Dear ladies and gentlemen, welcome to the OTP Bank second quarter 2023 conference call. This conference will be recorded. As a reminder, during the presentation, all participants will be in a listen-only mode. After the presentation, there will be an opportunity to ask questions. May I now hand you over to László Bencsik, Chief Strategic and Financial Officer. László, please go ahead.
Thank you. Thank you for joining us today. Good morning and good afternoon, depending where you are on this kind of mid-summer occasion. As usual, we have the presentation available here and also on the website. I'm going through the pages in a rather swift manner, and then we will have a Q&A session. Starting on page two, the quarterly results and half-year results for this year. Obviously, it's an all-time record and by a huge margin. This extraordinary performance was kind of supported partially by one-offs, as you can see. In the second quarter 2023, we had almost HUF 100 billion adjustments, one-off items. During the course of the first 6 months, these were more than HUF 100 billion.
We still have the special tax on financial institutions and the normal tax, and there is another interest rate cap extension as negatives, but these negatives were by far counterbalanced or superseded by positives related to the two acquisitions, which we have concluded during the first six months. First in February, NKBM in Slovenia, and then in June, Ipoteka Bank in Uzbekistan. Both of these banks' acquisitions entail badwill, and therefore the kind of starting when we included them in our consolidated reports, there's a subsequent positive one-off effect.
That is in a huge contrast with last year first 6 months, where actually we had more than HUF 200 billion negative items related to the direct effects of the war, of the Russian-Ukraine War, and also to the negative measures, I mean, from our perspective, at least of the Hungarian government. All in all, this big movement in the adjustments resulted partially in this large year-on-year and quarter-on-quarter improvement. If you look at the, the adjusted profit after tax, it's also a record high number, boosted by some, some one-offs, which I'm going to talk about later on, but mostly driven by low risk costs.
I mean, portfolio quality in general is stable and good. Macro expectations keep improving, therefore, our first line provisioning is less, or even in some cases, we can release provisions due to better macro expectations. I think, a notable number on this slide is the ROE, Adjusted ROE, 28.4%, which is much higher than last year. Therefore, we, as you will see at the end of the presentation, we kind of modified our original expectations for this year, where we had expected similar ROE, Adjusted ROE to last year. Now, it's quite likely that this number is going to be bigger for the course of the year. Slight increase in Net Interest Margin on the group level year-on-year. Some improvement in the cost income ratio.
If you look at the balance sheet, sorry, the PNL lines in, in more detail, and again, there's quite some noise here because of the two acquisitions, which happened in the first and second quarters this year. Therefore, it's worth looking at when we look at the differences between the time periods, to look at the without acquisition rates, growth rates, and then also we have seen some strong movements in FX rates, so therefore, we usually look at the FX adjusted without acquisition numbers. Operating profit year-on-year for six months, up 30%. Strong income dynamics and somewhat still, I mean, strong, but less than income growth increase in expenses. We are in a high inflation environment, especially in Hungary.
In the core business, Hungarian inflation peaked at 26%, so this is really high inflation environment, where cost growth is also strong, not just income growth. All in all, we managed to increase operating profit 30% without acquisitions. On this slide, you can see the risk cost number. It was pretty much zero for the first 6 months of this year, which is in a stark contrast with the -HUF 105 billion we provisioned last year when the war started and we had the expectation that there will be direct and indirect and negative ramifications regarding the portfolio quality of the war. Those negative expectations have not manifested. Portfolio quality is quite stable. It is quite stable also in Russia and Ukraine, which are primarily affected by the war, and also quite stable across the group.
Going forward, talking about Hungary and the core performance. Here, this quarterly improvement, but if you look at the first six months of this year and compare it to last year, there's still a decline, more than 30% decline, and this is primarily coming from the Net Interest Margin, being less, and I will kind of elaborate more on this, on the drivers behind the declining Net Interest Margin. Cost to income also worsen, and this is partially due to the tighter revenue margins, but also cost for assets slightly increased, due to the high inflation environment, exceptionally high Inflation Environment in Hungary.
Adjustments wise, in one-off items wise, last year, first six months was heavily impacted by the kind of war-related losses and write-offs, and then the negative is a much smaller number this year, but still negative coming from the windfall tax and the special bank tax and the interest rate cap expansion. When we look at the other group members, it's a pretty positive picture in almost every. Well, in every case, we improve the profit after tax compared last year.
ROE numbers are quite respectable levels. Even in Ukraine, Russia, especially if you look at Ukraine, and we have the highest ROE in the entire group coming from Ukraine and countries like Moldova, where you would not expect such a good performance, was churning out more than 30% ROE first half of this year. You can also note in this page the increase in Slovenia. Last year, first 6 months, it was HUF 10 billion. This year is HUF 54 billion, and that's because we included the contribution from NKBM, starting from February. Uzbekistan, the latest acquisition, Ipoteka Bank, PNL wise, it's not yet included, but we consolidated the balance sheet as of in the second quarter numbers. The PNL contribution, we don't see yet coming from Ipoteka Bank.
This is going to appear starting from the third quarter this year. Now, I'd like to point out here a very significant development in the group and taking a kind of bird's-eye view and a more kind of strategic look at what happened during the last couple of years regarding OTP as a whole. As you can see, we have gone through a tremendous growth trajectory. I mean, since 2016, we have almost tripled the size of the group, and now it's very close to EUR 100 billion total balance sheet. Part of that was obviously organic growth, but there was a large contribution from the acquisitions that we have made.
The, the flags here represent the, the year of the acquisition when we acquired a new bank in a given country. This resulted in a strong shift in the composition of the group, whereas Hungary used to be 60%-70% of the group profits and in many other metrics like total loan portfolio and such. Today, actually, the profit contribution is around 30%, and the foreign operations now outweigh the Hungarian one. Especially so the, the Eurozone Countries or the quasi Eurozone Countries like Bulgaria, which is about to introduce the euro, their size increased such that they represent today 40% of the total loan book of the group. That's a fundamental kind of growth-.
In overall size, but also internally, there has been a shift in the composition of the group. Hungary, contribution of Hungary shrunk and the rest grew, especially the Eurozone countries. A few thoughts about the new market in our group or the new country in our group, is Uzbekistan. It's a 36 million inhabitant people country, growing very fast. It's a very positive demographics country with median age being 30 years. It's a young and fast-growing population, relatively low GDP per capita, but growing rapidly. High level of education and schooling system, so well-trained workforce and kind of leadership strongly committed to market reforms and improving the well-being of the country and the people in the country.
So this is a country, in our view, on a very, very positive trajectory, where there's a lot of room to grow from a low base and a very clear intention by the leadership of the country to develop in general, and also in particular, regarding the banking sector. If you look at the bank, what we acquired, it's the number five bank on the market, and it's the smallest of the four, five large state-owned banks with 7.7% market share. This, this bank was the first in an expected series of bank privatizations. We were the first buyer of a state-owned bank.
The size, if you look at by total assets or loan book, is certainly not. It doesn't look like a game changer for the whole group. Kind of 4% share within the total. In terms of growth potential and in terms of profit potential, believe that actually is going to have a much bigger role and share in our future story than just a pure loan book or total asset size of the operation. A few words about Russia, Ukraine. In both countries, operation is stable, profitability high. In Russia, the Consumer Loan Portfolio started to grow. We still don't serve corporates with loans, and in Ukraine, we still continue to see a decline in overall loan volumes.
In Russia last year, we paid, paid back all the group funding, so there's this kind of small amount of sub-debt outstanding. Whereas Ukraine is still a gross intragroup funding, despite the fact that they actually keep more of their access security in Hungary than what the funding line to the, to the, to the leasing company in Ukraine. Nevertheless, the kind of gross amount is, is still there. Provisioning continued in, in Ukraine, so we are close to 15%, close to 25% total provisions to total gross loans coverage level, so that includes performing and non-performing loans together. This is quite a kind of comfortable and conservative level of provisioning, we believe, especially so because, again, portfolio quality seem to stabilize.
We, we continue to quantify the worst-case scenario potential impacts on our capitals. In case of Russia, it's 46 basis points, writing off the entire operation. The potential negative impact declined primarily because of the exchange rate. The half value of the, of the equity in Russia declined due to the lower, due to the weaker ruble rate. In Ukraine, the potential loss somewhat increased. That's due to the fact that we are piling up retained earnings. Capital keeps increasing in Ukraine, and therefore, the potential loss from writing the whole thing off is also there. I mean, just a technical remark. I mean, we certainly don't expect in either of the countries, this negative scenario.
We actually, certainly in Ukraine, see a large strategic potential once the country is the kind of rebuilding of the country starts and returning to normal happens, we expect further increase, especially in lending activity. Again, profitability is highest in the group and historically, also high. Whereas in Russia, we are kind of having this very narrow focus of activities, just doing consumer lending, point of sale, loan-driven consumer lending. We even discontinued recently dollar transfers, so that's we are not providing that service anymore to our clients. We even kind of narrowed down with another big step, the type of operations, what we do in Russia.
Next page about revenues, but probably more interesting is, is to go into the kind of different types of revenues. Maybe if you look at Net Interest Income, next page. We try to kind of explain the bigger movements on a quarter-on-quarter or year-on-year basis, and there was an improvement in Hungary, but that was mostly driven by technical or one-off items and also some calendar effects. Without that, we, we, we still have had negative NII growth slightly in Hungary. Whereas in all the Eurozone or Euro-related countries, you see, even on a quarterly basis, strong improvement, and that's due to the, the kind of increasing rate environment and us benefiting from the higher rate environment.
Page, you see the net interest margin numbers, and this trend is very clear. Again, in most of the foreign subsidiaries, we see improvement. We also see a quarter-on-quarter improvement in Hungary. But again, this improvement was mostly due to this kind of one-offs, technical one-offs. Maybe next slide might be helpful to you to understand the driving forces, the levers behind Hungarian NII and the net interest margin. On this page, we try to kind of describe the reasons behind or decompose the different factors behind the decline of NII and subsequently the NIM in Hungary year-on-year. Here we compare 2022 second quarter to 2023 second quarter.
As you can see, there is a HUF 17 billion decline in the NII, and there is a 64 basis point decline in the NIM. Here on the slide, you see the sources of this, the different factors having impact. The biggest one by far is the mandatory reserves and the changes of the mandatory reserve rules. Last year, second quarter, the ratio was 1%, and they paid market rates on this level of reserves. Now, this 1% was increased to 10 in two steps, and 75% of it, of the total pay is only 13%, when the kind of overnight rate in the second quarter this year was 18% and on 25%, since April, there was zero pay. This, this is huge, the impact just on 1 quarter.
This quarter-on-quarter difference, year-on-year. Sorry, this year-on-year difference between the second quarters, HUF 23 billion negative impact here, just coming from the mandatory reserve. The second kind of biggest negative was the acquisitions. When we do acquisitions, we, the Hungarian bank, the core, acquires these assets and these investments into these new acquisitions become non-interest-bearing assets. And therefore, has have a negative impact on NII. Here we just quantified the impact of NKBM acquisition in the first quarter on our second quarter NII, and this HUF 13 billion less NII in case of the core. The third negative was deposits.
Deposits declined. Year-on-year, they went down in Hungary by HUF 500 billion, and there is a part of that is retail and part of that is corporate. Especially in our retail deposits, we have a quite big margin, and any decline in deposits is negative from an NII and in perspective, another HUF 11 billion year-on-year impact. The new papers that we had to print in order to achieve the MREL targets by beginning of next year, that's another item which has negative impact on our Hungarian NII. As the issuing entity, given the Single Point of Entry approach, what we have is the Hungarian bank. We have not yet provided these MREL funds to the subsidiaries.
This kind of waterfall impact of distributing the MREL funds in the group has not so much happened because this only have to be done by year end. This is also quite negative for the Hungarian earnings. The factor which we have talked about before, that we have a surplus of fixed assets, especially because of the kind of actions of the government in making them fixed, is actually quite small in the NII. We also have positives. Obviously, I mean, loan growth is positive. We opened a strategic euro short position in February to hedge the investments into euro assets, primarily the NKBM equity investment, and also Slovenia and Croatia.
This might be helpful if you want to kind of understand at a deeper level, the potential developments and drivers behind our Hungarian NII. Maybe some more detail would be warranted here to explain the deposit dynamics. If you look at the following page. Hungarian inflation, the peak was actually close to 26%. At the same time, retail government bond yields were quite high and provide I mean, some of them are even inflation adjusted. The expected rates on these retail bonds is much higher than the actual one here, what we have on the slide. These two have a major impact on retail savings.
First of all, people use up their deposits in, on, in, at banks to because they, they kind of, save less and spend more due to inflation. Retail government bonds and, and the, and in other investment funds, have attracted a lot of retail savings. If you, you look at these kind of numbers, again, comparing the second quarter year-on-year, overall retail savings increased in the market by 12%. Within this, bank deposits declined by 11, and government bonds and retail investment funds increased quite substantially. What happened in OTP Bank, if you go to the following page, as you can see, pretty much similar trends took place. Retail deposits declined 9%, and this 9% decline is less than the market decline.
In fact, our market share increased by almost one percentage point in a year to 41.8%. Nevertheless, retail deposit volumes declined, and this is obviously a quite costly business development for us, because this is by far the highest margin product what we have at the moment with the current rate levels. Obviously, the big question is how long this process is going to continue. You will see the kind of recent numbers in terms of deposit volumes. We believe that we have been through the worst. In terms of kind of adjustment to the new norm in this kind of higher inflation environment, has already happened.
As inflation drops down, and the, and the potential forward-looking yield expectations on, on retail government bonds decline, we are quite hopeful that this trend will slow down, and then the, the decline of retail deposits slows down. This is something to be seen, and, and, and clearly, this is one of the kind of most important factors when we think about future potential revenues of the-- even on the whole group level. Going forward, volume-wise, loan growth across the group slowed down, especially in Hungary, where we have the highest inflationary environment. Now, these quarterly growth figures are somewhat kind of not misleading, but they, they actually include the impact of the moratorium.
These are kind of performing loan volume growth numbers, and the moratorium ended last year and some, and after 6 months performing, previous moratorium related loans are reclassified into performing. Besides Hungary, Bulgaria doing well, Croatia doing well, Ukraine continues to decline and Moldova continues to decline. If you look at the year-to-date data on the, on the loan volumes, you see that overall we had 3% growth in the first six months without acquisitions. If you also include acquisitions, then the growth rate was actually 18%, which is including NKBM and Ipoteka Bank. After this kind of 3%, six months figure, we believe that we might get actually close to or around 5% growth rate for the whole year.
Therefore, when we will talk about the expectations, this is a line where we somewhat positively revise our previous guidance. If we go to deposits and quarterly deposits dynamics, you can see here in Hungary we have this negative. This is what I told about. Again, financially, the retail decline has a quite a painful impact, but also corporate deposits decline in the second quarter. It's not just in Hungary, but in some other countries, but it's obviously a quite price-sensitive segment. In corporate deposits, we are pricing, actually, we are providing high interest rates, typically. Now, fee income increased healthy, I would say, 14% without acquisitions for year-on-year growth, and the second quarter was particularly strong. There are no particular one-offs here.
This is, this is basically a strong performance, partially driven by the high inflationary environment. I mean, transactions, volumes increase and therefore fee-related income increases. So it's a rather strong performance. Other income, there's a, there's a, an item here which we need to talk about. In the second quarter in Hungary, the revaluation of the subsidized retail loans in Hungary, namely CSOK, the, the, the mortgage product and, and Baby-Expecting Loan, consumer loans. Where, the subsidies are linked to a benchmark which, or a number, which includes the benchmark multiplied by 1.3, and therefore we actually have to, we have to mark-to-market them.
This, this was on a quarterly basis, slight negative re- last year, but this year, due to the strong downward shift of the yield curve, of yield curve, there was a one-off FV fair value adjustment positive we had, had to account for. That's HUF 34 billion, which is considerable from a kind of quarterly revenue perspective of the whole group, even. Obviously, this can, kind of. It's a one-off, but it can continue should the yield curve continue to move downward. On the opposite direction, if it moves upward, then it can turn into negative.
Since we are talking about rather sizable volumes here, more than HUF 800 billion in Baby-Expecting Loan and HUF 400 billion volumes in the Subsidized Mortgage Structure, or not mortgage, but Housing Loan Structure. These are, these can kind of materially impact the earnings as well in the future. Operating costs. We have in three cases, we have kind of larger year-on-year growth numbers. In Hungary, it's 24%, mostly driven by personal expenses, which grew 40% year on year. That's quite a substantial amount, and here the labor market is very tight, and we are trying to be very competitive to attract the best talent.
Therefore, we increased wages in two stages last year in September and this year in March, and they obviously reflect in the in the in the personal expenses. In Bulgaria, this 22% is distorted by the accounting of the supervisory fees in the 1st quarter. Without that, if we accrued them as we used to do, then this 22% growth would have been only 7%. In Albania, the new acquisition which came into our group in last year, in August, increased the cost. That's, that's here the increase is purely due to the fact that due to that acquisition. Capital, capital situation. Despite a sizable acquisition of Ipoteka Bank in the second quarter, the capital ratios improved.
As you can see, the Common Equity Tier 1 ratio improved by 80 basis points, and that's due to obviously of the, of the strong profit and retained earnings increase coming from the quarterly profits. We continued to issue MREL bonds, so we had a $500 million issuance in May, and then in June, we did a private placement of $110 million. We expect to do another benchmark euro deal during the course of this year in order to get to the to fulfill the requirements of next year. Here, one news, which we announced yesterday. Yesterday, we received the preliminary SREP documentation from the Central Bank.
They did the, the, the supervisory review. They, they, initially proposed 120% SREP ratio, which is five percentage point lower than what we have this year. This is a kind of preliminary number, but if it happens that this eases somewhat our, our kind of MREL issuance needs during the course of this year. Europe-wide stress test was done by EBA, the usual biannually exercise, and as usual, we came out quite successful. We are number four, if you measured by the, the kind of change in Common Equity Tier 1 ratio over a 3-year period of the, of the stress scenarios. One of the best banks or the most stable and resilient banks, according to the stress test in Europe, is OTP.
Again, this is quite in line with our expectations and, and, kind of same type of result what we has had before on this stress test. We are not just resilient in terms of our capital situation, but also continue to be relatively conservative in provisioning. You see the coverage ratios compared to some other banks, while the stage three ratio continues to decline, so it's well below 4.25%, even including Russia and Ukraine. Without Russia and Ukraine, it's only 3.4%. We are getting quite far from this kind of 5% magical level, below which banks are not considered high NPR.
A few more thirds, it's usual, on Hungary, without going too much into details, it's clear that mortgage lending is much less active than it used to be due to the high infl-- high rate environment. I mean, disbursements down by 40% year-on-year, applications down by two third year-on-year. Somewhat... I mean, it's positively surprisingly, actually, consumer loans continue to, to grow even in, in, in this environment. Year-on-year, we have 8% growth. In this segment, we continue to strengthen our market share, and it even exceeded 41%. In terms of cash loans, I already talked about retail deposits. Our retail deposit market share continues to increase.
In corporate, large corporate volume growth basically stopped, micro small corporates continued to grow with similar pace to last year due to this kind of subsidized program which still exists, the Széchenyi Kártya Program MAX+ and the Baross Gábor program, which are still available for micro small corporates. We continue to focus on ESG targets, recently, Sustainalytics improved somewhat the scoring of the group, so there's some small improvement there, which we're quite happy to see. We continue to keep this into strong focus. Now, a bit talking about the future and expectations.
If you look at the macro environment, actually this year, it, it seems to be much better than we expected, and even these, these numbers, seem to be quite conservative for me, regarding 2023 and 2024. Outside Hungary, talking to our-... banks and, and management teams in, in, in each of the countries, typically macro expectations, even for this year, are stronger than what we have here. The slowdown happens compared to last year, but not so much. For instance, the touristic season, seems to be very strong in countries of Croatia, Montenegro, Albania, Bulgaria, where they, they have a sizable contribution to overall GDP.
Unfortunately, Hungary, I mean, the most likely scenario is that we, we're gonna stay in recession for the remaining of the year and then come out of it only next year and kind of start to catch up to the neighboring countries. In general, labor markets are quite tight everywhere, so unemployment rates remain low, and therefore credit quality is good, and inflation moderates quite fast, typically in all countries, including Hungary as well. I mean, we just had the recent data coming out yesterday, and it was actually lower than market expectations. We, we continue to believe that year-on-year inflation will be substantially lower than 10%. The recent expectation is actually lower than 7% for year-on-year numbers.
In terms of formal management guidance, and two, we are kind of modifying the previous statements on two lines, basically. One is the growth of expected growth of performing loan volumes. Previously, we said that we expected kind of less than 5%, low single digit numbers, the growth rate. Now, after having 3% growth in the first 6 months, and again, operating environments marginally improving in the second half of the year, we believe that we can reach 5% year-on-year FX-adjusted, white loan, performing loan volume growth. Obviously, without acquisitions, so this is just organic. The other line is the ROE. It, we kind of originally said that maybe ROE can be similar to last year number, somewhere around 18%-19%, and I'm talking here about Adjusted ROEs.
After having 27%-28% in the first 6 months, and credit portfolios remaining strong, it's quite likely, and our current expectation is that the risk cost rate will be lower than last year, cost-to-income ratio might be somewhat better, and therefore, overall, we can have a better, ROE substantially exceeding last year level for the whole year. With this, I'd like to conclude the, the presentation, the formal presentation, and I'm sure you have very good questions to ask. Please, please open the, the floor for questions.
Thank you, ladies and gentlemen. We will now begin our question and answer session. If you have a question for our speaker, please click on Raise Hand icon or press star nine on your phone's dial pad. One moment, please, for the first question. The first question is from the analyst of Concorde Securities.
Hi, can you hear me?
Yes, loud and clear.
Okay, thanks. Thanks for the presentation, and congrats for the very strong results. Just two topics for me to discuss. The first one would be, it was very useful to see how Hungarian margins and, and I, I, improved or not improved or developed in, in the previous quarter or this quarter. My question would be, like, what is the deposit beta in the countries, in mostly Europe countries, where OTP was very strong? I guess it's Bulgaria and Croatia. That would be pretty useful for me. The second topic would be on dividends, because I can see that it's you, you provisioned for, like, HUF 70 billion for dividends, and this is not an indication from the management. Then, could you give us some kind of indication throughout the year?
Because it is quite clear that you have very strong results, you have quite good capitalization, so this should not be a problem. Are you still in favor of cash dividends instead of share buybacks? Thanks.
Yes. deposit beta in retail deposit beta in Bulgaria, Croatia, Slovenia, very low. retail deposit is hardly repriced. In corporate, beta is much higher and the larger the Corporates, and as we go towards Institutional Corporates, it gets actually quite close to even one. But for retail, it remained very low. Obviously that's a big question mark, whether this is going to stay like that or it's just it has not just happened yet. Obviously, it depends on our on the kind of competitive behavior of our competitors. Dividends, it's too early. It's too early to talk about that.
I mean, this is the, it has the deduction what we, what we applied here is, is according to the kind of, this kind of European standard. We haven't, we haven't discussed dividend payments and the magnitude of potential dividends yet in the in the management team. We usually do that at closer to the end of the year or after the end of the year when we have the full picture. As you said, I mean, certainly the the results over-exceeded our our our expectations already, and and and hopefully, then the rest of the year will be strong as well. I hope there will be room for more dividends.
As, I mean, regarding dividends where versus share buybacks, again, this is something which has not been yet addressed or discussed, in the management team. If you continue to perform as we, as we do, this is something we, we, we will address, obviously, and then, and I'll let you know, obviously, the results.
Thank you very much.
Thank you. The next question is from Gabor Kemeny, Autonomous Research.
Yes, hi, László. A couple of questions from me, please. The first one is on the, the core NII. I agree that these are very useful slides on the NII walk. Can you walk us through the outlook for the second half? I, I would be interested in the magnitude of the potential increase in your, in your Hungarian NII in an environment of falling rates, please. And the other question I have is, if you could comment on your M&A pipeline, please, and particularly on Poland, any interest there? I'm asking this in the, in the context of a very large asset being up for sale. Thank you.
It's always a problem when we kind of provide detail, detailed reasoning, then we are asked to be very detailed in the expectations. Look, maybe we can go back to that page. Yeah. Good. Thank you. Some of these stay with us. I mean, there's another acquisition, Ipoteka, which is going to have a similar impact, so it's going to grow the interest- non-interest-bearing assets. A kind of quarterly potential impact from that is, like, HUF 1.5 billion, it's not big. We did MREL, new MREL bonds, this kind of, this MREL impact is going to continue on a marginal level to be there. In the second quarter, we did new insurances which only partially impacted the second quarter.
As I said, we will probably have at least one more or probably have one more benchmark issuance, which is again, this is kind of expected to be slightly negative. There's a big positive expected there. If we... The Hungarian National Bank started to decrease the overnight rate by one percentage point per month, and it's already down to 15%, and we expect it to continue, and by year-end, we expect it, the overnight rate and the base rate together to be below 10%. As previously discussed, our sensitivity in this range, so in the kind of in between 13%-18% range, is roughly HUF 14 billion-15 billion half annualized NII per percentage point.
If you say that there might be, like, five percentage point difference in the rate environment between the second quarter and the fourth quarter, then the quarterly impact, then the kind of NII uplift could be HUF 18 billion. Right? Let's say the expected rate development scenario, ceteris paribus, results in HUF 18 billion+ NII in the fourth quarter compared to the second quarter. That's the kind of big plus, and then there's also lending activities, a few HUF billion coming from new lending activity. All in all, potentially kind of HUF 20 billion+, and then some minus regarding to, to Ipoteka and to the new MREL issuance. The big unknown is this deposit line here, right?
How deposit volumes are going to evolve for the remaining part of the year, especially retail deposits, which are quite high margins. If you go to the, maybe to the deposit quarterly change slide. As you can see, in one quarter, there is -2% deposit change, and overall, deposits declined in Hungary by more than HUF 400 billion. If this continues like this, which I think is unlikely, so we actually expect this trend to slow down and the decline to slow down as inflation goes lower and the rate environment declines, and economic activity picks up.
Having said that, this is, this is the unknown territory, and whereas we have a relatively strong view on the rate environment development and its potential impact, we have a much less strong view on the potential, kind of, deposit trajectory development. In a good scenario, it's going to have a small negative impact, but in a bad scenario, it can even counterbalance the positive impact coming from the lower rate environment. I hope this was detailed enough. In terms of M&A pipeline, we have been quite busy. We just finished two, two big acquisitions. We keep our eyes open, and we certainly look into every meaningful opportunity in the countries where we operate and and kind of around, more opportunistically.
I, I don't have anything to share concretely, on, on this dimension at the moment.
Thank you. All, all very clear. Just to quickly recap on NII. If I understood correctly, around the HUF 100 billion annualized upside from rates and volumes, then some minor negative from Ipoteka MREL, and then the unknown is the deposit side. Is this roughly fair?
Yes.
Okay. All clear. Thank you.
Thank you. The next question is from Mikhail Butkov, from Goldman Sachs.
Good day. Thank you very much for the presentation, and congratulations on the results. My first question is on cost of risk and asset quality. You have recorded quite exceptionally strong result in the second quarter of this year and then the first quarter. One would probably agree that it is, these levels are not those which can be named normalized levels of the cost of risk. The question which I could have is to some extent, about the guidance for the second half of the year and the next year.
How much of the buffers are accumulated from the last years and coverage do you have to keep, to, to allow yourself to keep this level of cost of risk at this low level for a couple of additional quarters, maybe? What maybe are the main factors which you take into account when you consider, either it's... Is, is there potential to allow some additional releases of provisions and reserves, or it, it is, or it is already de-deserves, deserves to get some more normalized level of the cost of risk? The second question which I have is on the loan growth. Following the first few rate cuts, do you see any acceleration already in the demand for loans from your clients, either on the retail side or on the corporate side?
Basically, do you think that in the next year, when rates will go down to single digit area, there will be some recovery to the historical levels of lending growth potentially, or it can take some time? Maybe if you could provide some color on the one-offs, which you expect in the second half of the year. Thank you very much.
Okay. Asset quality, again, I mean, fundamentally, asset quality is driven by the kind of, by portfolio migrations. Portfolio migrations are very low, and, and the portfolio quality is, is, is, is very-- is quite stable. We. If we look at the economic fundamentals and the operating environment, I don't see a reason why it should change. I mean, the macro trajectories are, look, look positive, I mean, even exceeding expectations. I mean, obviously, kind of big, big tickets, if, kind of one, kind of individual, tickets is, is, are, are difficult to foresee, and they might kind of happen, but on a kind of portfolio level, I, I just don't see, portfolio quality deterioration coming in, in, in the near future or, or even mid-future. That's one driver.
The other driver is the IFRS 9 provisions, which are forward-looking, once the operating environment and the macro environment, expectations, improve, we have to somewhat release, provisions. This is very kind of, automatic. This is kind of in a sense that it's model driven. We have the macro assumptions for the... and expectations, the models, kind of provide certain release or additional provision need. Again, looking at the improving trend of the macro environment, there might be kind of further, release of some provisions related to that. That kind of conservativism, compared to our peers, we would like to keep. It doesn't mean that we kind of want to have a, a major release of provisions or change of methodology.
This is, this is not on the table at all. I mean, if, if all goes well, then we... Then, then the third factor in, in, in, in risk cost is the, is the volume growth, right? One of the reasons why we have such a low risk cost is that there's not much more new volume growth. We, again, in the new IFRS framework, we, we actually have to provision after every new loan when we issue the loan. I mean, that means the higher volume growth, the higher risk cost. If the volume growth is low, the risk cost is lower. That's another factor which kind of contributes to this lower risk cost what we had seen in the first half.
All in all, the, the, the, the factors which affected the, the first half, in my opinion, will continue to into the second half. Maybe we will have kind of similar type of environment and, and maybe not kind of zero levels, but certainly low levels of provisions. Loan growth, I guess you refer to Hungary because, where we indeed we see a strong drop in, in, and especially expectation regarding the rate environment is a strong drop even during the course of this year, in line with the kind of inflation normalization. In mortgages, we believe it will take longer for the market to recover and demand to come back. Consumer loans, the, the drop in again, consumer loans kept growing, right?
With a lower rate than they used to, but still positive growth. I think, consumer loans will be kind of faster to recover and reach kind of, previous levels of growth rates, and mortgages will take longer, potentially a couple of years, to, to recover fully. There might be positive surprises there as well. Now, in terms of one-offs, there's this, share swap, kind of, adjustment or fair value adjustment. It will, kind of, reverse in the second half as more is going to pay the dividends. Big question about the rate caps, whether they will continue into next year.
We believe that in that again, by year-end, the reference rate might be well below 10%, or below 10%. Then certainly the SME caps lose their relevance. We are quite hopeful that the at least for mortgages, they will increase the level of the cap from 2% to closer to the market levels, so maybe, I don't know, around 5%. That means that there might be another negative one-off related to the rate caps if they are extended for mortgages, but hopefully that number will be much, much smaller than we have seen so far for two reasons.
One is that hopefully the, the level of the cap will be higher than the current and those, and because the, the, the reference benchmark rates will be lower, the, the actual difference can be even further lessened. Maybe another, kind of fourth quarter negative line on the rate caps, but, but with a, with a much smaller number than what we have seen before. Good, good. Thank you very much for very, very comprehensive, and detailed answers. Thank you.
Thank you.
Thank you. The next question is from Máté Nemes, UBS.
Yes, good afternoon, thank you for the presentation. I have two questions, please. The first one is on costs. Clearly, you're still seeing quite high underlying cost growth year-on-year, but I think on a sequential basis, the trends look somewhat better. I was wondering if you could talk a little bit about the expected seasonality and expected drivers and moving parts in the cost base in the second half of the year. Should we expect a typical pickup towards year-end, or this is not necessarily something that you would count on this year? The second question is on Russia. I think you're still considering strategic options in the country.
Could you update us on, on the, the assessments? Are you talking to, to, to interested parties? Are you considering a potential spin-off? Also, do you see any possibility about upstreaming dividend from, from the entity? Thank you.
Post seasonality, there might be some, but not, not material for a quarter. There's always some items which tend to pile up year-end, but this, this shouldn't be a, a big number. Russia's strategic options, well, we continue to look for for options, but it, it, it looks still very difficult to, to execute, and especially to realize a fair deal and to, to realize a fair value of investment in, in case of a divestiture. This is-- this we consider very problematic and outright banned, banned by, by local authorities. Dividends, we are hopeful. We are working on, on, on upstreaming dividends and, and, and we are quite hopeful that, that it can indeed happen. There's some, some positive development on, on, on that side.
For sure, we continue to kind of narrow the scope of activities, what we provide, and we again discontinued international dollar transfers, which is obviously a controversial business to do in Russia, albeit extremely profitable. As we know, and in our understanding, some of our competitors continue to provide that business for Russian corporates, but we discontinued that. That's, that's another, I think, big step in narrowing the scope of activities and really keeping the focus only on this kind of mass market, retail, consumer lending profile, what we have there.
Thank you.
Thank you.
Thank you so much. The next question is from an attendee joined via phone. I open the line. You will receive an automatic message about it. Please press star six to unmute.
Hello. Hello, and thank you for taking my call. This is Olga Grishina from Bank of America. Before I ask my questions, I wanted to thank you for the detailed explanations in your materials, including this, the composition of Hungarian NII. That really answers a lot of questions and is a great help. Thank you. My first question is about capital allocation. This combination of very solid ROE and muted loan growth brings back the question about what's your future strategy on capital allocation. Do you want to allocate anything that is above 15% CET1 into M&A, or do you want to preserve capital, given that there is this uncertainty around Russia and Ukraine? That, that would be a great help to understand what's your big picture view on how to use capital the next years.
My second question is, again, on Hungary, and again on loan growth. Loan growth can be held by lower interest rates, but also partly it was driven by state-subsidized schemes. My question is: Do you see capacity for the state to keep expanding subsidized lending teams in the next year or years? My third question is: Why did you have provisional release in Russia? My last question is about normalized cost of risk. Could you please remind us your normalized cost of risk for the group, but also maybe separately for Uzbekistan? I know you gave us some numbers historically, but there are brand new parts in this equation. You have added 2 big banks to big subsidiaries, and also Russia, Ukraine still remain in the perimeter of the group.
It would be great to hear what's your updated view on normalized cost of risk for the group. Thank you.
Yeah, capital. Okay, again. The second quarter was very strong and even exceeded our expectations. After the first quarter, the Common Equity Tier 1 ratio was 14.4. I think few people expected it to be about 15% after the second quarter. The trajectory indeed looks quite promising in the-- but we haven't kind of digested that internally. Again, as I said, answering one of the previous questions, we have not kind of structurally addressed the question of excess capital and at what level we would kind of start.
I mean, what level of dividends, what level we should start, kind of maybe buying back shares and, and what to put aside for, for M&A. These are very valid questions, and, and this is, we are going to address these in the, in the near future internally, but this has not happened yet. This is a problem which is, kind of nice to have, right? Certainly this is somewhat earlier. We, we, we knew that this was coming, and we knew that we had to kind of realize these positive developments in the future, but it, it came somewhat earlier than we originally expected, which is obviously very good. Now, M&As, I mean, M&As are difficult to plan, right?
It's, it's great to have access capital for potential acquisitions, but if there's nothing for sale which you want to buy, or not at a price which you consider realistic or attractive, then, then there's not much you can do. But we continue to keep our eyes open for sure. Loan growth-
Apologies. Before we move on, can I, can I just check on this? Do you, do you envisage potential M&A outside of CE? Is it possible?
Hmm, like... Certainly not in the focus, and I, I can't think of anything at the moment, really. What, what do you, what, what do you have in mind?
Well, there are more banks for privatization in Uzbekistan.
I see. We just brought this one, so again, I, I think this is way too early. Indeed, last week, they announced that they, they were going to continue the, the process, and I think even named the, the potential next one. We like Uzbekistan, and then the, the, the more we know, the more we like the, the opportunity there. On the other hand, there's, there's, there's a lot of work to do. We, we need to transform this kind of state-owned, previous state-owned organization into a modern, kind of digitally driven, commercial bank.
We know exactly what to do, but, I mean, there's, there's a lot to do, and we have a very strong management team already and, and, we try to provide every support that we can, but nevertheless, it's going to be a lot, a lot of work. The rewards seem to be quite, quite high as well. I, I'm not in a position to comment on these questions, but, but certainly we, we are very happy with what we have brought and, and what we see as an opportunity there. These questions, again, we will, we will address in, in due course of time. Certainly the, the good performance of the group and the faster than originally expected capital accumulation provides more opportunities and more, more choice, right?
In itself, this is very good, but we still have to work it out. Yeah. Certainly, we are not... What we are not going to do, like, I, I don't think we are going to buy a big Western European bank or something like that, so this is so there's less appetite on that front. It would be wonderful to buy more in the countries where we are present in CE. There's some countries which we really like to further grow, even through acquisitions, but obviously it's always a question of what available sale is. Your second question was loan growth and versus subsidized structures. Indeed, you are very right that the previous growth was partially fueled by these subsidized structures. I mean, the Baby Loan program is still on.
It would be great to have another green housing loan program. It's not there yet, and I'm not sure there will be or not, but demand would be, and the structure, it would be great. You are also right that budget constraints are stronger in the kind of foreseeable future than they used to be a couple of years ago. The room for maneuvering and for providing subsidized structure is potentially somewhat less for the state and for the central bank than they used to be a couple of years ago. That, that's going to have a somewhat negative impact on potential loan growth. Again, consumer lending seems strong even at these levels of operating environment.
As the late environment declines, we are hopeful that the recovery of consumer loan growth will be quite fast, especially when we see real wages growing again, potentially close to the end of this year, but certainly for next year. Retail consumption, which was actually kind of declining, retail has been declining recently. Hopefully, it will come back to a meaningful growth next year. Consumer lending, we are very reasonably optimistic. As I said, mortgage lending recovery will take longer, potentially a couple of years, and maybe we are going to have less subsidized structures there as we refer to. Nevertheless, the trajectory should be positive. In terms of kind of loan growth dynamics, we should see improvement in more...
In consumer, we might reach kind of previous levels. Certainly mortgages, it will take longer. Now, Russian provision release, I mean, again, it's IFRS 9 driven primarily. We always take this kind of 1 year forward-looking window, and the operating environment, using the macro forecast figures, and we plug them in into the models that we have. Then when the macro fundamentals keep improving, typically we release provisions due to the models or coming from the models. In Russia, we particularly kind of we're delaying, in a way, this release. Then we try, we use kind of conservative approaches to the models to, to delay, to delay it as much as possible.
We, we, we kind of lost for other reasons and, and, and, and, and we just kind of followed the models as they are. It's, it's basically due to improving macro expectations and also due to strong portfolio quality. The, the staging has improved, and portfolio migration is very low. Actually, we have probably best ever portfolio quality in the consumer lending book, and corporate, it pretty much disappeared. And there was a kind of a small, kind of technical, one-off release due to the, you know, Euroclear clearing house and the, the bonds there, what we created provisions. We released some because we got ruling that they will be paid, but that was a kind of smaller item. Normalized cost of risk, that's difficult.
I mean, if you continue to have such a... I mean, to be frank, I, I, I don't anymore know what the normalized cost of risk is, because, I mean, certainly it was, it was not a big crisis, but it was certainly a considerable worsening of the external operating environment last year and this year, compared to previous years. I mean, and, and now I'm putting aside Russia and Ukraine, but it's just the C countries. Last year, this year, C countries risk profile continued to be as good as in, in-- it used to be in previous years. It seems that the portfolios, what we have, seem to be quite resilient to, to... and, and, and in a way, structurally, potentially lower risk than, than what we used to have.
I, I think we still need to work on that to understand the implications of this. I think it's related to overall penetration levels still being low. It's related to the job markets being tight and unemployment not going up, and despite high inflations, wage inflations to be strong as well, or just kind of good policy measures. I don't know, I think kind of surprised and positive last year and this year. The additional provisions we created, especially for Russia, Ukraine last year, they were not warranted, right? The, the portfolio quality is even in those two countries where, I mean, in Ukraine, we have a war, and a huge war in the country. Despite of that, it's remarkably resilient, our portfolios behave.
I think these, these recent developments. I mean, if you want to draw a conclusion, then one conclusion might be that probably the risk profile of Central Eastern Europe in loan books might be more similar to Western European risk profiles than we had thought. That means potentially structurally lower, kind of normalized, if you wanted, risk or say, for, for the portfolios in these countries. Certainly it helps a lot if we don't have FX loans. I think FX retail loans historically turned out to be difficult, especially if they were not in the FX currency, which was anyway related to the economy, like Swiss franc or, or dollar, or things like that. But this is something to be seen.
Once you are through this kind of macro adjustment, what happened due to the war last year and this year in CE countries, I think we will have to put some time into maybe reflecting in our models and expected risk models. Because certainly what we have seen is better what we kind of originally had had expected.
Yeah, that, that's great. Thank, thank you, László. Can I just have check on the Russian asset quality? You mentioned that it's, it's actually very solid. I thought Russia has been expanding criteria of borrowers who can apply to banks for debt forgiveness. Do you have such borrowers at all, or these are usually not your clients?
These are not our clients.
Good. Thank you.
Mm-hmm.
Thank you. The next question is from Michał Konarski, mBank.
Hello, can you hear me now?
Yes.
Yes, perfect. Sorry for that. Just a quick question about Russia. Just quite recently, press reported that Russia is planning to introduce windfall profit tax. From what we've learned, actually, OTP probably could be subjected, yeah? The question is, do you have any preliminary calculation, what would be the impact of such a windfall profit tax? Is it any meaningful number or not? Thank you so much.
I hope they are not going to introduce windfall profit. No, we don't have preliminary calculations.
Okay, thank you so much.
Thank you. The next question is from Mehmet Sevim, JP Morgan.
Good afternoon. Thanks very much for the presentation. Just one follow-up to my colleague's earlier question on NII sensitivity. Your guidance for sensitivity was HUF 15 billion for each percentage point, until rates reach 13%, as you explained earlier, László. Could you please give us any indication of sensitivity for rates below 13%, if possible, maybe at least for the cuts that you're expecting by the year end? On the drivers of NIM decline at core, I just wanted to follow up again on this euro open position, given the 33 basis point impact there, which looks quite big. Just for me to fully understand, if you could please repeat what that is exactly. Is that a derivatives instrument for hedging purposes? If so, does it have an expiration date? Could that positive impact reverse at some point?
Any color would be very helpful. Thank you.
Mm-hmm. It's HUF 7 billion approximately, the NII sensitivity below 13%. It's a hedging position. It's an investment hedge, so. It's an open position, a short euro position, and we have a positive carry here. It's by quarter, right? We have this positive carry by quarter at the level of the half rate and the euro rate in the second quarter. The HUF 14 billion is a positive carry. It's not a one-off revaluation, and it's a hedging position, so there's no PNL impact. Mm-hmm.
Okay. That's very helpful and clear. Thank you very much. If I may squeeze just one more, and that's on Ipoteka and the consolidation. I see that the total amount of deposits that were consolidated, looks somewhat smaller than what the bank itself reported earlier this year. Just wanted to check what happened at the consolidation, if there were any adjustments, or are these just organic outflows? Then, maybe more broadly on the funding position there, can I ask how comfortable you are there with the very high LDR, and given the very strong growth profile, maybe what will be the funding strategy there going forward? Will you change, or will you try to gather more deposits, or will you be relying-
.O n the state funding programs, etc.. Any, any color there will be very helpful as well. Thank you.
Deposit volumes, I'm not aware of, kind of declines. We, we did a PPA, and, and, and we assume, we, we did adjustments on, on, on the, on the kind of asset and liability sides based on, on the customer values. I'm not aware of this being negative, so I, I don't have an immediate answer to that. In terms of loan to deposit ratio, yes, it is, it's high, and we definitely will continue to rely on the, on the state subsidized structures, for the current, of, of the current portfolio, for sure. The current refinancing structures will continue, and then if there will be any further subsidized program, we definitely want to be part of that, that game.
Yes, I mean, these kind of subsidized state programs, we want to participate. If you-- I mean, the loan to deposit ratio, if you, if you actually take out the, the refinance part, so this, this, the subsidized funding, then the loan to deposit ratio without this is, like, 200%, which is still high, but not as high as, as, as including the, the state-funded structures. Certainly, one of the strategic kind of goals is to reduce the loan to deposit ratio and to increase deposit volumes, especially retail deposits.
Great. Thanks so much for the color, László. Thank you.
Thank you.
Thank you. If you have a question for our speaker, please click on Raise Hand icon or press star nine on your phone's dial pad. Yes, there is a question from Simon Nellis, Citigroup.
Hi. Hi, László. Thanks a lot. A quick one from me, just on Romania, if you could update us on how the sale is going, and any thoughts on where you'd deploy that capital?
The process of exploring potential demand is in progress, right? This, the, the process is, is ongoing. We have received indicative offers, and we are in the process of... or the potential interested parties are in the process of generating binding offers. Once we receive them, we will make a decision whether selling or not selling the, the asset. There seem to be strong interest for the asset, so that's certainly positive.
In terms of if you do sell it, the, the capital distribution, I mean, would you be looking to increase the dividend payout maybe a bit?
It's, it's a very relative relevant question. Look, given the, the timing of a, a potential transaction, so at best, we, we can get to an SPA signing, stage kind of closer to the end of the year, and then, regulatory approval process can be quite a lengthy, lengthy one.
Mm.
For Slovenia, took almost two years. I hope it won't take that long, but it will take quite some time. I'm afraid this question will be.
Next year.
Be practical. Yeah, kind of.
Okay. I'll save it.
Right. Don't forget it.
I'll save it for next year. Thank you.
Good.
Thank you. If you have further questions for our speaker, please press nine, nine on your dial pad or click on Raise Hand icon. As there are no further questions, I hand back to the speaker.
Thank you very much. Thank you for attending this call for in middle of summer when all of us would probably rather be on vacation. That's highly appreciated. Thank you for the good questions. Wish you all the best, and I hope you will join us in November when we present the third quarter numbers. Thank you very much. Bye-bye.
Thank you for your participation. The second quarter of 2023 conference call is closed now.