Hello, ladies and gentlemen, and welcome to the nine months and Q3 2026 Analyst Conference of Deutsche Pfandbriefbank. The conference will be recorded. At this time, all participants have been placed on a listen-only mode. The floor will be open for questions following the presentation. Let me now turn the floor over to your host, Kay Wolf, CEO of Deutsche Pfandbriefbank.
Ladies and gentlemen, a warm welcome to our analyst call on the results of the third quarter and, consequently, the nine months of 2026. Thanks very much for taking the time once again and joining us and taking a closer look at pbb's results. Our CFO, Marcus Schulte, and I are happy to guide you through the key developments of the past quarter and the key figures for pbb Group. Afterwards, as always, we have reserved enough time for your questions. Ladies and gentlemen, Q3 has been a quarter of high volatility in the markets. Long-term interest rates rose by more than 100 basis points, which did not support market sentiment for commercial real estate. Despite this environment, we have been able to write good, or to better say, profitable new business.
In the first nine months, new business volume in Real Estate Finance Solutions rose by EUR 500 million- EUR 4.5 billion compared to the same period last year. Quality and profitability of the new commitments are encouraging. Return on tangible equity stood at 8% for new business, which is in line with our strategic targets. In the third quarter, ROTE was even at 9%. Due to early repayments, we are making faster progress than expected with our exit from the U.S. market. Since the start of the year, we have reduced our U.S. portfolio by 28%. Non-performing loans have even fallen by 40% to EUR 500 million. And we are continuing to successfully diversify our income streams. In our Real Estate Investment Solutions business, operating income for the first nine months rose to EUR 37 million, which represents a 14% share of the group's total income.
Until end of September, pbb generated a pre-tax profit of around EUR 28 million in total, of which around EUR 12 million is attributable to the third quarter. This remains in line with our expectations for the full year. Operating income rose from EUR 90 million -EUR 99 million compared with the previous quarter. Net interest income remained virtually stable at EUR 80 million. With EUR 69 million, general and administrative expenses remained stable at the level of the previous two quarters. In total, costs for the nine months amounted to EUR 206 million compared with EUR 189 million in the corresponding period of 2025. The increase is primarily driven by investments in our Real Estate Investment Solutions business. This is in part compensated by further cost reductions, particular in Real Estate Finance Solutions.
Risk provisioning in the third quarter stood at EUR 19 million, in line with the expected normalized level. The ongoing U.S. exit and the reduction in NPLs for development financing continue to progress in line with existing loan loss provisions, despite a significantly weaker market environment. Capital and liquidity positions remain robust. The common equity tier one, our CET1 ratio, stood at a solid 14.1% in the third quarter. Our refinancing requirements for the full year were already met in the first nine months. The EUR 500 million Mortgage Pfandbrief successfully placed in October is already contributing towards next year's refinancing requirements. Let me take this opportunity to take another brief look at the current economic climate on page five. At the start of the year, market sentiment was significantly better than it is today.
In particular, the war in Iran and the blockade of the Strait of Hormuz have caused global inflation to rise sharply. The consequences for key interest rates and capital market yields are obvious. Against this backdrop, the European economy is performing comparatively robust. Thanks to government investment programs, Germany is even set to grow by more than 1% for the first time in many years. However, we do not yet see any tailwind for real estate markets. On the contrary, I mentioned three months ago that the first transactions were being postponed or even canceled. The situation has not improved since then, particularly as interest rates have risen notably once again. We do not anticipate any significant improvements in commercial real estate markets in the coming months either. Ladies and gentlemen, let me now turn to our businesses. We start with Real Estate Finance Solutions on page six.
The 14% growth in our new business to date is encouraging, given the market environment just described. It is particular worth noting that we have been able to further increase the share of generating new commitments from 44% - 69%. Looking at the third quarter of 2026 alone, this share was as high as 75%. This shows that we are making good progress in the transformation of our portfolio. The share of new business accounted for by the growth asset classes we have defined as strategic, hotels, senior and service living, student accommodation, and data centers continue to grow. Over the nine-month period, this share doubled from 7% to 15%. The profitability in new business also remains encouraging. Our key performance indicator, ROTE, stood at 9% in the third quarter.
Looking ahead, new business pipeline also remains well-stocked at EUR 10.1 billion, despite the challenging market environment. We are therefore confident that new business will also grow notably for the full year of 2026. Ladies and gentlemen, despite our strong new business performance, our financing portfolio has declined by EUR 1.2 billion -EUR 25.6 billion over the nine-month period. We have not been able to fully compensate faster-than-expected reductions in the U.S. portfolio. For us, in this market environment, de-risking and profitable new business remains a greater priority than just financing volume. We expect portfolio volume to rise slightly towards the end of the year, but it will I hope we are still on. Yeah. But it will remain in the originally guided range of EUR 27 billion-EUR 28 billion.
This also takes into account that we expect new business for the full year to be at the lower end of our EUR 7.5 billion-EUR 8.5 billion guidance. Let us take a closer look at our progress in exiting the U.S. market on page seven. In the first nine months, we reduced the U.S. portfolio by 28%, faster than originally expected. In the third quarter alone, the decline was 17%, which is driven in particular by encouraging reductions in our SRT portfolio amounting to EUR 300 million. Over the same period, the U.S. NPL portfolio remained stable at EUR 500 million compared to the second quarter. Whilst we kept the momentum in exiting NPL deals with another two deals exited, this was offset by one new default.
Due to the utilization of risk provisions for the two exits in line with the existing risk provisioning levels, and therefore the structural changes to the remaining NPL portfolio, also due to a new default, the coverage ratio changed quarter-over-quarter to 33%. Over the nine-month period, U.S. NPLs have fallen significantly by 40%. Despite the market conditions having deteriorated, we remain confident of achieving our annual target of EUR 400 million in the final quarter. Let us now turn to our second business segment, Real Estate Investment Solutions, on page eight. In the first nine months, the business contributed EUR 37 million, or 14%, to the group's operating income. pbb invest, our investment management business, contributed roughly EUR 30 million to this figure. Assets under management remained stable at EUR 3.1 billion compared with the previous quarter.
Despite existing capital commitment, in the current investment climate, we expect little change to the AUM until year-end. Bottom line, Real Estate Investment Solutions contributed a pre-tax profit of EUR 2 million for the first nine months, compared with a loss of EUR 8 million in the previous year. The segment is making its first capital-efficient contribution to earnings without any significant commitment to risk-weighted assets. With that, I will hand over to our CFO, Marcus Schulte. He will now guide you in more detail through the bank's key financials.
Super, Kay. Thank you very much, and good morning and a warm welcome also from my side. As usual, I will now lead you through financials, portfolio development, capital, and funding. Despite all the market and geopolitical headwinds, our strategic transformation progresses and shows solid results in line with expectations. This achievement in a challenging operating environment is not least reflecting our comprehensive early de-risking for our U.S. and development books, which had burdened 2025 with significant one-off risk charges. As such, risk provisioning in the first nine months of 2026 has been normalizing, and we are swinging back to a pre-tax profit of +EUR 28 million for the first nine months. Both in line with expectations. You can see this fundamental year-over-year turnaround in risk costs and PBT in our group P&L table on slide 10. Also in operating income, you see the envisaged transition.
Year-over-year operating income is down by EUR 50 million, resulting from portfolio de-risking, including SRT costs of EUR 33 million, lower income from the investment portfolio, as well as non-recurring one-off income in 2025. On the flip side, the acquisition of Deutsche Investment lifted fee income by EUR 28 million year-over-year to EUR 32 million year-to-date. That said, operating expenses in the first nine months are up nearly EUR 17 million year-over-year, as the acquisition of Deutsche Investment was partially compensated by savings in the rest of the group. I will come back to that in the cost deep dive and in the segment reporting.
In summary, past and ongoing de-risking, including the SRT, enables us to show a nine-month result that is in line with expectations, while at the same time driving forward our transition to a more resilient, diversified, and profitable bank, step by step and in line with our outlined plan. This is also reflected in the third quarter developments, where we show an increased pre-tax profit of EUR 12 million. Operating income is up by EUR 9 million, or 10% quarter-over-quarter, with NII and fee income being moderately down by -EUR 3 million, while other income is up by +EUR 12 million. More specifically, NII came in just EUR 1 million lower at EUR 80 million. This reflects a lower portfolio and stable portfolio margin, which was largely compensated by past due interest accrual.
Fee income from REIS decreased by EUR 2 million -EUR 10 million, as the second quarter had benefited from EUR 3 million performance and transaction fees at Deutsche Investment. That said, realization income increased by EUR 4 million -EUR 3 million, benefiting from prepayment fees and liability buybacks. The fair value and other result is up by EUR 8 million quarter-over-quarter to EUR 6 million, largely due to positive credit-driven effects, including a release from U.S. fair value charges on a repaid U.S. loan and income from syndication business in O&C. Operating expenses remain strictly managed and stayed virtually flat quarter-over-quarter. With a marginal bank levy release in Q3, the profit before risk provisioning was therefore even up EUR 10 million -EUR 31 million. However, and in line with our expectation, risk provisioning increased by net EUR 8 million quarter-over-quarter to EUR 19 million.
I will, of course, come back to that. Overall, PBT was therefore up EUR 2 million and stood at EUR 12 million for the quarter. With that, I come to the usual deep dives on costs and risk costs. On slide 11, you see the operating expenses in the first nine months are merely up by EUR 17 million year-over-year to EUR 206 million, as the acquisition of Deutsche Investment was partially compensated by savings in the rest of the group. As such, personnel expenses were up EUR 20 million year-over-year, where last year had also benefited from provision releases. Non-personnel expenses, however, were even down EUR 4 million, as cost efficiency measures paid off as envisaged and were even overcompensating the acquisition-related costs.
Cost efficiency measure payoff in the pbb Group will also become visible in the segment reporting later on, showing that minus EUR 8 million lower year-to-date operating expenses in REFS are partially compensating the acquisition-related operating expense increase from REIS of EUR 21 million. Very good, Miriam? Good. I hope you can hear as well. There is a slight beep sometimes, but I hope you can hear as well. On the quarterly cost trajectory, you see ongoing cost discipline with, again, stable costs and an improved cost-income ratio, which is down to 70% on increased operating income. Even though we keep strict focus on costs, please keep in mind that the fourth quarter usually comes at higher cost due to seasonal effects, but at the same time, we continue to invest into the strategic development of the bank. This then brings me to the deep dive on third-quarter risk provisioning.
We are on slide 12. In stages one and two, net additions of minus EUR 8 million in the third quarter were mainly driven by deteriorated macro parameters, in particular interest rates. This net addition comes after net releases in the first and second quarter. On Stage three, net additions decreased quarter-over-quarter from -EUR 17 million to -EUR 11 million. Net additions of -EUR 16 million for European NPL were partly compensated by net releases from the exits of two U.S. NPL and one legacy U.K. shopping center. You can see again that after our comprehensive de-risking measures in 2025, risk cost allowances for the U.S. exit remain adequate, and therefore overall risk costs remain manageable, and we expect our full-year guidance of 25 - 30 basis point risk costs to hold despite all headwinds. This brings me briefly, as usual, to loss allowances on slide 13.
As you can see, total loss allowances are down, mainly driven by the exits of two European NPL with high Stage three allowances, namely one German development loan with usage of EUR 49 million Stage three LLP. The aforementioned U.K. shopping center loan with the usage of EUR 104 million Stage three LLLP. At the same time, both the European and the U.S. NPL volume stayed largely stable at EUR 1.8 billion and EUR 500 million respectively. That said, the total NPL volume shows a rounding-related increase to EUR 2.4 billion. As a result of the meaningful Stage three consumption mentioned for the two intensive care NPL exits, and a more or less net stable NPL portfolio, the REFS NPL coverage ratio decreased from 27% to around 20% in Q3. The coverage ratio now reflects well the structure of the remaining portfolio and remains adequate.
With that, I come to the segment reporting, starting with REFS on slide 15. Looking at the first nine months, operating income in REFS is down by -EUR 32 million year-over-year to EUR 219 million for the first nine months. Essentially, this decrease reflects the SRT costs of -EUR 33 million year-to-date. On the other hand, operating expenses in REFS have been managed down, as mentioned, by -EUR 8 million year-over-year through cost optimization measures in the context of the implementation of our target operating model. With substantially lower risk provisioning following the comprehensive de-risking in 2025 and operating expenses managed down, segment PBT of REFS thus swung back to a EUR 43 million profit for the first nine months, as you can see. This is, of course, in line and the main driver for the aforementioned year-over-year development for the pbb Group as a whole.
Also in the third quarter, PBT for REFS increased by EUR 4 million -EUR 18 million. In short, operating income was up by EUR 13 million quarter-over-quarter, operating expenses largely flat, and risk provisioning costs were up by EUR 8 million, as mentioned before in the group context. The increase in operating income of EUR 13 million quarter-over-quarter in REFS was driven by EUR 3 million higher NII and EUR 10 million higher other income. To avoid repetition from what I already explained in the group context, I would just like to mention here that REFS NII was up compared to the group, as pre-funding costs were borne by the corporate center. As usual, that brings me now to the REFS portfolio overviews, starting with the performing European REFS portfolio and the development of our key KPI.
The overall portfolio quality remains resilient with stable average LTV and stable 12-month rolling valuations. The exposure at risk is only slightly up in the third quarter, reflecting recent overall market developments, in particular interest rate movements. However, with Stage one and two LLP having increased accordingly, the respective coverage for the performing portfolio is largely stable at around 18%. With that, we are moving over to the European non-performing portfolio on slide 17. As already mentioned, the European NPL portfolio remains stable at EUR 1.8 billion in the third quarter, with two additions and two exits of EUR 200 million a pair balancing out. NPL additions comprise two office investment loans in established continental European office locations. As mentioned, NPL exits comprise one German development loan and one legacy U.K. shopping center. Two cases we worked on intensively for a very long time.
As a result, development NPLs are down by around EUR 100 million, whereas investment loans are up by the same amount. Let me stress that we are not satisfied with the NPLs plateauing here. Whereas the two office NPL additions are idiosyncratic and rather technical in nature, we have to acknowledge that overall market conditions are not helpful for bringing our NPLs down as fast as previously expected. However, we remain highly focused on workout with a clear view on targeted exits and potential new entrants, and are committed to bring the overall NPL volume down, that is for Europe and the U.S., by the end of the year. With that, we move over to our off-balance sheet business, the Real Estate Investment Solutions.
Kay has already given the overview on the positive year-to-date developments following the acquisition of Deutsche Investment, showing a jump in diversified income, a turn to moderate profit, and also the already value accretive nature of this capital-light business. Also on a quarterly basis, you see a solid contribution from REIS with operating income of EUR 12 million. This is moderately down, as mentioned, by EUR 2 million, as the second quarter had benefited from EUR 3 million performance and transaction fees. While the main contribution of EUR 10 million comes from pbb invest and to Deutsche Investment, Originate & Cooperate contribute stable EUR 2 million. At the same time, operating expenses stayed stable at EUR 12 million. Please bear in mind that operating expenses also carry the one-off integration costs for Deutsche Investment, but also the investment costs for further expansion of the business.
Going forward, the consistent profitabilization of the business will be a key priority. That includes both exploring investing in organic and inorganic growth, as well as targeted cost management. With that, we move to the corporate center on slide 19. In the corporate center, as you know, we bundle our treasury activities, including the investment portfolio, but we also show here the compulsory group costs. As previously mentioned, the corporate center is therefore not seen as a structurally defined profit contributor. In the third quarter, PBT remains flat at -EUR 6 million, with some movements between lines. Operating income was -EUR 2 million lower as NII was impacted by temporary funding excess, which was partially overcompensated by net other income, which was higher mainly in realization income, which was up on selected liability buybacks.
On the other hand, operating expenses improved by EUR 2 million, so that PBT for the corporate center overall remained net stable quarter-over-quarter. With that, I already come to capital, and we are on slide 21. The CET1 ratio remains solid at 14.1%, being down 50 basis points in Q3. While RWA decreased moderately by EUR 500 million -EUR 15.9 billion due to a reduced portfolio volume and portfolio migration, regulatory capital is also down by roughly EUR 200 million- EUR 2.9 billion. The latter is reflecting an increase in ordinary prudential backstops, especially an increased expected loss shortfall. At this level, capital ratios continue to provide solid buffers over regulatory requirements, with more than 400 basis points buffer to CET1 MDA and more than 300 basis points over own funds MDA.
Finally, my last remarks on funding and liquidity, and we are on slide 22. With EUR 1.8 billion Pfandbrief funding and the EUR 500 million Green Senior Preferred benchmark issued in July, we already achieved our funding objectives for 2026 in the third quarter. As we like to stay ahead of the curve, and as Kay Wolf mentioned, we started to pre-fund into 2027 with a successful issuance of a EUR 500 million Mortgage Pfandbrief, which again, like the previous ones, was well oversubscribed and came at largely stable costs. While the average funding spread year to date for the Pfandbrief came in minus 14 basis points lower compared to 2025, the unsecured funding spread was 38 basis points higher. That said, our unsecured wholesale funding costs are still significantly lower than they were in 2024 and 2023.
At the same time, retail deposit funding costs came down further, partially compensating for the aforementioned increase in wholesale unsecured funding costs. The deposit volume of EUR 7 billion remains stable quarter-over-quarter and is efficiently managed, with call money further down and the weighted average life of deposits further up. As a result of our proactive funding year- to- date, our liquidity position remains robust. With that, I hand back over to Kay Wolf.
Thank you, Marcus. Ladies and gentlemen, 2026 is coming to an end, and contrary to expectation at the start of the year, the market environment has become significantly more challenging. In this difficult environment, without a positive market momentum at all, we are proud of having achieved solid results for the three consecutive quarters that are in line with our expectation. We execute on our strategic transformation by investing and diversifying our revenue streams, whilst costs in our financing business continue to come down. Let me conclude in summarizing the key points on page 24 before we move on to your questions. In a challenging market environment, we increased new business volume in our financing business by EUR 500 million year-over-year to EUR 4.5 billion. The share of strategically important growth asset classes is rising steadily, confirming the progress we are making in the process of diversifying our financing portfolio.
We are also making progress in the diversification of our revenue streams. The new Real Estate Investment Solutions business already accounts for 14% of the group's operating income. At EUR 69 million, administrative expenses in the third quarter remain at the same level as in the two previous quarters. This demonstrates our continued cost discipline. Looking ahead, we do not anticipate any short-term improvements in market conditions. Nevertheless, we expect to achieve our annual targets for new business volume and pre-tax profit, albeit at the lower end of our previous guidance. Thank you very much for your attention, and Marcus and I are now happy to answer any questions you may have.
Ladies and gentlemen, if you have joined by telephone and would like to ask a question, please press star nine and pound key on your telephone keypad. If you would like to withdraw your question, press star three and pound key. If you are connected online and listening via the web interface, please click the telephone handset button and then the raised hand icon. This will allow you to ask your question verbally as well. Please bear with us for a moment while we register your questions. The first question is from Tobias Lukesch from Kepler Cheuvreux. Your line is open now.
Thanks for taking my questions. Two, three, please. Firstly, on the capital, I mean, this remains a roller coaster. Just wondering how you expect the capital as well as the RWAs to develop over the coming quarters. How do you see that in 2027? Will we reach a steady state going forward? Secondly, on the NII, obviously down and way below expectations. Here would be interesting how you see the future development in terms of interest income and interest expense in particular. And very lastly, on the U.S. exit and in the European book, is there more you still see for potential one-off provisioning for Q4, or are we at a steady pace now with the kind of EUR 19 million we have seen for this quarter? Thank you.
Thanks. Good morning, Tobias Lukesch. Thanks for your questions. I would address the first two, and then Kay will pick up your third question. On capital, I think we described the developments, which are, I think, to be fundamentally differentiated from the changes that we had previously discussed in artist [inaudible] or past regime status for the F-IRBA model that we had updated on Q2. This has nothing to do with that. This is purely ordinary course of business evolution of the capital base. If we go through numerator and denominator, on the denominator, of course, you had a lower portfolio. You had slightly or substantially increased interest rates. Nonetheless, the net effect is, as I mentioned, that RWA EUR 500 million down on the one hand.
On the other hand, we continue to see that, as far as prudential backstops are concerned, we are, of course, seeing movement in our NPL book. With that movement in our NPL book, we see migration, especially in the expected loss shortfall. In Q3, for example, I think a meaningful and important point was the aforementioned U.K. shopping center, which actually had a very significant expected loss surplus, yeah? I.e., we had more risk provisioning built than the models were suggesting. Therefore, when that loan departs because we've been getting rid of it, of course, the expected loss shortfall overall is the sum of expected loss shortfall and surplus is coming down. The migration in NPL will continue to be active as we discussed.
As we said, we want to be coming down in NPLs overall, but we will also see entrance. Therefore, we will continue to see a movement in the numerator. Therefore, I think overall, we would expect a capital to come moderately down from here, but clearly stay well above the 13% that we guided through the cycle.
Then I will take the question around U.S. exit and the European book and whether there's any kind of Q4 one-off. I think an NII question Marcus is going to answer, Mr. Lukesch, as well. Let me focus on the U.S. exit first, yeah? For the fourth consecutive quarter, we are now in progress of exiting the U.S. portfolio within the level of provisioning that we have been taking, yeah? That is bringing the performing as well as the non-performing loan portfolio down. If you see on the provisioning side, even in the third quarter, there was a slight release from exiting U.S. NPLs. So we feel, at this point in time, continues comfortable with the level of provisioning that we have to progress the exit out of the portfolio. That, by the way, also holds true for the development book.
You remember that we have been taking conscious provisioning last year on that book as well, and you see NPLs coming down, and we have not the need to additional provision, and we see that progressing in this book in the same way. Paying attention to the European book, we see the risk provisioning coming back to normalized levels. We guided 25 -3 0 basis points, and the way we are progressing in that book, here over the last three quarters is exactly in line with that. It is even slightly better. So with regard to your question, we would expect this book to perform in line with the guidance that we have given. Looking at year-end, we will probably see that coming in at the lower end of the guidance of 25 - 30 basis points. With that, Marcus.
Yeah.
You can take back on.
Yeah. Thank you. On the NII, I am not sure if it is substantially below. I think it was EUR 1 million below the previous quarter. I explained why that is. I think we had, as Kay mentioned, good new business. The new business, however, was back-ended towards the end of Q3, therefore, not really being drawn in Q3, but being drawn in Q4. Meaning that, as you see, the overall portfolio for REFS has been coming down from EUR 26.8 billion - EUR 25.6 billion. Despite of that fact, the portfolio margin was stable, and it could be largely compensated also by the fact that we had some NII which delivered accrual in the third quarter. Now, if we extrapolate that going forward. I think as Kay said, we expect the portfolio to stabilize from here. Funding costs are rather neutral at this stage.
What we expect, of course, is that the SRT, which you saw came down EUR 300 million quarter-over-quarter, will continue to come down in line with our guidance that we had been giving at the beginning of the year, actually. Therefore, will be starting to become a supporter for NII in Q4 and certainly in 2027. In a nutshell, we would expect that NII would very moderately increase from here in Q4 and then beyond.
Question is from Sharada Patel from Citi. Your line is open now.
My first question would be just on the lower coverage. You say that it is adequate, but what gives you that confidence? Is this the steady state coverage level that we can assume from here on? My second question is really on the new business margin. It was obviously quite a significant decrease. What was driving that decrease? Again, how stable is that from here on? More on the capital movements. What is the upcoming timeline in terms of updating CRE market loss rates? Are there any reviews in Q1? Obviously, France has just been reviewed, but it would be good to know when Germany is due out as well. Again, my last question there also refers to capital. What specifically is driving that expected loss deduction?
As you said, you have got a bit of the U.K. shopping center kind of move things, but also what are the other prudential backstops that you mentioned? Thank you.
Hello, Sharada, and thanks for your questions. It was partially difficult to hear you, so we might kindly ask you to repeat the one or the other question. I would start with your first one around the lower coverage ratio, which is driven by the movements that are happening in the NPL portfolio. First of all, as Marcus had outlined, in terms of the exits, in particular in the European book, we have been able to exit two transactions which rather had a higher provisioning level relative to the rest of the NPL book because they have been long-dated legacy transactions, in particular the U.K. shopping center, which you might remember we are working on for many, many years. That is one area. If you have transactions, legacy transactions leaving with high provisioning levels, because of that legacy, that is one impact.
The other impact is, Marcus alluded to that, as we are very granular in terms of what we are reporting, it becomes tricky. We have two new transactions that are coming in, your question of what makes us comfortable that lower provisioning levels on those two transactions are justified is by matter of fact, when we look into those transactions, they are from a cash flow perspective for the coming years stable and covered. The reason why they are, Marcus said it is technically driven, to become slightly more precise on that, it is primarily valuation-driven and not cash flow-driven. Therefore, in terms of cash flow for those financings, they are way more and better than the ones that we have been exiting.
That dynamic in terms of the structural composition of the quality of the NPL book and the underlying assets is a key driver. This is always not getting reflected in this ratio of coverage. I hope I could, to the extent possible, Sharada, give you a bit more insights where our confidence comes in that the level of coverage that we have is sufficient.
Yeah. Then I understood that you had two follow-up questions, Sharada, on capital. I think you were asking about the hard test regimes market loss rate updates and whether we expect anything here. I think the answer remains unchanged. We expect that we see now a more regular and more adhered to process for annual updates, which would be coming in the summer. From what we can see, we would not expect any updates before that, and therefore capital will not be affected by that. In the meantime, of course, we are working on optimizing the RWA according to that anyhow. Then I think you were asking a follow-up question on what is the actual drivers now between in the last quarter and here, and also going forward, which is more the ordinary steady state course of business.
I think essentially, the most important prudential backstop that we see deductions in regulatory capital from is the expected loss shortfall, as mentioned. With the dynamic NPL trajectory, we see movements. What was particularly important, if I repeat myself, I am sorry, but at the end of the day, it was also that we have been exiting a loan which had a particularly high expected loss surplus, meaning it was a loan where we had more, the U.K. shopping center, more loan loss provision Stage three than models were suggesting. Therefore, that surplus was leaving the ELS computation, and therefore, of course, meant a reduction as such. The other key prudential backstop that we have is the NPL backstop, which in our case is not meaningful neither in the second quarter, where you can see it in the pillar three report, nor in the third quarter.
Thanks. Yeah, so just—
And the other question we didn't understand. Sorry for that.
Yeah, so the question that was missed out was just on why the new business margin decreased quite significantly? And if I can just have one more coming back to the CRE market loss rate update. So you're not expecting any updates before the summer, but I guess then France and Romania is not in summer because that was updated this quarter. Thanks.
Yeah. Thanks, Sharada, and sorry for us asking back on those two questions. First of all, I start with the second one. This is, as we have outlined, is a yearly update process, yeah? And we expect that update to happen closer to what is the regulatory timeline, which is latest by June 30, yeah? So that update, yeah, some might update earlier, yeah, but latest by June 30, there should be more or less a complete update in terms of those assumptions. And to your other question around, which is a very good question and well spotted, that is driven by the composition of our new business. As you see, that margin per se, yeah, is not correlated with ROTE, yeah?
Because, yeah, ROTE for us is a key composition in driving the business forward, and the composition of the Q3 business was literally, for example, lesser developments compared to the developments to compare to the second quarter, more investment loan business, and some of which, generally have lower other grade entity. Therefore, also from a margin perspective, they tend to have a lower margin. However, net-net on where we are steering the business from a return on the required capital on those transactions, they were even better than in the second quarter, yeah? Therefore, I think we alluded to in the past that pure view on margin, yeah, might not give you the right steer of whether or not we are generating capital return sufficient for the financings that we put on the books. Q2 vis-à-vis Q3 is a good example of that.
Okay, that's very clear. Thank you.
Thanks.
Ladies and gentlemen, just a brief reminder on how to ask a question. If you're dialed in by phone, please press star, nine, and pound key. For those joining via the web interface, simply click the telephone handset button and then select the raised hand icon to speak. The next question is from Mr. Domenico Maggio of Jefferies. Please go ahead. Your line is open now.
Hi, morning. Thank you for the call. Look, on the capital move, I think I just heard your reply. You mentioned that in Q3, the NPL backstop effect on the Q o Q move on CET1 is negligible. Did I get that correctly? Am I thinking it right when I say that basically, if you were to incur further provisioning, you basically have the capital insulated from that in the future because of the prudential backstop? Then moving on from capital, what is your Berlin exposure? Do you have any borrowers who own more than 10,000 or more of units? Roughly, what's the share of the Berlin book that fell in that bucket? Lastly, maybe more on the bond move.
I'm sure you know, you must have noticed your subordinated debt, both Tier one and Tier two, have moved a lot since September. Clearly rates been higher and some CRE concern have not helped, but keen to hear your thoughts on how you have justified your underperformance, and if there is a message you want to send to investors. Thank you.
Let me start, Domenico, and thanks for your questions. Let me start around your questions on Berlin. Berlin is an important market for us. Always has been. It's the largest German city. Let me state, we are following the development and the discussion very, very closely. As of today, nothing is really clear of what the outcome will be, and therefore, there is a wide-ranging scenario of what can happen to Berlin. What is clear already is that investor sentiment around investing in Berlin has definitely taken a hit. That's not only for investing in residential property, but it's for investing in Berlin in general. That, honestly speaking, is a very sad situation. Therefore, we are very hopeful that there will soon be clarity.
It will be a longer way to regain confidence on the investor side, given this looming discussion that sits around there. To your question, yes, we do have exposure, and we do have clients, and we have financings in Berlin. On the residential side, we are in very close contact with those clients, discussing the various scenarios that could happen and how we are going to deal with that. We feel very comfortable in the way those discussions are progressing, respectively, have progressed. Therefore, we are well prepared. The other topic, when you look into the overall LTV levels that we are having around residential financing, and Berlin is not an outlier in any way out of this, that was around 50%, 51%, 52%.
Therefore, based on what currently is being discussed, and as I said, the outcome remains uncertain, we feel that whatever is going to outcome, that we can really manage that within our portfolio and with the clients. I think I would stress that we have very constructive dialogue with the clients who potentially might be affected. Therefore, for us, that is a situation we are monitoring very closely, but which we deem in terms of outcome, whatever way will come out, as a manageable position for our side.
Thank you, Kay.
Sorry, did you mention an exposure there? Maybe I missed it. There was some noise. Line was interrupted. On the Berlin residential, because I basically just estimated from the covered bond file, which is not inclusive of the whole perimeter, EUR 1.5 billion. Maybe you said a number and I did not capture that.
No, I did. Domenico, I did not mention a number because we have not disclosed, yeah, on that level of granularity. Honestly speaking, my concern around that is, yeah, that given the totally unclear, yeah, outcome of the discussion over there, I am always concerned around the conclusion that has been taken there, yeah? Therefore, we have not disclosed granularity levels around asset classes in respective cities.
Yeah. In the capital, obviously, you have the whole portfolio, including office logistic, where obviously, especially the office portfolio is also relevant in Berlin, and also the logistics around Berlin, and retail as well.
Mm.
On your other questions, Domenico, on capital, or again on capital, yes, you are right. Per Q2, and you could look it up in the pillar three report, the NPL backstop was - EUR 16 million, very marginal, and it was even more marginal in Q3, so it is really not driving the boat.
Okay.
You are right that, of course, first and foremost, we manage NPL, and we manage NPL, I think, in the common interest that we get NPL out, as good and as fast as we can, and deliver on our commitment that we want to have overall NPL coming down by year-end, and then swiftly going forward to de-risk that book. Then, of course, when we do our IFRS impairment tests, we have to look at a three-scenario evaluation for Stage three loan loss provisions. This is a very, as you know, codified and very precise test that you have to apply. That is a function and a result of the decision that we make. Of course, we also consider the capital ramification, but I think from our point of view, the most important is that we get the NPL ratio and the overall NPL book down.
On your question around the Tier one and Tier two performance, I mean, I have to say that I am disappointed by how these instruments have been performing in the last quarter. I think we have no particular indications of particular positioning one way or the other. I think essentially, we have to be realistic. It is a high beta product. I think we have to continue to deliver as we did with Q3, and get the concerns out of the market. I am not sure there is a lot of turnover and a lot of liquidity in this. Small sell orders create, of course, reactions. I regret those reactions. I mean, we spend a lot of time on constantly seeing the investor base and trying to reassure them about the path we are taking.
I think we just have to acknowledge that if there are spikes of risks, that we have limited liquidity in these sub-benchmark or just benchmark transactions, which mean that there is some valid volatility, which, by the way, investors get paid for. What is pleasing, in my opinion, is that the senior preferred and the Pfandbrief, which is where we are really refinancing our operations, is not suffering that much. So I was very pleased to see how our Pfandbrief was performing. I was very pleased to see about the very strong quality interest that we had in our Pfandbrief benchmark, especially from abroad, including official institutions. I am also okay with how the senior is performing.
It seems to be really about the capital, and I think the only thing we will do, we will continue to try to show that we take risk out and therefore reduce the volatility of the trading pattern in these instruments.
Thank you. Here to help that liquidity, Marcus. Thank you. Very helpful. And just sorry, follow-up. Maybe I did not understand. Am I right thinking that if you were to further provision—
Domenico, we can't hear you.
Are we still on?
Can the operator hear us?
Apologies. I will now conclude the Q&A session. Thank you very much, and I'm handing the floor back over to Kay Wolf. Thank you.
Sorry.
I think we may have had still some questions, operator. I think Domenico—
Domenico, you broke up when you were talking. Yeah, we couldn't hear you. That's why.
Oh, we lost his connection. Let me see if I dial it back in. He is Oh, no, I think he just lost the connection again. There he is again. Domenico Maggio, if you would like to ask a question again, you can raise your hand again. Okay, here we go.
I think we were done, to be honest. Yeah. Was just going to follow up on, so further provisioning y our capital would be somewhat insulated from that because of the NPL backstop and what happened in Q3 and Q2. Is that fair?
I think it's a function of both, right? It's a function of what NPLs come and go, surplus or deficiency. I think it very much depends, as I said, on the particular impairment test that you did do for every and each loan compared to what models show. This dynamic is then influencing whether you have a shortfall or a surplus on a given entry or exit. That is a complex dynamic. I think, without being too bold, I think we are quite professional in our NPL trajectory and forecasting in seeing what the effect of NPL migrations would be on capital. I think we have a good steer and handle on the effect that the primary goal of getting NPLs down will have in capital, and we will, of course, manage that accordingly.
Thank you. Very comprehensive. Yeah, let's hope that the liquidity on the sub improves. Here to help. Thank you. Bye.
Yes, thank you.
Thanks.
Thank you, Domenico. Thank you.
Thank you, Domenico.
Gentlemen, there are no further questions at this time, so I will now conclude the Q&A session and hand the floor back over to Kay Wolf.
Thank you very much. Thanks for dialing in. Thanks for asking the question and having the interest in the firm. Given that everything regularly, we are also approaching the year end. I hope even if it is a couple of weeks to go, that when Christmas is then arriving, it is not a surprise for all of you. Enjoy that period, and I am looking forward, we are looking forward to having you on our next regular call. Thanks very much for dialing in. Have a good day. Thank you.