 19, '17 figures against '19 -- '18 figures -- wish it would be '19 figures. This is the '18 figures with 3 basis points on mortgage Pfandbrief against '17 and 46 basis points against 77 basis points. Now that's with a pinch of salt. You can see that on the Page 20, spreads are going up. And they also go up in the wake of the overall interest rates development in terms of a better differentiation of market demand markets, in terms of risk. So we would expect that and we would also expect that the 46, which is secondary market spread, would come out higher when we do new issuances, new benchmarks these days. That usually prices a bit higher than that. Still the good -- the very good message is that the average prices which we hold on senior unsecured on our books are well above these levels and any replacement, which we do going forward comes cheaper than what we have on our books.PBB direct stable at EUR 3 billion. Still, if you compare that against the 46 basis points for senior unsecured, still the most expensive funding, which we hold, but it is a very stable one, it's a price sensitive one. We can scale it up if we need it, and therefore, it's important that we keep it.AT1, I don't need to go into because we commented on that last time. And just for the sake of completeness, liquidity indicators are all above -- well above internal regulatory levels. Now on capital -- before we come to the numbers, 1 or 2 things to mention. First of all, we do not yet have a new indication for the new SREP ratio for 2018, 2019. That's expected to come sometime this year in November. So then we can comment on that and the other thing is you may have observed, you may have noted, that we have not yet presented stress test results. We are not an EBA, not an EBA bank, which came forth with their results a week ago. As part of ECB stress test, which is in sync and in line with EBA stress test, results are being published at a later point in time. I would leave it at that. My personal expectation on that is that we are not going out of that worse than last year, probably a little bit better. That brings me to the capital ratios. We are at 19.7%, which is slightly higher than the 19.4%, which we showed on half year figures, due the AT1, we are coming out at 26.7% for own funds. We have some improvement over the course of the year on the risk weighted asset side, which is to a large degree, driven by credit risk, by LGD improvements. That is something, which we can also see going up the other way. The new business, which rolls in against the old business on the repayments and prepayments, which are rolling off, are sort of a net figure in terms of additional risk weights.In terms of forecasting the effects from targeted revenue of internal models, Basel IV and the [ draft ] of the new guidelines, we are standing at exactly the same forecast figures, the same forecastings, which we gave a quarter ago. So there's not much of a change. With that, let me conclude my presentation. PBB shows continued good performance, with the PBT of a EUR 171 million for the first 3 quarters of this year, which underlies, which underpins and underlines the solid trends, operating trends, which we have shown for the year. We therefore, have the raised the guidance to EUR 205 million to EUR 215 million, with a stable NII for the fourth quarter. Some further additions to loan losses -- loan loss provisions as well as an increase internal admin expenses. For the new business volume, as indicated, we are optimistic to see a good fourth quarter and heading at a figure, which is around EUR 10 billion. 2019 to underline that -- 2019 outlook is not pessimistic but is cautious. The market environment and the competitive dynamics in commercial Real Estate Finance will become more demanding. I think that's a safe part of the forecast. In addition, PBB expects higher funding costs and additional cost due to investments and regulatory requirements. We believe that for those who are willing to go the extra mile and who stick to their rules and guidelines, 2019 despite all of the cautioning, which I gave, will provide still good opportunities in doing your business. The strategic initiatives against all headwinds, which we have, we need to hang on to, we need to move on in these points. And that's notably the U.S. business with the growing portfolio share to come with a build-out of infrastructure and personnel. And the other point is the digitalization, based on 3 pillars as we go forward. Client relationships, strengthening client relationships through client portals, which we are in the process of building, taking efficiencies which stem from that into the process efficiency within the bank and within the credit processes and back-office processes and look at new products, such as the CAPVERIANT, which we have launched now as a means of being more flexible in placing assets into the markets going forward. So with that, I'm done with my presentation. Thank you very much for your patience and your attention. And I am happy to answer questions if you have them.

[Walter Allwicher, Head of Communications]

[Operator Instructions] First question comes from Johannes Thormann from HSBC.

[Johannes Thormann, Global Head of Exchanges and Analyst]

Johannes from HSBC. Two questions, please. First of all on your NII outlook, where we've seen an increased uplift in realization result. And then you expect this to come down again? What is your view in the next year's on the level of realization result because you have given enough details to margins? And that's the first question. And the second question is, your personnel expenses have been surprisingly flat at EUR 28 million over the last quarter. So is this also the outlook for the next quarters again? Or should we now, with the U.S. office opening, expect an increase there?

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

Thormann, thank you for your questions. Now to start with personnel expenses. One driver, which was not yet the driver for the third quarter, but will be driver for the fourth quarter and 2019 is higher personnel expenses. And that goes with, of course, goes with the opening our U.S. office. We have some people on board. But the cost of it we will see coming through and crystallizing in fourth quarter 2018 and 2019. And we will increase the [ guidance ] of the headcount attributable to the U.S. operations -- will increase significantly. That has to be the natural and the obvious counterpart to the fact that we want to write more business in the United States. And if we want to adhere to our risk standards and process standards, we need to back that and bolster that with sufficient personnel. The other thing is digitalization does not come by itself. The CAPVERIANT has been running on the low FTE or headcount number for quite some time. We would like to build that out because of the strategic value of that going forward for the bank. Strategic value, which we'll try to give more insight to when we talk about full year figures. You know we have been working on that for that quite some time now. I think it is very important to have a platform which allows us to disseminate and to place assets over time in the market. In the long-term perspective, not only municipality loans, public sector loans, but also branching out and reaching out to other asset classes. So that's the other field where we're going to invest in and again, how much that will be is a matter for the next analyst call, early in 2019. Now on realizations, as you observed, the number is down. The number ought to be down because we see less prepayments. We do, in fact, account for, or plan for, less realizations also in 2019, which is the normal and the logical conclusion from being more cautious on prepayments for the coming years. The downside of that is it's sort of -- it drags on the actual run rate. The positive of that is, as we keep things longer on our books, we have more to live on for the next years to come. So in principle and structurally, I always welcome lower prepayments going forward.

[Operator]

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

[Nicholas Herman, Assistant Vice President and Analyst]

Three questions, if I may. Firstly, on capital management. Can you just update...

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

Sorry on what?

[Nicholas Herman, Assistant Vice President and Analyst]

Capital management. Can you update us on your current thinking around that? Particularly, I'm interested in how you intend to prioritize growth versus dividends to achieve financial targets. You have obviously a 19.7% CET1 ratio right now. I expect that you probably have 20% to 21% pre-dividends end of the year. So clearly a very healthy position. Secondly, on targets, it's good to see that you've increased your targets for this year and not wholly unexpected. What I'm interested in is actually what has been the most variance between the previous target of EUR 175 million to EUR 195 million and the new target, presumably that was around funding spreads and loss provisions. So I'm interested in terms of what assumptions there were embedded into your previous plan? And then finally, on UK-3, sorry to keep on coming back to this. Can you provide us with an update on that, please? Because there was just very little information and investors do regularly ask about it. So if you could provide some color on the dialogue between yourselves and the trustee or bond holders as well as with the experts? I'm trying to understand in particular why the process is taking so long? It's been, if I recall correctly, you tried to allocate the losses almost 2 years ago. And I'm just a little surprised that nothing has happened since because what -- I've looked at transaction documents, I'm sure you have a better technical understanding of them than I do, but even so, they seemed incredibly prescriptive to me and it didn't seem to leave much open to interpretation. So that's why I'm a little surprised that it has taken so long.

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

Well, I would put it this way. To start with your third point, I mean, first of all, you would have disappointed me not asking. The other point is, I'm surprised at the lengthiness and the dragging on of the processes as much as you are. It was -- I must confess quite openly beyond my imagination how much paper and how much expert opinions and papers and files could have been shuffled around in such a span of time. We are diligently asking all questions, which still come out of the process. There have not been many questions lately. I cannot sort of by the situation which we are in, and by the legal surroundings of that, I cannot go into more details. And to be frankly, I don't have much more details. I think I did venture to undertake to utter a sort of assumption around how the long process will take, saying that probably by the end of year or possibly by the end of year, we should see more results coming through. I'm not going to make the same mistake again giving any indications about the lengthiness or the possible duration of the process. All I can say is it is amazing how much expert opinions A and B, sort of compare against each other originate a new expert opinion, another expert opinion and all that. The key...

[Nicholas Herman, Assistant Vice President and Analyst]

So what is holding it up? Sorry.

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

Let me finish. So the key point from my side is we look at that on the regular basis for all expert opinions, which we see and all what we see and hear, we have no reason to deviate from our risk assumption -- from our risk assessment around the transaction. For us, it's a matter of time and we patiently or impatiently wait for things to come. There is not much more I can say on that, Nick.

[Nicholas Herman, Assistant Vice President and Analyst]

So it's around -- what's taking so long is the expert process? I mean, that is where -- it is with the expert? That's where the lengthiness is coming from, if I understand you correctly? And as part of that, you sound pretty confident still in your own case. So can I from infer from that you have third-party services look at the case and they and you feel pretty comfortable with it?

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

Well, I mean, first of all, when I say expert opinion, I don't refer to the expert. Yes? The expert opinion is something the expert or the trustee or somebody else may seek for by asking third parties for the expert opinion. And you may safely assume that such a process does not go without third-party opinion being inserted into the overall judgment or the overall process. But that's all what I can say. That's, I think, that's usual in such a process and nothing which is out of the ordinary. So let me turn to the capital management. I think I can answer that pretty brief and short. We'll say something about dividend once we have full year figures. We have no reasons to deviate from our present dividend policy, which we have increased recently. All in all, I think, what you need to take and should take into account is that dividend and stable dividend is an important feature to our strategy and we will contemplate 2018 results in the light of it. So otherwise, as I said before, in terms of giving estimated forecast, what the Basel IV impact will be? What EBA impact will be? I refer to what I've described first quarter and second quarter. We would expect roughly 5%, 5.5% reduction in CET1 due to these effects and that might vary half a percentage point up or down as we go forward. There is no change in our estimation on those parameters. That is as much as I can say on that topic just now. On targets, what was causing the variance, as you called it, in our estimation about total 2018 picture. What it was not -- to be very clear -- was loan loss provisions. Loan loss provisions as we provided for and we may provide for, for the remainder of the year. It was well within our own forecast planned figures and prognostications. The 2 driving factors were by mid of year, my expectation was actually that we are losing more money on gross margins on the asset side and we have been holding onto that much better than I thought. And the other thing is on cost, my expectation was that we pick up in terms of cost much quicker on both sides, personnel costs as well as other administrative expenses, much quicker than we did. And those 2 factors together were the driving forces to revisit the total forecast figure. There is an element, a smaller element of that, which pertains to the Heta extra effect, which we have second quarter. That alone would have not triggered rectification of our forecast.

[Nicholas Herman, Assistant Vice President and Analyst]

Okay. Fine. That's helpful. Just quickly on the capital point, I wasn't asking you -- I understand that you can't provide a number for the dividend, but that's clear. But just if you think about it you're 19.7% now -- add on a couple of billion for risk weighted assets probably takes you down to about 7% -- takes off about -- takes off up to almost less than 3% -- sorry, that EUR 2 billion was the 15% of that, that you guided to in the past, which is considerably less than 5 percentage points, but I think if I take off 5 percentage points at 14.7%, I know that you want to run 13% to 14%, ultimately at 12.5%. It sounds like there's still a significant buffer there. What is -- do you still feel that -- is it literally just for regulatory uncertainties that you need to be at 14% versus 12.5% or is that also for growth of ambitions as well potentially?

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

Well, let's put it this way, what we look at as a sort of interim result as of third quarter 2018, we're coming to a fuller and more thorough assessment of where we think we should land by the end of 2018, and then within the total context of dividend and so on, would give probably more guidance and more appropriate answer to your question than I would do as of today.

[Walter Allwicher, Head of Communications]

We do not have any further questions registered I suppose that's not -- I was about to say not because you don't know how it works, you know exactly how it works. Next question comes from Philipp Häßler from Equinet.

[Philipp Häßler, Director of Research]

Yes, Philipp Häßler from Equinet. I have one question, more or less a clarification, because with the press release from early November you said that you were expecting additional risk provisions for Q4, now you have booked for Q3 for the U.K. shopping center exposure. So how does it work? Do you expect more to come for the same subsector? Or is it more a cautious statement because, I mean, if I understood correctly, the risk provisions you booked in Q3 were due to reduced market values. So how do you know already that you will have to book more in Q4? That's basically my question.

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

Yes, Andreas Arndt. Thank you for your question. Two answers to that. First of all, there is an element of being cautious in that statement. There is also an element of, well, we forecast the figure until the end of the year, which fits well into the overall forecast and well into the overall prediction of loan loss provisions as we see it or expect it to come through in 2018. And it is a reflection of what I tried to explain earlier. It's not so much specific on these subsegmental issues than it is more specific around or unspecific around the observation that low yields and changes in yields will trigger changes in valuations and that we need to be prepared for situations where we take valuation differences from that effect. And that can be U.K., but that can also be something else. But that's the topic in my view, that's the topic going forward, how valuations will developed over the next time. And it's always good to have some cushion for that.

[Walter Allwicher, Head of Communications]

I'm giving a next try. We have no further questions registered. I take this as we have answered all your questions, which leads me to the point of saying thanks for joining us today. And we'll be back with preliminary results at the end of February 2019. Speak soon, take care. Bye.

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

Thank you.