KBC Group NV (OTCPK:KBCSF) Q2 2022 Earnings Conference Call August 11, 2022 3:30 AM ET
Company Participants
Kurt De Baenst – Head, Investor Relations
Johan Thijs – Group Chief Executive Officer
Luc Popelier – Group Chief Financial Officer
Conference Call Participants
Tarik El Mejjad – BofA
Giulia Miotto – Morgan Stanley
Johan Ekblom – UBS
Benoit Petrarque – Kepler Cheuvreux
Kiri Vijayarajah – HSBC
Anke Reingen – RBC Capital Markets
Raul Sinha – JPMorgan
Operator
Good day, everyone, and welcome to the KBC Group Earnings Release for the Second Quarter of 2022 hosted by Kurt De Baenst, Head of Investor Relations. My name is Ben and I’m your event manager. During the presentation, your lines will remain on listen-only. [Operator Instructions] I’d like to advise all parties that this conference is being recorded.
And now, I would like to hand it over to your host, Kurt, the word is yours.
Kurt De Baenst
Thank you operator. From my side, a very good morning to all of you from the headquarters of KBC in Brussels and welcome to the KBC conference call. Today is Thursday the 11th of August 2022 and we are hosting the conference call on the second quarter results of KBC.
As usual we have Johan Thijs, Group CEO with us; as well as the Group CFO, Luc Popelier and they will both elaborate on the results and add some additional insights.
As such it’s my pleasure to give the floor to Johan Thijs, who will quickly run you through the presentation.
Johan Thijs
Thank you very much Kurt. And also from my side a warm welcome to the announcement of the second quarter results. And as usual we start with the key takeaways and that always starts with the final number of the second quarter profit and that was a very excellent €811 million.
As a matter of fact despite difficult circumstances, we all regret what’s happening in Ukraine. The impact of that on the economy and on inflation is becoming quite obvious, but nevertheless, we were able to indeed post an excellent €811 million, which was actually supported by all our activities in all our countries.
As a matter of fact our bank insurance machine has been firing on all its cylinders. The customer loans were up significantly. I’ll come back to that later on in detail, but I can already say 9% is a stellar performance. Same can be said about customer deposits, which also grew on a yearly basis by 9%. We were able to have more net inflows on the asset management side despite the fact that of course, the financial markets had a negative impact on our assets under management.
We were able to sell more insurance contracts than originally budgeted because we have a growth of 9%. With an excellent combined ratio, we were able to maintain our costs at a very decent level, despite a very high inflation and we have hardly any impairment charges.
This is indeed also quite extraordinary given the circumstances. No big surprise that our solvency and our liquidity position have even further improved and now stand at a solid 15.9% and a solid margin upon the regulatory requirements of more or less 50 points percent on the liquidity side.
On the back of that we are happy to announce that we are also going to pay out an interim dividend of €1 per share in November of this year. And that also the return on equity of this first half of year when we spread out the bank taxes over the entire year stands at 15%. Coming back bank taxes they have increased further and very significantly and they are now a whopping €659 million [ph] for the full year estimate.
Let me also highlight that also on the sustainability front, we made further achievements. Actually as a matter of fact, we have achieved all our targets which were quite ambitious when we set them a year or two ago, but we have achieved the majority of our targets, which were forecasted for 2030 already now and therefore we will review them in the course of September.
Also in that perspective reviewing targets, we are also updating our financial guidance on all the numbers, which we have put forward in the first quarter given the changed market circumstances, given the uncertainty which is there. I’ll come back to that at the very last part of the presentation. In terms of sustainability you’ll find more details on page four. On page five you find the traditional overview of the building blocks, but that’s not waste time there.
On page six, you can find the exceptionals in the second quarter results. And once again we have a list of exceptionals which are totaling €32 million negative. This is mainly influenced by the bank taxes in — the extra bank taxes in Hungary. As you know the Hungarian government decided to implement what they call a kind of a windfall tax on certain sectors energy sector was part of them, but also the financial business including banks and insurance companies was part of that windfall tax and that will — that cost in KBC Group €78 million in Hungary.
Now, positive one-off was €68 million, which is this which is linked to the sale of a real estate subsidiary of KBC Insurance Belgium and that is totaling €68 million. All the other stuff is mentioned on the page. For the sake of time, I suggest to skip that because there’s minorly jumps up and down and it results ultimately in the €32 million as I referred to.
If I look at the split up between the bank and insurance activity, then it is a bit better for the insurance company this quarter, of course, influenced by the sorry the taxes bank taxes in the banking side. The split up is 80-20, which is more or less in line with the 85-15 average long-term average.
Okay. Now, the serious stuff the different P&L lines, we go into net interest income. And the good news is that net interest income once again increased this time with 4% on the quarter, 14% on the year which is very good. And this is driven by two things. First of all, it is driven by of course the change in the interest rate environment.
We all know what happens in Czech Republic, where the interest was pushed up by Czech — the deposit rate – sorry, was pushed up by the Czech National Bank to 7% in a very short time period. And also have a similar trend in the Hungarian area where also the national bank has pushed up their interest rate.
It contributes obviously positive on the transformation result in these countries, but also in the Eurozone because of the shift in the interest rate long-term interest rates that has had a positive effect on our transformation result which has increased quarter-on-quarter with €36 million.
In terms of the lending business, we have a very good result on the sales side. We have been able to grow our mortgage book, our commercial book both on the SME side and on the corporate side in a significant manner 9% year-on-year, 3% on the quarter. And is an excellent result without any doubt.
And also on the mortgage book 7% growth. It’s quite significant. So in that perspective indeed, the sales machine has been doing its utmost in this second quarter. And actually is a reflection of what has happened in the full year up so far.
Also on the deposit side, we were able to increase our positions with 9% which is also given the fact that interest rates are now shifting becoming beneficial and no longer detrimental as you know. And negative interest rates are changing to the positive side.
In terms of the net interest margin, net interest margin is increasing. You don’t see it at first glance. And this has to do with the fact that in Ireland which is where we are waiting approval by the Minister of Finance for the sale transactions agree upon with Bank of Ireland.
Of course the book there is shrinking and also the margin is coming down a little bit there. If you would take out Ireland in this comparison in the net interest margin then the net interest margin would have been three basis points higher. So actually also on the net interest margin we were able to manage this in a positive manner.
All other things are components which are more or less growing not necessarily in bigger numbers so dealing room results short-term cash management all that had a positive performance. Our ALM result was — our net interest income generated through ALM results significantly up has to do of course with amongst others the transformation result, but also in the inflation-linked bonds which are located in that book in that part of the P&L line. So in this perspective, positive elements to mention.
This also triggers us to reassess the net interest income guidance and therefore we also increased and the net interest income guidance for full year 2022 to ballpark €5.05 billion.
In terms of the fee and commission business next page, the story is actually a bit different. As a matter of fact, we were able to increase our sales again also in the second quarter despite the very turbulent financial markets and despite the very difficult circumstances we were able to create a net inflow of roughly €0.5 billion. That brings actually the total net inflow for the six months in this year to €2.2 billion. To just give you an idea and to make a comparison possible last year same — last year — full year we had a net inflow of €2.4 billion.
So in this perspective, positive net inflows. You don’t see it in the fee, which are generated by asset management business because of the deterioration on our assets under management because of the performance of the financial market.
Assets under management down €17 billion because of that performance and that obviously reflects itself in the management fees you know how it works. In terms of the entry fees, we saw lower entry fees than previous quarter, but that’s obviously to do with a record quarter which was noted in the first quarter of this year.
All other parts of the fee and commission business you know that the split up between asset management, banking services, securities businesses, 65 asset management with 35% all the rest. We do see in the financial services business good performance and stronger growth on the traditional business like credit-linked fees like payment-linked fees.
We have a slight decrease on the securities business €3 million. It’s not tremendously high, but it is only to do with the fact that we make a comparison between two top quarters namely second quarter last year and the first quarter this year which were record quarters in our securities business in Belgium and Czech Republic.
And therefore, we do see a 3% — €3 million decline in the revenues. Just to give you an idea on the securities business we have 10% more new customers year-to-date compared to the record year 2021. In terms of assets under management already mentioned that that stands at an 8% decline.
Going to the insurance business. We have a stellar performance on the insurance business definitely on the non-life side. We had a 9% growth year-on-year which is indeed very strong is driven by and Belgium, but also of course by the Central European countries Belgium is about 7% growth. Central Europe is more than 10% on average. So it is indeed strong performance.
What is also excellent news there is the fact that the combined ratio stands at 85%, which is excellent because let’s remember we had a windstorm which was very significant about €90 million payment and reserves for the first quarters are included in that 85%. But despite that windstorm, we’re still at a very low level 85%, which gives you an indication how sound the portfolio and how sound the underwriting policy in KBC Group is.
To give you an idea, the combined ratio stands below 90% in all countries 85% Belgium, 85% Czech Republic, 89% in Slovakia, 90% in Hungary and 79% in Bulgaria. In the life business side on page 13, the situation is a bit different. We see an increase on the interest-guaranteed products is a slight increase year-on-year 1% up, always have to take into account seasonal effects.
So let’s be careful when making any comparison quarter-on-quarter. But what is clear that unit-linked was having a decline of 22% on the quarter, and that is of course, it has to do with the very difficult market circumstances we are currently in and people then shift in KBC. It obviously doesn’t make any difference, if you shift from life insurance to investment products, where we had the net inflow. So customers buy their products and take into account, the circumstances and the availability of products at hand.
On page 14, you have the comparison of the financial instruments fair value over the different quarters. At first glance, you would say, there is a significant drop. This is fully related to the dealing room activities. As a matter of fact, the dealing rooms had a good performance with €34 million profit, which is perfectly in line with normal quarters, over the last couple of years. The comparison quarter-on-quarter is distorted by the fact that, in quarter one of this year, the dealing rooms had an extremely good result. And therefore, that is a difference of roughly €80 million.
In terms of all the other building blocks, so equity we realized less equity than in previous quarter, which was a voluntary choice by the way. And in terms of our mark-to-market of our ALM derivatives this is of course positively be influenced, because of the increasing euro rates. We had a significant increase of €50 million.
XVAs which stands for the funding value just count of party value adjustment the market value adjustment situation is pretty stable. Net other income is in principle pretty normal but is heavily distorted by the one-off, I already referred to the €68 million of realized gains on the real estate subsidiary of KBC Insurance, which we more or less offset it by a sale of bonds, where we use the momentum of cutting the losses and investing those proceeds in higher-yielding bonds going forward. So, it’s actually good for the nearby future.
In terms of – on the OpEx side, well the situation cut the long story short 47%, excluding all bank taxes. Cost/income ratio is better than what we budgeted for significantly better than we budgeted for. This is due to the fact that we are able to maintain our cost at a very low level. If you exclude the bank taxes, if you exclude the one-offs, amongst others mainly influenced by Ireland and so the pending sales, if you would exclude those the cost increase is 5% year-on-year and only 3% on the quarter. This is obviously heavily influenced by inflation, which as you know is 8.9% in Belgium, and more than 10% in the Central European countries roughly 15% to 17% in Czech Republic and in Hungary.
So with an increase of 5%, this is pretty low compared to that and that is due to the fact that we were able to decrease our FTEs in the second quarter again. So cost income ratio is 53%, if you spread out all the bank taxes across the year in a uniform manner, and also that is substantially better than what it was last year. Remember 2021, was still a year which was in terms of profit and expenses positively influenced by COVID.
Going forward, of course inflation will further kick in. We are of the belief that inflation is not going to undergo to normal levels in – for sure not this year and also next year probably is pretty high. So in that perspective we expect that, our costs will further increase will go beyond the guidance, which we gave. And costs will therefore go from €4 billion guided earlier to €4.15 billion going forward.
Now as a matter of fact, cost increases are lower than the income increases. And as a consequence the costs the jaws are reviewed as well. We have now a jaw of 4% going forward for the year 2022.
In terms of the bank taxes already mentioned that they increased as well. So we are estimating a €659 million bank tax for full year 2022 and that is more or less 14% of our total OpEx and that is indeed a lot of money.
Going into the credit impairments. As a matter of fact, we had no credit impairments. We had €1 million to be precise of credit impairments. We had €13 million which is related to the pending sales in Ireland and we had to review according to the sales transactions and the current stance of that sales transaction. As you know, we received the approval of the antitrust authorities of CCPC of Ireland on that sale.
And therefore, we reviewed a couple of things and that brought in certain impairments an accounting impairment of €13 million. But the real underlying impairments net were only €1 million for the entire book. So in essence, we do have for the year-to-date release of impairments and that means that the credit loss ratio stands at minus 0.1%. That’s one thing.
The other thing is also that we have — as we have no impairments, we don’t have impairments, which are related to COVID. We still had a covered buffer, which is released in the quarter €55 million, but we use that buffer to further assess our book and take into account potential negative impact of the Ukraine crisis combining with all its additional impacts like inflation, like energy prices going through the roof and so on, and so forth, and therefore, a potential negative impact on our lending book.
That impact was analyzed further. We have all that detail on the pages following and that is coming to a €50 million, €50 million increase of our buffer for emerging and geographical risks which now stands at €268 million.
For good understanding, I repeat it, again, this buffer is not used whatsoever. As a matter of fact, we got some recoveries from earlier positioned buffers. We have recoveries on two assets, which were called direct exposure. We had a buffer put in there, or provision put in there of €50 million. We recovered €20 million, because of the current situation. So as a matter of fact, in total no impairments buffer for emerging risk €268 million and our impaired loan loss ratio now stands at 2.2%.
In terms of Page 18, where you can see how it worked with the COVID buffer and the buffer for emerging risks. The detail is there explained. On Page 19 you see the full detail where you do see that indeed it is built up taking into account several elements. For good understanding I repeat this again, we don’t take into account only risks, which are generated by for instance disruption of gas or oil or disruption, because of business activities, which are linked to Ukraine and Russia, but we also take into account impact, because of the change of economic circumstances high inflation and so forth on our book.
We have there now an outstanding exposure of €6.3 billion. So we increased that up from €5.9 billion. And the total charge we set aside for that emerging risk on those portfolios, which I repeat are not directly related to the Russian and Ukraine business is €168 million.
We also changed our macroeconomic scenarios and that macroeconomic scenario is expressed in the column or in the line E, which added an additional €32 million in the second quarter. For good understanding this was an assessment made by the end of quarter two. We are reviewing that again, because since end of June the world has changed again and the world has not changed for the positive. So we will review that probability 65%, 35% downwards more to the negative than what it is here. So probably we’ll go to 55%, 44% and 1% for the positive scenario.
€268 million estimate for the total buffer at the end of second quarter. And we also confirm the guidance for the credit cost ratio, which was set to be somewhere in between 10 and 25 basis points. Yes, indeed you could say that given where we are today at minus one basis point is pretty conservative, but we consider this to be an expression of further deterioration of the economic situation, and therefore a conservative stance going forward.
So if you take into account, the scenarios of the economic forecast, which we predict that is we will go in — we are in a fundamental slowdown of our economic growth, we have a high inflation. The base scenario which we use is a scenario whereby the European institutions are able to potential gas cuts, full gas cuts of the Russians to mitigate those to the level that we don’t have an energy deficit. So it will be a kind of a speculation scenario.
If you take that into account, we do estimate that there is a negative impact on our lending book and that negative impact is then buffered with 10 to 25 basis points of guidance. In a no-recession scenario, we will be for sure at the short end of the range so close to 10 bps. If we go into a recession for 2022, we are 100% confident that given the €268 million buffer on top, we are very confident that we will not overshoot the 25 basis points end-of-range target for 2022.
All the other pages, which are following 20, 21 are indicating further detail, but I will skip those. If any questions obviously we will answer them happily.
And on all the other countries, Belgium and so on the detail is further in the next following pages, but let me skip immediately to Page 42, where you actually see the summary of all those countries. You see that all countries have been contributing and they have ROACs which go beyond 20%, the national market business unit is therefore negatively influenced by the €78 million of taxes in Hungary, otherwise that would have reached easily that target as well.
In terms of our balance sheet Page 43, you see the growth levels, and there indeed also all growth levels exceeds the original guidance, which we have given. So we gave a guidance of 45% on the growth side. We are now increasing. We are now having 9% on average. We are changing our guidance to 7% in that area. And therefore, that has also a positive impact, of course, on the guidance of our net interest income, which I was referring to earlier.
Let me go into capital now on page 45. You can see the evolution of our capital position. We are at 15.9%, which is substantially higher than the MDA and the OCR. So we have a very sufficient — we have a very interesting buffer compared to the OCR.
Let me also highlight again that this 15.9% is positively influenced by the fact that the Belgian National Bank has decided that the one-off which was added for mortgage loans is cut and has been replaced by an increase of the requirements in the OCR of 33 basis points. So we have a drop of the risk-weighted assets with €3.3 billion and that is replaced by an increase of the systemic buffer of 33 bps in — which is part of the OCR.
Also, we have some changes in the OCR because of countercyclical buffers in Slovakia and in Hungary. That is 10 bps. So we are substantially above the target with 50.9% and then, also giving the profitability allows us to say that we give — we are announcing an interim dividend of €1.
The detail of the capital ratio, how it is built up, you can see on page 47. And on page 48, you see the leverage ratios of KBC, which stands solid at 51% — not at 51%, that would be a lot, at 5.1% part of the thresholds which are indicated by the supervisors.
The insurance company has a solvency ratio of 242%. That is significantly up compared to previous quarter. And that is obviously to do with the fact that higher interest rates play a role. Also, the increasing corporate spreads and the lower equity markets have an impact.
At first instance, you would say that must have a negative impact for sure, but that is obviously in the Solvency II methodology, compensated by the symmetric adjustment factor and the volatility adjustment ratio. So both have a positive effect on this result. And therefore it stands at a solid 242%.
In terms of liquidity, also there a further improvement of our positions. We are at 142% and 158% respectively, in the long term and the short term. So rock solid 70% of that is customer-driven. And in that perspective also we have a TLTRO which is still part of that liquidity ratio €24 billion.
Let me end with two things. First of all, the wrap up. I’m not going to develop on the numbers you already know, but I just want to highlight one thing that is, Kate was launched one-year-and-a-half ago and Kate is now rolled out in all our countries. We launched at the end of July in Hungary, which was the last country to catch up.
So now it’s officially launched in all countries. And what we see in the two countries where it was launched first, Belgium and Czech Republic, it goes much faster than we anticipated. We have 2.1 million users of Kate, which have been interacting with Kate at 11 million times. And why is the number here different on the slide? That is because these interactions are interactions straight through until the end of the issue, which they asked to Kate. 7.7 million interactions, which means that we are interacting with our customers in a more and more Kate way.
What is also fundamentally is that the autonomy of Kate, which means Kate can answer and give a solution to the customer without any kind of help of a human being in KBC Group that, that autonomy is rising. Currently it stands at 50% in Belgium and it stands at 45% in Czech Republic, as we speak. So it means that one out of two questions can be answered by Kate, can be solved by Kate, which means that the NPS by our customer is increasing and is becoming extremely positive.
In that perspective also, I would like to highlight that Kate has been also launching a digital coin. It’s called obviously the Kate Coin, it’s blockchain-based and it is launched and tested already in Belgium and it will be set — will be launched to our customers in September, October.
By the way, for those who say, listen, on the slide you have an autonomy of 40% in Czech Republic, that was end of second quarter. In the meanwhile, it’s 45%, which I mentioned.
So looking forward, well, the economy is going to shift massively. It’s having the impact on what’s happening in Ukraine. We already know the impact on inflation. We do see a slowdown indeed in the growth levels. Our forecast is that, number-wise, we will be not in a recession yet by year-end, 0.4% growth in European level, which intrinsically means if you cut out the spillover effects, that you are having a negative growth in quarter three and quarter four. That’s one thing.
The other thing is that, interest rates grew further, take into account the high inflation. We do not believe that the national banks will get inflation under control by year-end and we do not believe that inflation will be at the expected levels of 2% in 2023 either.
And as a consequence, central banks are going to use interest rates to put more control on that inflation to bring it down. I think this is a narrative which is in the meanwhile accepted by most central banks, including the ECB and therefore we expect interest rates to go up in the next coming period. And the expectation is that, they should go to what is called a neutral interest rate that is inflation of 2% plus 0.5% real interest rate.
So in total, ultimately they should go to 2.5%. The question is by when and the question is by how many rate hikes. So the expectation is that, the 2.5% will only be reached in the course of ’23, ’24. And the short term — so the deposit rate will go up by year-end to the tune of €125 million, €150 million. That is taken into account in all our guidance, which I already spoke about.
I want just to mention one extra thing. We are guiding the total income for the full year 2022 as well. That is €8.4 billion now. That compares to €8 billion, if you do comparison like-for-like. Be aware, that in the previous guidance which we have given, Ireland was included. So the deal transaction was included as well. Given the fact that we’re still awaiting the approval of the Ministry of Finance in Ireland, we do not expect this to happen this year anymore the closing and therefore it’s shifted to 2023.
The €8.2 billion guidance included €0.2 billion. Therefore the guidance has brought down like-for-like from €8 billion taking into account what I just said on the economic evolution to €8.4 billion ballpark going forward. All the assumptions which we have used in those guidances, all of the net interest income, total income, OpEx and the credit cost ratio are mentioned on page 53 in the footnotes and are part of that guidance.
Also, on the long-term guidance, we also reviewed that one. And the most important thing there is to mention that, we do expect the jaws to be at 4%, rather than on the earlier guided 3%. So also there a slight positive impact. We do have reviewed our interest sensitivity that now stands at first year 7%, second year 14% and the third year 17%.
I would like to keep it there. I think that’s it. And I hand over the floor to Kurt, who will guide us through your questions.
Question-and-Answer Session
A – Kurt De Baenst
Thank you, Johan. We will open the floor now for questions. Please restrict the number of questions to two to allow for a maximum number of people to raise questions. Thank you.
Operator
Thank you. [Operator Instructions] Thank you. And our first question is coming from Tarik El Mejjad from BofA. Please go ahead.
Tarik El Mejjad
Hi, good morning everyone. Two questions please. I mean, the first obvious one I would say is your — and this is your latest comment is your assumptions for rate assumptions for your new guidance, especially on the NII. I mean you — it sounds to me quite punchy especially for 2023, as because you seem to have a high conviction that inflation will continue to be very high and ECB has to act through much higher rates than — but this is actually much higher than the forward rates and what most economists expect especially for ’23. So, maybe you can I mean tell us, why you’ve been so optimistic there, especially we are used to you being generally quite conservative? And maybe you can shed the light on what would be your jaws or your NII, your revenue sorry CAGR, if we assume rates going to 1.5% and that will be like the neutral level.
And then the second question is on the assumptions, on volume growth. You — when you look at your — for 2022, you expect a 7% growth, given what you achieved in the first half. So naturally expect some slowdown in second half this year. What about 2023? What kind of volume growth you’re assuming? Thank you.
Luc Popelier
Yes, an obvious question, many thanks. Luc here. Obvious question, the assumptions that we’ve taken in our forecasts, I think the most important ones are the euro yields. And for the short term, the ECB deposit rate. We’ve taken an assumption that the ECB deposit rate would still increase quite strongly, given the fact that the inflation is still very high in Europe and the inflation is driven by a supply shock, not by demand pool. Therefore, we believe that, by the end of the year, the ECB rate will be about 1.25% to 1.5%. ECB deposit rates.
On the longer term, we will be around by the end of the year, we believe given that the short-term rates will go up, but also the long term will further improve to around 2.5 or a bit higher perhaps. These are the most important ones. If we then look at the Czech deposit rates, we assume there will still be another hike of 50 basis points somewhere in September and then it will stay at that level for the full year. And in ’23, ’24 it will come down again gradually. For the Czech Republic, the long-term rates will be more or less around these levels — a bit above 4% and stay at way around above 4% in ’23, but then coming down slightly the next years. I think it’s the most important ones. You take the second question Johan? Okay.
Johan Thijs
Okay. So Tarik, thank you for your second question. So on the loan growth. So, first of all, I mean actually your question was loan growth in 2023. But I mean you know that we don’t predict now or don’t give the numbers now for loan growth of next year or for any other detailed number for next year, we will do that as always at the beginning of the year with a bit of detail which you are used of us.
But let me give a comment on the expectation for the second quarter, the two quarters to come sorry. So yes, indeed we do have a 9% growth of loans in the first half this year. We bring down the guidance to 7%. The reason why it is obvious that is, we do see the fundamental slowdown of the economy.
As I said, we predict at the European level a growth of 0.4% which is a bit different for Belgium and the Central European countries and Belgium is forecasted at 0.3% which is de facto actually a recession because you know how it works how it is calculated. You always have a spillover effect of the previous quarter and Czech Republic and other Central European countries is, 1.5% full year and all the other countries are around 2.2%.
So, it is indeed a slowdown. Now the fact is that, the third quarter obviously the production in the third quarter obviously is already realized. Let me give you an example. When you look at the Belgian situation mortgages are having a throughput time because of legal requirements of three months. So, the production of the third quarter is already produced, that will no longer suffer from further deterioration of the economic growth.
We only start to see that in the first — in the fourth quarter and then obviously in the first quarter next year. So that will be reflected in the numbers of 2023 for sure. And the same can be said about the credits on the SME and on the corporate side. You have already, a big chunk of what this produces already invested and therefore is a given. We will see the slowdown in quarter four and for sure in quarter one and quarter two next year. So that’s the reason why we went down from 97% and that’s what we are going to see further going down in 2023.
Luc Popelier
Maybe just as additional information, the 9% that Johan is referring to is the year-on-year growth. It does not mean that there is a deceleration, that there is a negative growth in the second quarter. If you look year-to-date, the growth is 6%. We think there will be an additional, 1% growth for the full year so it will go to 7% coming from 6% year-to-date. So, you cannot compare the 7% Johan mentioned with the 9% year-on-year number just additional information.
Operator
Our second question comes from Giulia Miotto from Morgan Stanley. Please proceed.
Giulia Miotto
Yes, hi. Good morning. My first question is on costs. So, if I take the 3% CAGR and then I compare 2024, excluding bank taxes with what consensus has for 2022, it looks like the increase in costs is only €160 million more or less which would be a 2% CAGR from 2022. And I was wondering, given your comments on inflation how can you keep costs growth so low?
And then perhaps another question was related on costs around bank taxes and what do you expect there? Some of your peers seem to suggest that, we could have bank taxes everywhere in CE pretty much. There is a very lively debate in Czech Republic. Yes, what is your sense there? Thank you.
Luc Popelier
So, on the cost side. I’ll take that question. First of all, our guidance is excluding bank tax. So that’s an important element. And secondly for 2022, you’re talking about 2022 I believe. The costs — yes. Okay. There we think that the — well first of all, the inflation impact in this year will not be much greater than what was included already in our guidance back in February.
The reason is, I mentioned before that in the SG&A costs the — most of the contracts we have are fixed. So we have to of course have vendors who are trying to get — to increase their prices, but most of them are fixed costs. Then look at salary levels in Central and Eastern Europe, there is normally an annual negotiation around, increase in wages. Of course, there will be some further discussions with unions.
But given that we’re already six months in the year or maybe actually almost eight months in the year, the effect of any discussions would be limited for this year.
The only important factor of course is the increased inflation on salaries that we have in Belgium. And that is an important factor because automatic salaries are automatically indexed. That increase will be absorbed by further savings or to a large extent, absorbed by further savings identified in the organization both in numbers of FTE, but also a number of other savings in the SG&A. As an example, travel expenses we’ve been able to keep it at less than half of the budget. So that is — these are the main explanations.
Giulia Miotto
But sorry, can I just follow-up on costs. What I meant is that the CAGR that you’re giving the 2% starts from 2021. But if you take what — the implied cost for 2024 is and you compare it to 2022, then the reminder between 2022 and 2024 the increase seems very small, considering that as you mentioned inflation implies it to stay quite high. So I’m just asking how the years what offsetting factors do you see? I’m sorry if I…
Luc Popelier
Yeah for that guidance, you should make sure — yes, I should exclude Ireland in 2021 because Ireland was in for the full year. That’s about €200 million of costs that Ireland has. That of course is no longer there in 2024. On the other hand, of course, we have Raiffeisen, which we included as of this year will also be there in 2024. But the cost base of Raiffeisen is half of that of Ireland. So that’s one important correction that should be made to look at the underlying elements. And then the rest is explained by already the factors I mentioned before on the savings that we identified. And yes, the reduction of FTEs that we see going forward as we’ve been doing the last few years.
Giulia Miotto
Thank you.
Johan Thijs
And then going back to — hi, Giulia, going back to your last question regarding taxes and bank taxes. So yes, indeed, you said like everywhere in the Central Europe, there are conversations in some other countries, but it is not yet the case. And then you’re specifically referring to Czech Republic. Yes, indeed in most countries where we are present, we already have bank taxes and the only exception until further notice is Czech Republic. You are right. There are conversations ongoing. There is a discussion ongoing between the authorities and the banking sector in Czech Republic. It’s far too early to conclude that there will be bank taxes. I think that’s an early shot because the discussions are ongoing. As a matter of fact, yesterday evening there was a discussion. And earlier this week there was other discussion with the bank sector and the authorities.
What is clearly true is two things. First of all, the Czech authorities really understand that they need to have a strong banking sector to underpin their economic growth and to underpin the stability of their country. That is for sure. And that is also well-appreciated. And the second thing is that is what we need to understand is of course that the budgetary deficit in the Czech Republic is given as well and they currently don’t have bank taxes. But are you going to combine the two, then you do not necessarily come to a solution where there are bank taxes. You can have also alternatives. One of those alternatives is which is currently being discussed is, how we can integrate the banks more in the for instance, the financing of the public spending of government for instance in infrastructure and I can give other example if you want to. So that debate is currently ongoing.
And what is for sure, I think that’s a guarantee that is the banking sector will be interfering in that funding in one way or the other, which is requested by the Czech government. If it will be bank taxes, we’ll see soon. If it will be something else, then it will be something for instance, which is I don’t remember of if you — I don’t know if you remember the nationally — the national, what’s the name again? The National Development Fund, which was a setup, where also banks were interfering in financing. This can be done in another way, where you use instead of funding capital and so on and so forth. Those ideas currently are on the table. And I think it’s too early days to make a bold statement about taxes as a given or taxes as not a given. So in the next coming weeks will be continued. I think the deadline is within three weeks.
Operator
Our next question comes from Johan Ekblom from UBS. Please go ahead.
Johan Ekblom
Thank you. Can we come back a little bit to the interest rate assumptions? Because I’m trying to pick up on what Tarik said before that we’ve been used to you being very conservative. And when the market was pricing in very material hikes in the Czech Republic, you were always presenting a picture that was based on much more modest hikes? And now we kind of ended up in the opposite situation, where you’re talking about 75 to 100 basis points more hike than the market is pricing in for the Eurozone. What has driven this I guess very different view on the inflationary pressure and incorporating this in your guidance. And I just want to also maybe tie it in with Julia’s question. Is that consistent with the 2% cost CAGR for the next two years if inflation really is sticky enough to force the ECB to go to 2.5% plus by next year?
Johan Thijs
So thanks Johan for your question. Indeed, we mostly the time are indeed conservative on our assumptions and mostly of the time are also — as a consequence modest in our predictions. We were indeed when we were giving the original guidance extremely careful. We did not take into account any rate hikes in the eurozone, which is indeed very conservative.
Now what has made the change? First of all inflation is much higher than what was originally the case when we were giving the guidance, much higher. And then also the lessons learned in Czech Republic are quite straightforward. I come back to what Luc just said a second ago, mind you this inflation is not a demand driven inflation. This is a supply-driven inflation. And that makes also things different. It’s also not true that this inflation is purely linked to only energy prices. It is a combination of what is called core and noncore inflation. So that is quite important to understand.
Now the return of national banks or central banks have changed fundamentally since we gave the first guidance. That is we want — originally they were saying, we are not convinced that the guidance is — that inflation is sustainable. And therefore we actually wait what we’re going to do. The fact was in that perspective more assertive than what we have seen on the European continent and there were two exceptions and that was Czech Republic and Hungary.
What we have learned in those two countries is that the rate hikes, which were taken, and which were quite substantial have not led to a decrease of inflation on the contrary. But still the national banks or the central banks in this case have continued the further rate hike.
Now the rhetoric of the European Central Bank and in that perspective we make indeed or we at least try to perceive what they are saying is changing and said we want to tailor the inflation. Therefore, they made the first rate hike. Now if you combine the two things then it’s quite clear that if the Central Bank is serious, European Central Bank is serious about they say they said listen we want to return to a normal inflation, which is 2%. Therefore, we will adjust — we will use the instrument of interest rates. They have to continue to a level, which is now depicted by us. And for that reason we have increased the assumptions on interest rates short-term to 125, 150. And also as a consequence the interest rates on the longer term are increasing as well.
So it’s actually a combination of the two. If the European authorities leave that position, so if the European Center Bank leaves that position and do not return to a normal let’s say a normal policy that is 2% inflation and a real interest rate of 50 basis points, which in the combination is 250 if they leave that position and they let inflation go, let it lose, because I don’t know — I mean the traditional economic solutions for curtailing a high inflation is interest rate increase. If they leave that philosophy then, of course, our assumption is too aggressive. But if not then it’s perfectly in line with what is said by the European Central Bank and by the other central banks in Europe.
That’s also the reason why we think that the Central Bank of Czech Republic is going to further hike 50 bps in the course of September probably towards the end of September, because inflation is still rising. Despite 7% short-term interest rate it is now at 15%.
Johan Ekblom
But maybe just to follow-up then on the inflation. So what inflation should we think of as an input into the automatic wage increases in Belgium, right? We’re looking at Central and Eastern Europe double-digit wage inflation and it sounds like Belgium should be mid-single digits for the next 12 to 18 months then in terms of the lags of that getting priced in, which makes it even harder to see the 2% CAGR 2022 to 2024 cost being — that implies very, very substantial cost savings, right?
Johan Thijs
Let me answer your question. You’re right and there is a fundamental difference between Central Europe and between Belgium, namely Belgium you have an automatic indexation of your wages, correct? We do expect inflation to be roughly around 4% in the year to come. And that will be automatically put into the wages. That’s correct. But the reference you made to Center Europe, indeed you refer to double-digit wage increases. This is perhaps true for the Central European market, but this is not true for KBC Group at all.
So we have been able to manage our wage increases in such a way. And that’s one of the reasons why the earlier question asked by Julian, how come your cost is not increasing according to the inflation. That’s one of the reasons. We do have the savings. By the way this is amongst others triggered by the increased productivity, which is generated through Kate and the way of using AI applications.
So the investments start indeed to pay off, but also because of the fact that we are able to manage the wage inflation down compared to the double digits you were referring to and down is a significant down. So in that perspective, indeed, there is inflation, but it is not correct to state that in Central Europe we have double-digit wage inflation in our group.
Operator
The following question comes from Benoit Petrarque from Kepler Cheuvreux. Please proceed.
Benoit Petrarque
Yes. Good morning. So I’d like to shift a bit the discussion away of this 2024 level and maybe look into 2023 and the more immediate sensitivity to Eurozone rates. I think you provide plus 7%, plus 12%, plus 17% your one-year, two-year, three-year 400bps, I just wanted to reconfirm with you that it is netted of TLTRO tiering exiting negative charging and also addressing the margin flow.
Because if I do the math that could be actually a plus 25% NII sensitivity 400bps, which if I plug that on the NII, the Eurozone, NII will leave — well will bring me to roughly €700 million for 400bps.
So just speaking about just — talking about 100bps interest rate hike I mean we got already 50. Is that fair to assume that in the kind of next couple of years these 100bps interest rates higher interest rates will result into roughly €700 million additional NII will be useful to get a bit of sensitivity on that.
Second question is on costs. Yes, sorry to come back on that but if — so if I do the math, I think, you expect €4.25 billion of costs in 2024. You’ve got €4.15 billion in 2022. You’ve got this €200 million of M&A effects. So it’s a delta of €300 million for 2022-2024. So that’s roughly plus 3.5% cost growth in 2023-2024.
Is that broadly what you have in your assumptions? Is that the kind of expected cost inflation you have in mind. And I think you were talking about Belgium at 4% see a bit higher. So it means that there will be a bit of cost savings around that figure. So that’s the second question.
And just maybe finally, I see a Solvency II ratio on the insurance at 240% end of Q2 up massively. And I just wanted to ask a question on potential dividends upstream from KBC Insurance. Thank you.
Luc Popelier
Benoit, the questions you asked are very detailed to be honest. And going through that will require a lot of explanation, but the only thing I can confirm is the sensitivity the 1% — the 1% parallel shift for the group as a whole will be 7% on the NII of 2022, yes.
And we should remember 2022. And you can look at our guidance for the group as a whole. So that means that for year one, if you take it from here onwards you take one year going forward that’s €330 million approximately extra.
And of course the next year, because of replication of the portfolio it will be increasing to 17% by year three which is almost €900 million. But for the rest what exactly will be in 2023 and so on that’s quite detailed. We can have an off-line discussion on how the mechanics work. But I don’t think this is the purpose of this call at the moment.
On the cost growth, it’s also, yeah, very detailed that you want and we don’t give any guidance as you know for 2023. We’ve given the guidance for everyone for 2022 and 2024. But I can always stress what Johan was saying that, we do see a relatively high inflation also continuing in 2023, but we have significant productivity improvement projects within the group which will reduce the cost.
And if you then look at what the cost growth will be for 2024, adjusting for the fact that Ireland will be out and Raiffeisen Bulgaria will be in you can see what the actually the productivity gain is against inflation. It’s actually quite easy to calculate over that period. But exactly for 2023 versus 2024, we don’t give that detail.
Johan Thijs
And Benoit good morning also from my side, and then coming back to your question on the solvency position of the insurance company indeed, it’s with 242% quite high. What about the dividend and going forward. So that’s in principle the same as we always do. The insurance company will stream up 100% of its profit to the group.
As always and definitely with the combined — sorry, with the Solvency II ratio of 242% there is no issue whatsoever to be expected from the regulatory side. By the way, we didn’t get any questions from the regulatory side neither on our dividend up-streams in the last two years, so, full up-streaming to the group.
Operator
The next question comes from Kiri Vijayarajah from HSBC. Please proceed.
Kiri Vijayarajah
Yes. Hi. Good morning everyone. Just a couple of questions on my side, so firstly, with the elimination of that mortgage risk weight add-on in Belgium, I just wonder does that have any impact on mortgage pricing in Belgium.
It looks like spreads are already under pressure year-to-date, but is there more to come through in the second half with capital requirements on writing Belgium mortgages is now more generous. And then on the loan impairments, you’ve given guidance upper end of the 25 bps, if there is a recession and that applies to 2022. And obviously, that comes after a very benign first half outcome. But my question is more can you keep to within 25 bps in 2023 in that same kind of adverse recessionary scenario you talked about earlier? Thank you.
Johan Thijs
Hi, Kiri, let me answer your first question. So the impact was indeed minus €3.3 billion on the risk-weighted – the impact of the decision of the Belgium National Bank to get away of the add-on on the mortgages has an impact of minus €3.3 billion on the risk-weighted assets, fully correct. And then they replaced that with an increase of the buffer of the OC buffer. So the systemic buffer of 33 bps. So that’s the mechanics. For them it’s a kind shifted from one pocket to the other but that’s not how it works.
I do agree with you. And because you put it into the capital requirements in a requirement as a buffer in principle you should put that into your pricing. I fully agree with you. How it will be in practice, we’ll see. It is indeed well-spotted that the Belgian market is very competitive and that the margins have been coming down in general in the market and also with us to what it is today. So it is competitive pressure.
There is a declining margin and with what they decided now in principle you should price that through. We will do as always we try to optimize our margin. So that is indeed looking for a higher margin is the red line in the way how we deal with our business but we will not push up the margin at further dispense of market share.
For good understanding, KBC has been increasing market share in the mortgage business to more than 21% in the first year half. So in that perspective we have been having a good trajectory.
On the guidance of the loan impairments, so let me repeat what I said earlier. So we do have as we speak a buffer of €268 million. Let me now do the math a bit differently. We have – let me round the numbers. We have roughly €200 billion of credit portfolio, 10 basis points low end of the range, 25 high end of the range means €200 million low-end and €500 million low-end guidance for this year full year.
So it means that intrinsically, we can absorb if we use all between roughly €470 million and €770 million for this year. So this includes a very adverse scenario. If we do the numbers, if we do our assessment and we stress our numbers, we will be actually even in a stress scenario around 15 bps. So it really needs to go really sour this year to get at that high end of the range reached.
Now your question was about what happens in 2023 when we go into an adverse scenario. Kiri, we gave guidance on 2023 always at the beginning of the year. I can only indicate that if it really goes sour we will not use the entire 25 bps, which we have today and the full buffer which we have today, yes. So it probably will shift into 2023. But what it precisely will be? I give a very clear idea about what I expect this to be for 2022, 15 bps. If you want to have that number you have to wait a couple of quarters. We will give that in the beginning of next year.
Kiri Vijayarajah
Okay. Fair enough. Thank you, guys.
Operator
Moving on to Anke Reingen. Please proceed.
Anke Reingen
Thank you very much for taking my question. The first one is just you were suggesting that you think the environment has been deteriorating a bit, which might lead to you visiting the shifting in your expected credit loss assumptions. But I also want just confirming that this more conservative view is also already being taken into account in your revenue guidance.
And then just secondly on your client behavior. As you said, you have a number of products like deposits, insurance, mutual funds. If you can talk a bit about do you see more clients shifting into deposits given the not-so supportive markets? And I know you said you’re not going to talk about the assumptions on your interest rate sensitivity. But if you can maybe give an indication of your assumption on the deposit beta that will be welcome. Thank you very much.
Johan Thijs
Anke, I’m sorry we had a very bad line. And we understood your second question and I will take that answer for sure but can you repeat briefly your first question because we – none of us could understand what you just said.
Anke Reingen
No problem. When you talked about the expected credit loss and how you do the percentages or the weighting of the different pessimistic optimistic scenario, you suggested that you might shift that more towards a conservative view given recent developments. And I was wondering if you have taken just confirming that more conservative view has already informed your revenue guidance for 2022 as well. But just to make sure that it’s consistent. I hope that came clear.
Johan Thijs
Okay. Now it’s everything clear. So first of all the — so numbers which are on slide 53 on the credit cost ratio and that guidance that — and also on the slide where we have the buildup of the €268 million that was at the end of second quarter and that is still the old scenario.
Now if we shift to the new scenario which is 55% positive, 44% negative and 1% — sorry 55% base, 44% negative and 1% positive. Why 1% positive because of accounting rules we have to have three scenarios. We actually don’t believe in a positive scenario anymore, but that’s something else.
Then this goes up. But that goes up and is still within the guidance of the 10 bps – 25 bps. So it is what — I just come back to the question I answered Kiri’s question I answered the second ago. That still holds in that scenario because that has been taken into account when we set the guidance at 10 bps – 25 bps. So if there is no real issue then the 10 bps – 25 bps range will be low end if everything goes well being speculation if you go into a recession then we move up to the higher end of the range 10 bps – 25 bps. That has been taken into account and that includes as well the change of the probabilities of the different scenarios.
Now has had an impact on our revenues. The guidance which we have given in net interest income and in total income takes into account the economic circumstances as we have depicted on page 53. So therefore we indeed include there what was set on the probabilities of the scenarios as well.
Coming back on your second question on client behavior do we see a change of client behavior? Well, the answer is, yes and no at the same time. Let me explain what that means. First of all, if you compare the client behavior in terms of investment products and then the usage of saving accounts versus investment products then I mean let’s be aware we have never had a better quarter than quarter one in that perspective of investment products. So it was literally top quarter.
So every comparison made for the first quarter is a change of behavior. Okay. This is on the basis of numbers. Now on basis of behavior without looking at the numbers there is a slowdown indeed in the shift to investment products. For good understanding, we had net inflows in the second quarter as well. And the net inflow is one-third of what it was in the first quarter just to express how extremely good the first quarter was.
The expectation going forward that is if the situation on the financial market keeps as volatile as it will be if we go into the scenario whereby the Russian authorities decided to put a full cut on the gas supply to Europe. And therefore, Europe — and Europe is not able to manage that energy cut in an appropriate way. So we will have an energy deficit that will have a negative impact on the behavior of our customers. There is no doubt that this will be the case.
And for that reason we do not we do not guide. We don’t — we never give guidance on fee and commission as you know. But we do not guide to multiply the first half year by two for getting the numbers of the second year half. There’s no way an option. We do see that slowdown already happening.
Do we shift — do you see more shift towards deposits? The answer is no. We do not see that happening. What we do see is that we have a lot of inflow from other institutions. And for that reason deposits increased with 9%, but we do not see more shift from investment products for instance to saving accounts.
What we do see is a shift, of course, within the products and that is true for Central European countries. So from traditional saving deposits more to term deposits that is indeed giving high interest rates and the pass-through to our customers in Central European countries. But in Europe the eurozone we don’t see this yet. If the interest rates are going to increase on the saving deposits then things might change, but at this instance we don’t see it.
Anke Reingen
Okay. Thank you. Thank you very much.
Operator
Our next question comes from Andreas Scheriau. Please proceed.
Unidentified Analyst
Thank you very much. I want to come back to the rate assumptions and apologies in case I missed the answer to this particular question. Market pricing is for an ECB terminal rate of around 1.3% at the end of 2023 whereas your revenue CAGR assumes 2.5% terminal rate from 2023 onwards my understanding.
And given there’s such a big difference between the two, I think it would be very helpful to understand the downside risk to your revenue guidance. Would you be able to quantify where this revenue CAGR, could be if you put through let’s say 1.5% terminal rate? And if not could you talk about it more qualitatively?
Luc Popelier
Yes. No that’s indeed a very valid question and we do have the answer to that question. Obviously, we make our own sensitivity calculations. But unfortunately, we’ve decided here not to give any guidance on such a scenario. We just stick to the 1% sensitivity, which is a impact on the full curve of 1%. In reality obviously, that is not the case. If you would say, the deposit rate will be lower by say about 100 basis points you don’t necessarily have also a shift of the long-term. So we unfortunately can’t give that guidance.
Andreas Scheriau
Okay, understood. Thank you very much.
Operator
[Operator Instructions] Thank you.
Raul Sinha
Hi. Good morning. It’s Raul Sinha here from JPMorgan. Sorry, I’ve — my pin didn’t work, someone else registering for the call. I’ve got two questions if I may. Just firstly, on your targets, am I right in thinking that the IFRS 17 impact is kind of excluded from targets on revenue and cost CAGR? And just to understand that in a little bit more detail, is that because it’s not very material for you, in terms of the impact from a cost-to-income ratio perspective?
And then secondly, if I can just ask about Czech Republic where you’re assuming gradually declining rates. Have you changed your hedging policies recently in Czech Republic in order to perhaps protect the NII from rate cuts? I’m just trying to understand if the sensitivity of NII when rates start falling is going to be similar to the sensitivity it was more recently when rates were going up. Thanks so much.
Johan Thijs
Hi, Raul. Thank you for your questions. Regarding the target setting in IFRS 17, so IFRS 17 has not been included in the guidance, which we have given for obvious reasons. Obviously, IFRS 17 is going to change completely the way how we are going to report numbers and we will give you some insights in the quarters to come.
And for good understanding and also in that perspective, a clear cut what is for sure is that IFRS 17 has no impact on our solvency ratio, has no impact on our common equity ratio, as a consequence of the way how we validate — value the KBC Insurance into the KBC Group and has no impact on our dividend policy. I think that is one of the main important conclusions we already have. Further detail we provided in the next coming quarters on specifically IFRS 17.
Luc Popelier
And maybe on the way we hedge our positions, in particularly the Czech current accounts and savings accounts. We have indeed are shifting our strategy, already for more than a year by the way. So we are reducing — we had reduced. The duration was already quite short versus our benchmark and we’ve been extending or lengthening the duration on the replication portfolio since a while already.
That is the reason why our sensitivity to a 25 basis point Czech rate hike has decreased from — in the middle of last year €30 million to €25 million in the third quarter and by — to €20 million in the fourth quarter. And we gave new guidance in the first quarter of this year. That sensitivity has further reduced to €15 million. And that will remain around €15 million, because it was the full year guidance that we have 2022 versus 2021.
That included everything. But you can see that the sensitivity has come down quarter by quarter by quarter. That means that we’re lengthening the duration and therefore, protecting our interest income for further downward — well, for a reduction in the some of deposit rates which we expect as of 2023-2024.
Operator
We have currently no further questions in the queue. [Operator Instructions]
Kurt De Baenst
If no further questions then it is time to wrap up this call. I would like to thank you for your attendance and hope you remain healthy. Take care and enjoy the rest of the day. Cheers.
Operator
Thank you for joining everyone. That concludes your conference. You may now disconnect. Please enjoy the rest of your day. Goodbye.
Be the first to comment