Deutsche Pfandbriefbank AG
XETRA:PBB
Earnings Call Analysis
Q3-2023 Analysis
Deutsche Pfandbriefbank AG
Against the backdrop of a particularly challenging environment marked by high interest rates, inflation, geopolitical uncertainties, and shifts in real estate dynamics such as remote work, the company has increased its risk provisions, particularly for the second half of 2023. The bank reflected these challenges in its increased loan loss provisions (LLPs), which grew from EUR 21 million in the first half of 2023 to EUR 104 million in the third quarter. Moreover, the company foresees a stabilization of real estate prices leaning into the first half of 2024.
With the aforementioned factors taken into account, full year guidance for 2023 has been adjusted. The bank anticipates a pre-tax profit (PBT) of EUR 90 million to EUR 110 million for 2023, with a positive outlook for 2024, expecting to reach a PBT of EUR 200 million and move towards a target of EUR 300 million by 2026. The guidance incorporates additional risk provisioning and strategic investment expenses. Despite a downturn in certain U.S. asset classes leading to value corrections, the bank remains profitable and is on track to meet its 2026 targets. Net interest income (NII) has shown improvement in Q3 and is expected to continue this positive trend.
In an extremely challenging market environment, the bank has preserved its operating resilience through effective cost-cutting measures and strategic investments in new business lines. These efforts include process optimizations and investments in digital capabilities to achieve a total cost reduction of EUR 45 million by 2026, with 80% anticipated to materialize in 2025. Expenses for these strategic measures are expected to conclude over the next year, resulting in a significant cost reduction and aligning with the overarching strategy.
In light of the commercial real estate market conditions, the company is contemplating a conservative approach to its dividend distribution, prioritizing a base payout ratio. The special dividend, usually dispensed during favorable times, is not expected for the current period. Nonetheless, the base dividend will be determined post the year-end results, signaling a forward-looking decision-making approach that takes market conditions into account.
On the European front, despite risks and the addition of EUR 178 million in non-performing loans (NPLs) in Q3 2023, the risk costs associated with these loans remain low at EUR 8 million. The contrasting volatility between European and U.S. markets is noted, with the former seen as less volatile. No provisioning for development loans in Europe has been necessitated thus far, indicating a stable outlook for the bank's activities in this region.
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Good morning, ladies and gentlemen, and welcome to the Deutsche Pfandbriefbank AG conference call regarding the Q3 2020 results. [Operator Instructions] Let me now turn the floor over to your host, Andreas Arndt.
Yes. Good morning, ladies and gentlemen. Welcome to our analyst call regarding PBB's third quarter and 9 months results for '23, which follows the first set of first release, the figures, which we announced and published already last week. I will walk you through the key developments in Q3 with a particular focus on risk provisioning and the U.S. portfolio, and we'll try to give you an outlook for the full year for 2023 and beyond. After that, I will be happy to take your questions as usual. Before going into the slides, please allow me for some summarizing comments. We continue to navigate in a particularly challenging environment given the sharp increase and still high interest rates. There's still too high inflation, the geopolitical and economic uncertainties as well as the structural changes in commercial real estate markets, which all seem to take more time than expected earlier this year just to think about the structural challenges around the new work or remote work and ESG, which are the key words here. All this, we reflected a sizable increase in risk provisions in the third quarter. And indeed, for the entire second half of the year 2023. We, however, maintain that PBB is and remains overall well positioned. But even though focused on prime and core, we cannot escape from some of the individual and singular high dynamics on asset quality in certain areas and asset classes, especially in the U.S. office segment. There's currently only very few transactions take place and present offers are strongly driven by opportunistic investors, the so-called bottom fishers. We have, in some cases, to account for decreases in expected market closures that derive from low bits of comparable assets, which cannot be ignored even though 1 could question the sustainable fundamental valuation. Thus, we have increased our total LLPs from EUR 21 million for the first half of '23 to now EUR 104 million for the year-to-date third quarter year 2023 figures, but this is based on a revolving ongoing and thorough portfolio review and cover amply the cases we know. We also have built in a further amount for cases we do not yet know. We have not yet identified for Q4. Taking this into account, taking into account the overall difficult times in commercial real estate, and taking into account that the stabilization of prices will overly come second -- first half 2024. We decided to adjust the full year guidance for '23 million to EUR 90 million to EUR 110 million with a decidedly more positive view and outlook towards '24, where we see the bank subject to this situation, of course, back to a PBT level of EUR 200 million and on track to move towards a PBT target for '26 of EUR 300 million, as announced earlier this year. This implies, as mentioned, that we invest in the fourth quarter '23 PBT, substantial amount of further risk provisioning and further invested expenses for our strategic agenda in '26. In short, the [indiscernible] downturn in certain asset classes, notably the U.S. office leads to some value correction on some selected individual cases, which were beyond our expectations which are amply provided for in Q3 and Q4. While overall portfolio quality remains strong. We remain profitable for Q3 on an isolated basis, for the 9 months and expected full year '23 with still significant profit as our revised guidance shows. And the operating trends remain intact, in particular, NII after week show in the first half year of '23 has improved markedly and expect it to continue strongly also in the fourth quarter '23, and we remain fully on track to deliver on 2026 targets. And that sort of turns around to Slide #4. As mentioned, due to increased risk provisioning and substantial business invest, we adjust our PBT full year guidance of '23 to EUR 90 million to EUR 120 million. This is based on increased LLPs of minus EUR 104 million for the first 9 months in '23 and anticipate a further noticeable Q4 addition to potentially including a management overlay, which remains to be seen, caused by still dynamic market situations. Thus, we follow our risk conservative approach in reaction to the ongoing weak commercial real estate markets, especially in the U.S. However, given PBB's sound financial strength, we are still able to deliver significant PBT of EUR 91 million for the first 9 months despite increased risk costs and substantial expenses the strategic agenda '26. As you know, we are calibrated on Page 4 since quite some time and in specifying the base I orientation intends to move the so-called on the move to the so-called foundation internal rating base to approach the FIBA and has discussed this with the ECB. After a transition period in '24 with somewhat higher risk parameters, we expect CET1 ratio to return to about 15%. We are September, as we speak, at 15.2%. After implementation of Phase IV in '25 and here to inform you ECB and folds on Friday and the portfolio and other banks informed on Friday that they expect the implementation of Base IV fully fledged by the first of January '25. This will provide for 3 things. First of all, we have opportunity to move to the FBA, which is and will be the most preferred and most suitable standard for low default portfolios. It somewhat anticipates for the interim parameters. It somewhat anticipates market-related changes parameters in current market environment. And third point is it will lead to an overall more stable regulatory capital ratios in future. Taking into account the challenging situation in the real estate market, we assume that unlike in previous years, the special dividend will not be contemplated and will not be distributed. However, the overall dividend proposal remains subject to the conditions of DB's dividend policy and will be decided upon and communicated together with our full year results in '23. All in all, as I already said at the beginning, we remain fully on track to deliver the '26 targets with an increase in NII and NCI of 20% quarter-over-quarter. The portfolio growth stands at EUR 1.2 billion with a continued margin increase on the business margin plus 30 basis points. Strong retail deposit growth, that's a plus of EUR 1.5 billion year-to-date and significant cost cutting to set for delivery from '24 onwards, going back to the levels of '22. And in total, taking out costs to the tune of EUR 45 million until '26, of which 80% is planned to materialize in '25. On Slide 5, you see the operating and financial overview you accustomed to, and that sort of should show you that despite -- irrespective of these operating trends are intact and significantly improving. The year-to-date new business volume remains solidly within guidance, which we lowered to EUR 6.5 billion to EUR 8 billion earlier this year, amounting currently to EUR 1.7 billion in third quarter and EUR 4.2 million for the first 9 months and is well supported by our actually new business pipeline. Gross new business margin stands at elevated level of 200 basis points. The portfolio is further up by EUR 300 million in Q3, thus showing a strong growth of all in all, EUR 1.2 billion year-to-date. We expect a further growth to about EUR 31 billion by year-end with continued margin uplift. Going along with the further buildup of our cost-efficient retail deposits, which is also reflected in our NI and CI development, strong increase, as I said, in Q3, EUR 233 million. That's 20% up Q-o-Q or quarter-over-quarter. The full year figure is expected at around EUR 480 million, which is well ahead of our latest guidance, which did stand at EUR 450 million. General admin is driven by expenses related to our strategic agenda '26. As you know, '23 is our year of investment on our path towards '26 year-end figures to turn out higher than initially expected out of the business investments we still have on the plate, i.e., we will be coming out more around EUR 260 million or slightly below EUR 260 million, while former and previous estimate stood at EUR 235 million. On LPs, a few more words in a minute. And all that together, despite increased risk costs and substantial investments into our strategically tender '26, we are able to deliver significant PBT of EUR 91 million for the first 9 months and expect to remain profitable also in Q4 while accounting for further risk provisioning on the conservative side.
Now on Page 7 or Slide 7, the usual overview on the P&L, which I will only address selectively. We're making good and even better-than-expected progress on the earnings side. As I always told you that it will take some time to gain momentum on NI after digesting the loss of TiO2 benefits and flow income, which at that time, we indicated at a minus EUR 70 million impact on NII. Actually, we see even better development than we initially expected with a strong uplift in Q3 and on the 9 months year-to-date basis against previous year. NI and NCI that's only slightly down from EUR 358 million to EUR 349 million, and we are catching up on that figure. This mainly reflects the real estate finance portfolio growth plus a significant uplift in portfolio margins. Increased level of new business margins since Q4 last year is now gradually contributing to the overall portfolio margin. The positive momentum has strengthened by the favorable buildup of our retail deposit base, also Tier 2 related hedging instruments, which still did burden the NII in the first half, has now fallen the way which strengthens NII level going forward. Furthermore, we benefited from loan extensions and payment of past due interest. And as I said before, overall level is expected to stay high and grow further. We said earlier this year that we aim at a faster rundown of our noncore portfolio, which is the now combined value portfolio in Public Investment Finance. Hidden reserves on assets and spread advantages on our issues did allow us for higher realization income of EUR 45 million, benefiting from sales from noncore units i.e., optimization of public investment funds value portfolio and liability buybacks to the tune of EUR 24 million within this EUR 45 million. And as you may not be surprised, prepayments, prepayment is actually currently not happening, it's not the flavor of the day. Net operating income, mainly driven by -- was mainly driven by releases of provision for litigation costs in the third quarter. Those were -- those what I referred to as the reserves for all time about potential litigation claims regarding administrative fees, and time but litigation claims to round out participation rights and other things. Last line, I would comment on, on this page is on the net income and write-downs. -- which is slightly up, reflecting regular depreciations and extraordinary full depreciation on the software subvariant which, as you may remember, we discontinued in the first half and of course, the increased investment spend on client culture and credit workplace as the key initiatives on the IT side, on the technical side, on the digitalization side. within our 2026 program. Now on Slide 8, the significant increase in risk reducing is mainly driven by the strong dynamic in the U.S. markets. especially the U.S. office segment. What are the specific drivers. Now in general, the market environment is highly challenging, driven by high interest rates, as I said, high inflation, seduction uncertainties as well as structural changes. The used market is more strongly impacted than, for instance, to European affecting, as I said, some in the video, as I said, some individual loans and accounting for 80% of the new NPLs. The problem in short is not an average 20% to the 30% downturn in the market valuation. The problem is about specific individual cases in an otherwise strongly resilient segment of prime or lifestyle or Tier 1 assets with only moderate change in valuation, which is confronted with a sudden significant discount due to idiosyncratic changes in either location quality. The most significant example of that is what happens or happened on the West Coast in San Francisco, Los Angeles and [indiscernible] Seattle, where the CBD was and is still occur by homeless people or by the competitors -- and/or by the competitive situation such as a new development next door, fully green lifestyle office building which absorbs high demand for attractive office environment to attract people to return to office. On the third point, structurally, the vicinity to traffic and commuting points former less desired locations gained to the extent of being closer to the next train station or vice versa and all that exacerbated by the specific syndication structures. By the most action in recent valuation, which the syndicate may have on hand, is meant to deliver an actual and recent and at the same time, sustainable level of valuation. Pricing actually might be severely influenced by bottom fishers in times of low or no transactions. The syndicate decides to go for immediate exit. The opportunistic growth becomes the relevant case instead of the more pragmatic, realistic valuation case from a professional workout scenario of the repossession case, as you may call it. So in short, the combination of various factors of structural changes in locations and preferences such as new remote work, green ESG factors and so on, leads to shift in appreciation of macro and micro locations in May, together with opportunistic price offers or [indiscernible] and the specific syndisituation lead to significant lower valuation than expected within the default values. But what is important also is 2 things. First of all, it's a few cases, not many. It's not on a broad scale, but it is where exactly this constellation of factors come together. And the second point is the provision which we provide takes into account, in most cases, the more conservative side of the situation, i.e., if their bottom fishers out is the bleeding of the consortium is more towards immediate exit. Those are the prices and those are the valuations, which we assume. At the time of origination, all the U.S. offices, which we did finance were 8 properties in 8 locations. Now with the structured shifts, which I try to depict and illustrate some 5% plus, 5% to 10%, mainly considered as a B location, at least temporarily. The structure and very select changes have led to a partially fast and steep target decrease in for prime properties. And at the same time, they showed refinancing cycles in the U.S., together with a faster and more significant increase in interest rates compared to Europe, work on valuation levels in general. However, we believe that 80% of the interest rate induced cyclical market correction is assumed to have happened. Many of prime locations are likely to achieve prime status again in the expected market recovery. And that should not be sort of forgotten on the flip side, on the other side of the coin, the market environment, as we see presently provides perhaps only a few, but attractive business opportunities based on already corrected valuations but is a very favorable margin. Now on Slide 9, some further details on non-loss provisions I mentioned the figures, the risk provisioning significantly increased by EUR 83 million in Q3 and 9 months altogether, EUR 104 million altogether, which was, as I said, primarily driven by already existing used office NPLs. EUR 95 million additions in Stage 3 come from a limited number of individual cases, the majority portion, i.e., EUR 76 million are related to existing office [indiscernible] enters. NPLs, which were booked already before the third, i.e. mainly derived from a decrease in expected market values based on low bids on comparable assets in a very weak market with opportunistic investors only. Individual situations are developing in parts dynamically EG, ongoing negotiations on restructurings or sales process in complex banking consortium is the point in question. With that, I turn to Page Slide #10, which I leave basically for your reading. I think that's the extrapolation of the figures, which you know and revert to the NPL portfolio on Slide 11. The key takeaways are for the third quarter. Overall NPLs increased by net EUR 241 million after some minor releases. The figure is made up by 5 cases, 5 new cases, there are 3 offices and 2 European cases, of which 1 is in Poland and 1 is in France, both with minor LLPs for the quarter, it totaled EUR 1 million. Year-to-date, 9 months is EUR 465 million gross increase in U.S. loans with EUR 390 million net due to 1 removal and technical effects, bringing up the total NPL of U.S. loans to EUR 691 million. This corresponds to Stage 3 LLPs on 12 used loans in total to the tune of EUR 109 million, of which EUR 9 million came from the first half of EUR 23 million, EUR 18 million from the third quarter, new and EUR 76 million from existing loans, i.e., loans before third quarter with additional Stage 3, the other piece booked in the third quarter. And 11 out of 12 properties in question are office, 1 is mixed use retail and office. Now aside from the provisioning on the Stage 3, which amounts to EUR 109 million. We should not forget that there is Stage 1 and 2 LLPs, which are also being geared up and million EUR 95 million are attributable to U.S. loans. On our use NPL portfolio, we saw a decline in property market values of roughly, on average, EUR 41 million in the last 12 months, which we believe is that equally considered in our actual risk provisioning both Stage II and Stage I and II. In contrast to that, European NPL loans represent the minority, i.e., 5 pieces at EUR 178 million. In France, Germany, Poland and the U.K. with a total LLP stage 3 of EUR 8 million. That shows also, I think, very clearly the different degree to which the European markets and the U.S. markets are being affected and confirmed again the thing which we know since going to the United States that the U.S. markets see much more volatility in value development much faster coming into the curve, but also usually going out of the curve. So to sum it up, LLPs in Q3 mainly result from additions for already existing U.S. NPLs, which so far until half year '23 have required no, only small LLPs the so-called zero LLP NPLs. We are talking about a relatively small number of individual cases, which have turned into NPL in 9 months '23. In total, 14. They have 9 U.S. cases and 5 European cases. Only certain singular areas are affected and the overall quality of our portfolio remains high. And that is something which you can also see on the next page, you've been given a more general view on the real estate finance portfolio. The use portfolio has been reviewed in '23 on a revolving monthly basis with all revaluations are based on external appraisers and again, being reviewed and looked after by internal appraisers as well. There's not 1 external valuation, which has not been vetted also internally and measured and looked after. All in all, this resulted in property value decreases in the last 12 months of average EUR 24 million on performing properties, resulting in still a moderate average LTV of 60%. And an average EUR 41 million, as I just mentioned, on nonperforming properties, so the decreases are equally considered in Stage III [indiscernible]. Office accounts for 80% of total EAD and residential is making up for '16. And the regional setup is in the East, 74%, which is mainly in mostly New York, but also Boston and Washington, Chicago accounts for 12% and the Western cities. The large gateway cities, also another 12%. All those engagements are in gateway cities with the usual characteristics about transparency and liquidity in these markets, which according to the situation is hampered at this point in time. The NPL, the percentage NPL of respective outstanding EAD in the East is 10% as the other regions coming with 30% to 35%. And as I said, the Western cities have a CBD problem with homeless people and rental overhang from the big techs that sort of adds to the structural weaknesses of those regional markets. And Chicago is traditionally high in terms of vacancies, but now certainly at a much higher level than we have seen typically and traditionally before.
Now the overall portfolio. Real estate finance or taking a view on to the total is something which you find on Page 14. In reflection of the current market environment, new business volume remained on a rather low level, slightly up to EUR 1.7 billion, of which brings a total of EUR 4.2 billion for the first 9 months. This is fully in line with our expectations and based on a good pipeline, supports our recent guidance of EUR 6.5 billion to EUR 8 billion. This comes as a continued elevated margin of 200 basis points, i.e., 30 basis points up against last year, while supporting the margin is up in the portfolio and our target in 2016 to lift margins up by 15 basis points. So we are actually better than that. The real estate finance portfolio volume further increased by EUR 300 million in Q3 and EUR 1.2 billion year-to-date to now EUR 30.5 million supported by remaining low prepayments while extensions are naturally higher. We account for 40% of that in the total figure. As we expect even stronger new business in Q4, we set files portfolio should increase further by the year-end to at least EUR 31 billion. A quick look on the new business and portfolio distribution. All in all, we stick to our focused and selective approach with presently lower shares of business in the United States and the U.K. However, what we also should keep in mind is looking ahead and in the longer term, we expect the used market, as I said, to provide attractive opportunities in current market environment. This makes sense where new business is based on already corrected valuations, attractive margins with tight risk parameters and contractual parameters. Now that takes me to Slide 16. Despite the recent valuation adjustments the average LTV on the total real estate finance portfolio stay started at 52%, and the focus remains on prime properties and in city locations and conservative risk parameters. We continue to closely intensively monitor our portfolio in a timely manner. As I said and described already. I'll repeat myself a little bit, but I think it's important to make that transparent. So the first one is in doing so, we do not only rely on external prices, but also have our own real estate appraisers. In this respect, it has to be noted that the appraisals are designed to be both timely and sustainable. But in times of only a few transactions happening in the market, valuations might be influenced by opportunistic of the so-called bottom fishers. These have to be taken into account when a property sale is more likely than a price preserving work out. This is what we currently observe in a few, but important cases. And for those who know, we accounted for in Q3 with significant risk provisioning and for further so far not specified or identified cases. We have anticipated a further substantial amount in our full year guidance for the -- as part of the fourth quarter. As far as risk models are concerned, we still expect further valuation adjustments for PBB's portfolio in Q4 and in '24, which are taken into account in our model parameters for Stage 1 and 2, we increased the risk parameters for U.S. office portfolio valuation-wise to 10%, another 10% on top of what we have already provided for. We've increased the same figure for European office and total office portfolio by 4%. Now as every bank, we also have a funding side, which so far works very nicely. The funding activities reflect lower overall funding requirements due to lower new business volumes, increased substitution of senior unsecured capital market funding by retail deposits. Higher spreads for senior unsecured and funds we are likely to stay on for some time. Retail term deposits come in almost at 0 or negative spreads and effectively counter by its higher overall costs from market funding. Our liquidity position remains comfortable with the LCR of EUR 218 million and NSFR of EUR 114 million. Now that brings me to Page 19 on Slide 19 with a few more details on retail deposits, which I can make short because it's rolling according to plan. 34% after year to date and even 84% up since '22 with now almost EUR 6 billion accounted for by the end of September and well above EUR 6 billion as we speak. As mentioned, retail deposits come at a favorable condition compared to unsecured funding and this supports our NII line significantly. Term money, and that's good. That's what we want. Term money accounts for 85%. This money cannot be called earlier and provides for high stability and planning reliability. Average term stands at around 3 years, thereby is matching nicely the calculation. Slide 21 brings me to capital and risk models. I keep it rather short on Q3 capital ratios. Should not be a surprise that in current market environment plus portfolio growth, we see an overall uplift on RWA. All in all, relatively moderate, but expected loss shortfall deducted from the capital position then results in a reduction of CET1 ratio by 80 bps to 15.2%. And a word about risk models. Since some time, we calibrate our risk models on day 4 levels, as we have discussed with you many times to further specify this approach and to make it concrete -- we will apply the so-called foundation internal ratings-based approach, the FIRBA based on base 4 implementation for our core portfolio. They force to come on the 1st of January 24, as ECB circulated last Friday. And with that date, we should be in a position to apply the new standard. We would expect similar capital levels, as we show today, i.e., around 15%. And one of the many advantages of turning into the foundation approach is we have a simplified model setup with significantly less work and hassle with a standard LGD to be applied. And the higher -- the other advantages, I think the high regulatory model acceptance as foundation approach seems to be the preferred set for low default portfolio in Europe or from the perspective of the regulators. Until the new rules come into effect and in order to avoid costly and tedious adaptations to present standards, i.e., the old foundation approach, we will transitionally apply standardized parameters, which may lead to a temporary reduction of CET1 ratio. However, we remain well above current regulatory requirements, of course. With that, we continue to follow our risk conservative approach. A, we assume that due to ongoing difficult situation on the commercial real estate markets. This equity anticipates a market-related change in parameters in the transitional period, i.e., '24. And B, I think, and that's safe to assume. It would provide PBB with a high stability on our regulatory capital ratios going forward. Now to close the presentation, I come back to what I said at the beginning on the strategic agenda. As a clear perspective on to what we need to do in difficult times to restore the ample profitability of the bank to return to -- return on equity, which suffices capital markets requirements. And therefore, as I promised to you earlier that we give monitoring and transparency on the initiatives on a regular basis. I would go through the next 2 or 3 slides briefly to show you where we are, how we do on this in terms of project work in terms of program work and in terms of operational development. We are, as I said at the beginning, fully on track to deliver '26 targets. The portfolio, the real estate finance portfolio growth. The system works as designed, lack of prepayment supports portfolio growth. The portfolio, as I said, is up by EUR 1.2 billion. New business pipeline supports the full year guidance. And thus, we remain on track to reach our '26 targets of about EUR 33 billion portfolio size. The second point in focus is the margin increase on our core portfolio. New business margin stays is states at elevated level of 200 basis points since quarter '22, which is, as I said, 30 basis points up and is supporting the strategic target that we, on a broad basis, increase our business margin by 15 basis points across the board. Retail deposits, we sold to that a few minutes ago. But the increases are not going to repeat. That's rolling according to plan. and that sort of directly transforms into our earnings, NII and NCI as I have laid out already when we talked about NII and P&L. The gelatin is a necessary requisite for getting these investments done. As intended, 3 remains the year on investment with substantial investments in our strategic initiatives. We will run a bit higher than initially planned. As I said, EUR 260 million is more likely or somewhat below EUR 260 million is more likely than the initial planning. However, our cost-cutting program is set to deliver which you see from the next page, operating expenses and the development over the next 2 or 3 years. Our significant cost cutting is set to deliver from 24 onwards and is aiming at going back to 22 level in '26, overcompensating for operating uplift from new business lines until '26.
Important, what I want to take you along is to remember the cost cuttings are largely predictable time wise and in terms of amount as relating to clearly defined measures the cost reduction, which totals EUR 45 million is planned to materialize already in '25. The agreement with the workers' council was signed last week and confirms our previously communicated target and further uplift in personnel expenses from new strategic business largely is expected largely to be compensated by process and our team measures such as the digital credit workplace. On the nonpersonnel, the start-up expenses for strategic measures expected to fall away in the course of the next year. The new IT setup in state of funds in the state of finalization. The contracts are more or less concluded and will be signed shortly and will bring a significant cost reduction afterwards to the bank through in-sourcing through new IT provider and other measures. And the write-downs in '23 are related to office space optimization which are expected to result in future positive cost effects in addition to immaterial assets, which are to be reviewed in the light of the new strategy. To sum it up, ladies and gentlemen, PBB proves operating resilience in most challenging market environment. Given PBB's sound financial strength, we are able to provide for adjusted but significant PBT full year guidance for '23 of EUR 90 million to EUR 110 million. This is despite significant increased costs with further notice in anticipation of the Q4 addition, potentially also including new bid to be allocated new management overlay and substantial savings of EUR 45 million to deliver on strategic tender '26. All in all, we are fully on track to deliver '26 targets by looking at the increasing NII portfolio growth, margin uplift, strong retail deposit growth, significant cost cutting to deliver from '24 onwards. With that, I close my presentation. Thank you very much for your attention, and I'm happy to take questions.
[Operator Instructions] The first question comes from Johannes Thormann from HSBC.
Three questions from my side, on summary. First of all, the NII was nicely up so far better than planned, but fee income was -- is down on a 9 months despite all your new projects. So the previous revenue planning was really bad. How can you say that you're on track to reach the 2026 revenue targets? That's my first question. Secondly, in terms of OpEx, I would doubt that the EUR 290 million is a slight increase versus the EUR 60. We see another year of restructuring -- we see more of those one-off charges like in the previous years, should we model continued one-offs into your cost base nowadays or what would you consider your underlying cost from 2024 onwards as you just indicated it was slight minuses, but no real numbers to it. And last but not least, on your lending policy and risk costs, we saw probably also need as high charges at your peers but you never recorded the margins they recorded. And it seems like dilemma with your syndicated loans that you were trapped and now forced to do impairments do you plan any changes to your lending policy?
Okay. Now Johannes, thank you very much. On the NII side, on the fee income side, there are 2 things to be considered. First of all, in times where we have less true and real new business, we have less potential to look great and to generate fee income. So that sort of comes with the market situation. The real increase in fee income, and we should carefully distinguish between fee income, which comes with the lending business and fee income, which comes with provisioning business provisions such as investment management. That is still to come in the next 2 to 3 years, which we want to build out and want to achieve this share in total NRI plus provisions of fee income to the tune of 10% to 15% as we go along. Now we started that. The team is there. We expect first placements of a fund debt fund in the first quarter of next year, we will gradually build out the fee income. So those are the 2 elements which need to be considered when we talk about fees. The other 1 on OpEx, I do agree with you, the increase is not small is significant because the investments which we bring on the road are significant. And you were asking for the underlying costs. I think the easiest indication is what we said about the level we want to reach, and that is the -- in absolute terms, the 2022 level of EUR 224 million general admin expenses plus the AFA. So -- and that basically translates from a total cost perspective into a decrease of cost against '23 levels of EUR 45-plus million, EUR 45 million to EUR 50 million. And that is significant. That's a 17% decrease, and I don't know many places and many, many banks, which show that such a restructuring exercise within 2 years or 3 years, basically 2 years because we expect 80% of that being done by the end of '25. '24 will be will be sort of quite in terms of reduction because, as you know, the measures around personnel come into force only during the '24-'25 period. So there's a gradual movement. And the other point is we are exchanging the entire IT, the entire hardware and part of the software in '24, and we have need -- that's a technical necessity to run the old system, the new system in parallel, we will have to pay for that in '24. So we will see some cost reduction in '24 already, but not to the tune as you may wish for. So once that is out, '25 brings the big step down in terms of cost development. And when I say, it's fairly safe to forecast, the personnel costs are being clearly identified and clearly allocated and being contracted by the workers' council in the so-called [indiscernible]. So that's a set and agreed measure. And the alleviations, which -- and the cost cuts, which we expect to come from the IT measures are also exactly planned and part of the overall service contract, which we are in the process of signing and that's also locked in. So I don't say that's all safe and done. There's certainly some measures which are still to be affected and to be implemented. But I would say by and large, the world is clear and is firmly set to achieve the cost cuttings, which I have tried to lay out. Now -- and on the syndication, what you said on the syndication trap in [indiscernible] I think there are 2 sides to the coin. And obviously, we're looking at the not so desirable side of the coin just now. But the good thing about syndications is when you go into a new market, you go with banks you know, banks who know the market and it will take you a long and give you the comfort of better market transparency and guidance in these markets. And this is exactly what we did. And we did we did assume that to be the good approach, the right approach also in terms of diversification of risk and reducing on ticket risk at the same time. And I would do it the same thing again. We have to go from syndication situation to syndication situation. and make our judgments and set out our strategy on that as we go along. There will be no change in lending policy to the tune of saying we only do this in bilateral loans, which is from a risk strategy, not with us anyway because the size of the large institutional loans, which are requested in the United States is to the fact that we probably would hardly suffice their requirements by taking the full piece i.e., taking pieces of EUR 300 million, EUR 400 million, EUR 500 million in a row. If we would do that, if we would have done that, we would have had a much bigger problem just from 1 case. And therefore, I think it is still advisable to go on a diversified way. If you take the average size of NPL loans, you come up with a figure of roughly EUR 50 million. And that's much more digestible also in terms of one-off hits, which you may want to allow for your bank. So yes, it is an uncomfortable situation, but I think it's the necessary outcome of otherwise strategic positioning of the business, which I fully agree with.
Okay. Just a follow-up question on your revenues then. So increase in commission income is really a hope factor because we see nothing from the investment business so far. And the second probably more important thing is net interest income. What would you consider a good underlying level for the next years. The EUR 132 million we are seeing now in the quarter or rather the like a blended range of EUR 120 million coming from the EUR 480 million you guide for the full year?
Now I don't want to sort of anticipate any guidance for '24 at this stage. So that's why I'm a little bit cautious -- but you will see a fourth quarter EUR 133 million coming up again. That's at least what our plan and our forecast is, and I would consider that as a good indicator to go into '24. Unless we say we need to reduce the portfolio, suddenly, the margins all come down or things like that happen. But the adverse factors which we had, i.e., washing out the TiO2 with a negative outlets into the first half of '23, the missing of flows at these effects, which did hamper with our NII results severely and significantly. Those things are washed out.
[Operator Instructions] The next question comes from Boris Ramirez.
I have 3 quick questions, if I may. Firstly is on the nonperforming loans, I would like to ask how you see the evolution going forward? Then the second question is, if you could please remind me on the collateral coverage of the NPLs? And lastly, I would like to ask how you see the NPL coverage, the provisions coverage going forward. I think the issue is backstop would require a 40% coverage within 3 years. If I'm not mistaken, I would like to ask how do you see this going forward?
Now on the 40% back stop, I must confess that I don't have that with me. So we'll come back to you on that one. The other one, the NPL evolution to start with that point. I would put it this way. I mean we're talking about EUR 104 million now for risks, which we know. And we said there's a substantial amount to come for the fourth quarter for things we don't know. Now given the structural elements, which Richard described to you, there's no easy forecast, no easy prediction possible, as you would say, on the retail mortgage portfolio or with consumer finance portfolio where you say we calibrate that around some risk parameters, economic macroeconomic risk parameters and do a forecast on that. It is very much due to the syncratic situation, which we experienced. Now -- but we have identified sort of potential candidates, which may cause trouble going forward, and we have accounted for that -- or not accounted, that's the wrong word. We've put in place in our forecasting exercise for the entire year for Q4 and believe that based on that placeholder based on that forecast, we should be in the position to hold on to the guidance, the adjusted guidance of EUR 90 million to EUR 110 million. Now how much that is going to be in real figures for the fourth quarter is something which I leave to your ingenuity and your calculation if you would assume as a sort of point to that, if you would assume that our guidance of EUR 90 million to EUR 110 million compares with EUR 90 million, which we have booked as PBT in Q3. The more likely assumption for the fourth quarter would be something around 0 to come out with that. And if you take a normalized quarterly results and take that figure as an indication where we would land in terms of additional LLPs for the fourth quarter that should give you some indication of what we see coming along still this side of the year in terms of LLP requirements. Now that's sort of approximation, which you may or may not find applicable. It does not say something about or anything about how much we would of that, we would allocate to a management overlay or not. So that's something which we look at by the end of the year and see what we can do in terms of the overall figures. Now the coverage ratio, if I remember correctly, coverage ratio, Robert, where do we have that? It is relatively low because what we see as a structure is that we have a couple of cases in a few cases out of the 9, which we have built in third quarter. That's -- you were asking about the coverage ratio for the U.S. exposure, I suppose. And the coverage ratio there is more on the side of 10% to 15%, if I remember correctly, Stage 3, 16% is the figure. I hope that answers your question.
I really appreciate your comments and your time. My question was more -- I'm so sorry if I wasn't clear, it was more on the collateral coverage.
Okay. Now the coverage ratio which you're asking for is basically 100% because what we -- the way we calculate is if the loan if EUR 100 million, we hold the security in a collateral of EUR 50 million, then the remainder if it is a performing loan. It is EUR 50 million on the performing side or it's EUR 50 million on the NPL side. So NPL usually -- not usually, but always calculated in a way that the 100% coverage can be assumed.
So if I understood well, Stage 3 loans in the U.S. have a coverage ratio of 16% of provisions? And the remaining 84% is the collateral coverage?
Yes.
The next question comes from Tobias Lukesch.
Yes. Also 3 questions or both from my side. Maybe just a quick 1 on the other income. This legal risk provision. I was wondering how big the amount really was just for modeling purposes. Secondly, did I catch correctly that you were kind of indicating a EUR 200 million pretax profit for '24 in your earlier statements. Then thirdly, maybe touching on risk costs. I was wondering, in terms of developments since you have EUR 2 billion to EUR 3 billion, maybe you can remind us of the number and potentially, also a bit the split regionally. Do you see any difficulties here in terms of development, European developments, maybe even potentially single names. I mean, you read various companies in the newspapers who basically stop these developments. And lastly, I was wondering on the Tier 1 capital. So it seems to me that the acquired 1 capital basically fell throughout the year. Maybe you can give us an indication what the comprehensive income effects are where the Q1 capital standards of 9 months and where you expect that by year-end, so we have an idea basically, from which level then to calculate the further effects.
To come back to your last point, you're referring to CET1 levels, right?
Correct, yes.
Yes. Now as I said, we are at 15.2%. I mean, apart from recalculations around foundation approach or whatever we would assume that we hold that level roughly by year-end. So that's what the expectation is. Then you did ask for risk cost. I wasn't quite clear on that part of the question, risk cost and the development loans in Europe. Now 2 or 3 remarks on the NPL situation in European loans. The amount of NPLs on European loans, which we did account for in the third quarter is EUR 178 million. It's 5 new loans. That compares to 9 NPL loans used on the used side for '23, which amount to an NPL -- additional NPL of EUR 465 million. So that gives you already a sort of indication where we stand in terms of risk cost, European territory or European region versus U.S., which does not come exactly as a surprise, as I said earlier on. The U.S. markets have always been seen as the more volatile one and more demanding parts, but they are quick in sort of building up a crisis, but they usually also quick in resolving a crisis. Now the European loans, the amount which we said against that in terms of provisioning is rather small. It's EUR 8 million altogether, and that compares with close to EUR 100 million on the U.S. side. So that gives you another indication about the, say, volatility of risk cost on this side of the Atlantic and the other side of the Atlantic. Now what as far as development loans in Europe are concerned, we can say, up until now, the situation for the bank is that we have no provisioning for development loans. So what we have left, which is not much is all on current levels. All in all, I'm personally not so much worried about development loans about trigger loans in Europe or in Germany for 2 reasons. First of all, in general terms, the situation a couple of years ago, 10, 15 years ago, the large crisis when developments were abundant in the market. We have now a situation that actually much fewer developments are underway. And if the market should pick up again, that's supply, which will be also picked up again fairly easily. The second point is typically the amount of equity spent or invested in such a development loan is typically much higher than it used to be in the past. And the third point from a sort of -- from a senior loan perspective, first class development, if it is correctly built and correctly seen through in terms of valuation as opposed to 20, 30, 40 years old, existing building can be much more attractive because it's a point of interest where people assume that ESG standards are being uphold that people assume that is the right lifestyle investment being done it is attractive enough for employees to go there. And therefore, the really good investment -- the really good developments, they will have their valuation in their own rights. So yes, I know there are some problems out there. We're luckily not part of that. But overall, I'm perhaps less critical of development loans than others might be. Now the other point, the second question, so working the order from the back -- from backwards, whether 200 million sort of guidance for 2024. I think the way I've mentioned it was saying that we're moving towards it, but I would not give out guidance at this point of time. That's something to be done in the context of fourth quarter results and full year outlook for 2024. So I apologize if I've been a little bit too direct on that. But directionally, I think we should strive for that. But in terms of concrete guidance, that's something which in 3 months' time will be part of the conversation. Now on the first point, I wasn't quite sure on that one, what you were asking for. I think it was related to other operating income, right?
It was the legal provision release, basically. And I think you did not state the exact amount that would be helpful for getting the underlying of the quarter.
First half -- exactly first half of the year, we had 0. And the third quarter, we had 17.
Yes, you have these figures would be just interesting to get the exact amount. .
Yes, 17.
17 for the legal provision release, that's a net number or the gross number of the release, basically, not just the net number for the quarter.
Yes. Yes.
Yes. Okay. And the final one, if I may. So on the dividend policy, if I understand you correctly, it's going to be maximum the base payout ratio of the 50% rate on the kind of net profit that you generate for the year. And so the specialty of the 25% is definitely cut. So we are talking about 0% to 50% from the net profit for '23 as a potential dividend payment next year.
That is, by and large, correct. I think it is understandable that in such a situation with commercial real estate markets being slightly in disarray, to put it this way, that prudence requires that we are also giving a signal out to markets. And therefore, we said is a supplementary is an additional dividend, which we pay in good times. Times are obviously getting better every day, but not so good just now. And therefore, we said we will forgo the 25%. And on the rest, as far as the base dividend is concerned, we will make decisions when it is time to make these decisions, and that's usually after fourth quarter results. And markets will take it from there.
So at this time, we have no more questions. Therefore, I hand back to Mr. Arndt.
Okay. There's not much left to say. The only thing I want to leave with you is, thank you for the discussion for your questions. I hope you're well and all the best to you. Have a good day and [indiscernible] to close on the German note. Thank you very much, and goodbye.