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Edited Transcript of KOMB.PR earnings conference call or presentation 6-May-20 12:00pm GMT

Prague 1 May 25, 2020 (Thomson StreetEvents) — Edited Transcript of Komercni Banka as earnings conference call or presentation Wednesday, May 6, 2020 at 12:00:00pm GMT

Komercní banka, a.s. – Senior Executive Director, Chief Risk Officer & Member of the Board of Directors

Komercní banka, a.s. – Chairman of the Board & CEO

Komercní banka, a.s. – Executive Director of Strategy & Finance

Wood & Company Financial Services, a.s., Research Division – Co-Head of Research & Head of Research Poland

JP Morgan Chase & Co, Research Division – Executive Director and Head of Emerging Market Europe, Middle East and Africa (CEEMEA) Banks

Citigroup Inc. Exchange Research – Research Analyst

Hello and welcome to the Komercní banka First Quarter 2020 Financial Results Conference Call.

I will now hand you over to your host, Jan Juchelka, to begin today’s conference. Thank you.

Jan Juchelka, Komercní banka, a.s. – Chairman of the Board & CEO [2]

Okay. Good afternoon, everybody. Thank you very much for being with us. We are connected, the whole management board of Komercní banka, and ready to guide you through the presentation and ready to answer any of your questions.

So please let me start with Page #4, which is displaying the main highlights of the first quarter, which to a certain extent started to be an unexpectedly interesting period of our doing business.

So being impacted by the COVID-19 epidemic, we took care first about our people and were able to procure the purchase of hundreds of thousands of respirators, face masks, gloves and hectoliters of disinfection in order to take care of the safety and security of our employees. We have made fully operational 230 our branches. And obviously, we’re ready to provide services through the fleet of 800 ATMs, out of which 1/2 approximately is ATMs able to provide the deposit service as well. As a result, we were able to manage more than 5,000 employees working from home on either the company-provided notebooks or directly connected from their home PCs through secured video, digital working space.

We are — during this period of time, it started by quite strong January and February. We continued providing the economy by loans. We have introduced 1 month before the law was adopted our clients with voluntary repayment rescheduling based on the EBA introduction of rules. And we have — we were — we took an active role at the Czech Banking Association when discussing with Czech-Moravian Guarantee and Development Bank on designing the special programs dedicated to small and medium-size companies. As a result, there was a program named COVID III adopted by the government, where the government is providing or is ready to provide up to CZK 150 billion guarantees, which will cover up to 30% — on portfolio basis up to 30% of the total exposure of banks. We continue and, to some extent, accelerate our KB Change transformation program as we are learning new lessons coming from the COVID-19 situation. I will come back to it in more detail in few minutes. The crisis obviously accelerated digital solutions which were supposed to take place, in normal circumstances, a little bit later and also led us to a certain reduction of the branch network, streamlining the processes and increasing the effectiveness of operations. We continued our citizenship or our corporate citizenship obligations and assisted and donated (sic) [donated to] senior homes and children’s homes as well as supporting and partnering online cultural events and others.

As far as business is concerned, the lending to clients went up by 4.9% on year-over-year basis. The deposits grew by 8.3%. I will come back to it in deeper detail. The revenues for first quarter 2020 went down by 1.4%. OpEx was up by 5.2%, driven by majority by the higher charge on Resolution Fund contributions. Net provisions (inaudible) CZK 0.2 billion. Jirí will provide you with this interesting chapter of our being at a later stage of the presentation. As a result, the net profit went down by 16.3% on year-over-year comparison to CZK 2.7 billion results.

We remain very strong from a capital point of view. Currently, we are displaying 20.2% of Tier 1 capital after helping the dividend payment. And we will — as far as dividend payment is concerned, we will stick to the recommendation of European regulator and the local regulator, and we’ll wait with the final decision on dividends for 2019 — from the 2019 profits until October 2020.

Let me bring you to Page #6 now. Here, we are showing you our view on the potential scenario of the evolution of macroeconomic indicators. The GDP, we expect, will grow by 6.5% — sorry, will drop by 6.5% in 2020. We are currently experiencing gradual reopening of the economy, and we believe that this one will bring us back to a rather fast recovery which will be realized in 2021 and 2022. One of the key pillars of Czech economy, which is car production, remained resilient for January and February of 2020, with certain slowdown in March obviously. And all 3 main carmakers located in Czech Republic started to restart their production. Hyundai started on 14th April; ŠKODA AUTO on April 27; and TPCA, Toyota Peugeot Citroën, on May — they are planning to start at May — on May 18. One should remind that they are not starting with 3 shifts per day but rather with 2 shifts per day as for the beginning.

The unemployment was very low. Before the COVID, March was still registering 2.0% of unemployment rate. Inflation went up to 3.4% on year-over-year basis in March, which is beyond the tolerance band of Czech National Bank. Czech koruna has depreciated in first quarter. The Czech versus euro went down by almost 6% on year-over-year basis and 7.5% on quarterly comparison. The Czech koruna yield curve remained inverted. The 10 years interest rate swap was at the level of 0.75%, down by 99 bps on year-over-year basis, whereas 3 months PRIBOR was at the level of 1%.

Czech National — the Czech National Bank and Czech government were taking, immediately after discovering the pandemic, appropriate steps, which were quite nicely aligned. And I will start with those who — with those measures which were adopted by the central bank. The monetary policy after the increase of base rate to 2.25%, which was approved on 6 February, was — took quite quickly the reversed direction and went down by 50 bps on March 16 and further 75 bps down on 26 March to the current level of 1%. And we expect this will become again a point of discussion at the Czech National Bank Board of Directors session, which is organized for Thursday this week. The macroprudential policy and stabilization measures as — were changed in parallel with that, so the countercyclical buffer requirement went down by 75 bps to 1%. Czech National Bank relaxed the housing loans regulation. Loan-to-value went up from 80% requirement to 90%, debt service-to-income from 45% to 50%. And debt-to-income was — the last — as the third indicator was completely canceled with the effective date of 1st April of 2020. As I have already mentioned, the Czech National Bank has made a very strong recommendation to banks to not to pay any dividends and stop buybacks. They have allowed the postponement of loan installments without necessarily requiring reclassification of clients from S1 to S2 or from S2 to S3 and aligned their steps with the EBA guidelines for COVID-19 loan repayments moratoria.

Czech National Bank has reactivated the existing tool of 0-spread fixed-rate liquidity, providing repo operations which are organized currently 3 times a week. This tool was available even before but not used, if I may say. Parallel with that, the parliament adopted new law which gave a broader portfolio of tools to the hands of Czech National Bank in the field of quantitative easing, and Czech National Bank is now entitled and authorized to purchase also long-term securities not only from banks but also from insurance companies and pension funds. The 2 latest measures are supposed to have limited validity until the end of 2021.

What did the Czech government do? Pretty similar steps as other European governments. So first, they have started to inject directly the cash to Czech citizens and Czech entrepreneurs and Czech companies; covering employers subsidizing 60% to 100% of salary costs of employees which were put at home, to closed or financially distressed businesses or quarantined establishments or people who are taking care of other family members. Employees and self-employed people were given the 60% of previous income as caretaker benefits, including those who are staying at home with children due to school closure. The self-employed people got CZK 25,000 direct cash payment for April, and it will continue also in May and potentially other months — the following months. And the government has put in place postponement of certain tax, social and health insurance duties.

As far as guarantee programs are concerned, the Czech-Moravian Guarantee and Development Bank was in charge of providing up to CZK 10 billion interest-free or 0-interest loans. This scheme was fully processed by the — this bank and was used only partially. As a second step, a program named COVID II was already a guarantee scheme using the European money and supporting the small and medium-size entrepreneurs through guaranteed loans where we have successfully placed 120 loans for — of our clients, but what is stemming out from this number is that it was not broad enough to help the Czech economy to get new cash. Hence, there is a new program named COVID III, which is using slightly different scheme of CZK 150 billion guarantee provided directly from the state to the Czech-Moravian Guarantee and Development Bank which is dispatching the guarantee towards the commercial banks. And those CZK 150 billion would cover up to 30% of a bank’s exposure, on portfolio basis, up to 30%. The targeted companies are SMEs, up to 500 employees. The maximum loan is set at the level of CZK 50 million. It’s mainly working capital loan, overdraft and revolving. The guarantee will be in place for 3 years.

Parallel with that, there is the export agent — agency activated for providing new cash to large Czech companies through a program named COVID export. And as it is visible from the name, it’s mainly for those companies who have at least 20% of their production dedicated for export, and here, we expect up to CZK 140 billion capacity of guarantees here. This program will be managed directly by EGAP, the export agency, and will be provided on case-by-case basis. Czech parliament has also adopted new law on credit moratorium and the postponement of residential and retail premises rents. In total, what is expected here? The help or the stimulus provided to Czech economy should bring — should be — should bring its size to a level of 10% to 15% of GDP.

Let me take you to Page #10. Here, I have — here, I will just quickly remind that we were active in all these fiscal and monetary measures I have just commented, and we also played our role as corporate citizen towards those who were in need. So we distributed our help to seniors and children, either financial gifts or donation of 30,000 face masks to senior homes. And we have also provided partnerships either to artists or to chefs who were providing meal to policemen, firemen and doctors in the first line of the fight against the virus.

On the right-hand side of Page #10, you can see that also our foundation, Jistota, remained active in their traditional field of activities. And for this, worth to mention here is that we did not forget all the programs which are provided by European Investment Bank and continue providing the SMEs with the guaranteed schemes coming from the European Union. We are very proud also to announce that in the partnership with our sister company SG Equipment Finance, we have concluded a memorandum of understanding with CEZ ESCO in a new product, solar energy as a service, which is de facto providing an entrepreneur with solar panels, battery charger and electric car and charging him or her on that solution provided as a service.

So let me turn the page to Page #12 now, where you can see the impacts on client activity. One, we can say that we have recorded quite nice and very, I would say, natural reaction of the clients who on-boarded much more solutions under the name of KB Klíc or KB Key, which is an authentication tool for accessing the Internet banking, as the clients simply preferred to step in the contact with the bank on a rather remoted basis. We continued the sales of retail products, either small businesses loans which took a sharp increase in the recent weeks; mortgages, with — after a certain drop, with again rebounding, increasing the tendency consumer loans being rather flat. And mutual funds, after a quite steep drop, are getting back to the positive territory.

As far as transaction activities are concerned, we have — we are — you can see the trends on the lower part of the left-hand-side graphs — on the left-hand side of the page. As I have already commented the number of branches, home offices, so I will skip the right-hand side of Page #12 and will move us to Page #13.

So the [increased] activity of and usage of our retail clients of various digital channels. The mobile banking penetration is heading already to 850,000 users. The digital wallet, which provides the user also with, let’s say, a noncontact solution when paying in a shop or in — at the POS, is growing mainly amongst the users of Apple solution. The transaction channels are by 97% mobile or Internet banking, and only 3% are the others. Speaking about achievements in digitization world, it’s worth to mention that together with Ceská sporitelna and CSOB, we have announced the establishment of a joint venture in the field of digital ID. We are currently going through an antimonopoly assessment at the level of European Commission. And hopefully, after collecting the approval, we will be able to put in place this bank — or a digital ID based on the existence of a bank account and help the state to elevate the overall digitization of public and private services to the new level.

On the right-hand-side column, you can see the share of sales of digital sales by channel provided on the logic of products. We are currently growing quite nicely the consumer credit in a fully digitized way and helping ourselves also to grow faster with personal account packages. As a result of the increased pace of digitization of our services, we have decided to accelerate optimization of the branch network. And starting August 2020, we will be lighter by approximately another 64 branches and operate 241 branches, starting in September.

Let me move to Page #15 now and show you the business performance. The gross lending, excluding repo, went up by 5% almost, on quarter-on-quarter basis by 2.2%. When we focus closer to the business and other loans, SGEF, the SG Equipment Finance, was growing by 7.8%; whereas the corporate and other loans grew up by 5.1% and small businesses by 4.4%. The overall loan book on corporate lending grew by 5.2%. What is interesting here is that, despite this dynamic evolution, our net loans-to-deposits ratio remained at the level of 73.6%, and the liquidity coverage ratio in more than comfortable 241% in the first quarter.

At Page #16, we have listed 6 [stepstones] of remarkable financing transactions for Czech clients across the industries and across the segments and sectors.

Let me jump immediately to Page #17, which is describing the deposits — the evolution on the deposits side. Our deposits rose by 8.3% on a year-over-year basis and by 9.6% on a quarterly — quarter-versus-quarter comparison. As you can see on the right-hand side, on the upper part, the graph is showing that it was mainly current accounts, who — which grew by 8.2%, and the term deposits and saving accounts by 6.4%. As far as the non-bank assets under management are concerned, there was a dynamic growth in the pension schemes, quite mediocre growth of life insurance provided by Komercní pojištovna. And the mutual funds, which we are selling in partnership with Amundi, grew up to — by 3.5% on year-over-year basis.

One could say that here, we are taking certain attention of Czech citizens and Czech companies, being recognized as a stable partner in this turbulent times; and partly also the old, good habits of Czech citizens to save a little bit more money for the uncertain period of time.

Here, I would like to hand over to Jirí Šperl, our CFO, who will provide you with the comments related to financial performance. And he will directly hand over to Didier Colin after, our Chief Risk Officer.

Thank you.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [3]

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Thank you. Thank you, yes.

As mentioned by Jan, the situation around COVID-19 already hit [partial of the bank]. We are reporting Q1 has profit at the level of CZK 2.7 billion, which is by 16% lower than the last year, and it basically goes across all [13 checklist]. In terms of material trends, it’s mainly about cost of risk which is, after a release of provisions in Q1 of last year, higher by CZK 330 million, taking at the same time into account that COVID-19 impact is not part of these figures yet, or it is only partially. And Didier will comment on that more. All in all, this transposed also to the profitability indicators that remained sound but obviously (inaudible) year-over-year. So in terms of ROE, it was from 14.5% to 12.1%. In terms of ROAA, it dropped by 20 basis points down to 1.1%.

In terms of balance sheet, after seasonal shrinking at the end of the year, it got back growing by 15% quarter-over-quarter and almost 10% year-over-year. It’s worth to mention that these figures are influenced also by weakening of Czech crown. So using constant FX rates, the growth year-over-year will be around 8%. As is usually the case, the main driver on the liabilities side were deposits growing year-over-year by almost 8%, when 1/3 of these new funds has been placed into loans; another 1/3 into securities, mainly [Czech govies]; and the remaining [securities] surplus into repo loan with central bank.

All in all, the liquidity of the bank further improved and remains extraordinary strong. It is also the case of the capital. At the end of Q1, the capital adequacy ratio stands at 20.8%. It is more than 4 percentage points above the requirement. Of course, and it’s obvious, the main contribution since the end of 2019 is retained 2019 dividend at level of 250 basis points positive impact. Otherwise, the organic growth consumed roughly 80 basis points of the capital. And also OCI and other effects consumed something that is at the level of 70 basis points, and it is very much related to widening of credit spreads on securities.

And moving to net interest income. Both quarter-over-quarter and year-over-year, it went down by roughly 1%. On one side, I will say pressures mainly on retail loan spreads continue. On the other hand, the reported income from deposits remains resilient. Yes, there are already signs of deterioration related to — mainly to lowering of reinvestment yields on them. The (inaudible), and Jan already touched this point, on the left bottom chart, where 3-months PRIBOR dropped in March by 130, 1-3-0, basis points in reaction to CNB repo rates down. And also, longer rates went significantly down. We are showing here 5 years interest rate swaps that went also down by more than 130 basis points, out of which half was down in March.

Moving to fees and commissions. So these have been impacted by SEPA regulation. Our estimates indicated to the markets last year was roughly minus 5% of total fees and commissions. And [SEPA was behind] reported decline year-over-year of minus 5.3%. On top of that, [this line] was in Q1 already influenced by lower number of transactions in March. On positive side, on year-over-year basis, both loan fees and fees from cross-selling achieved nice increases. For loan fees, it was on the back of increased production of mortgages and consumer loans, as was already commented by Jan. And on fees from cross-selling, it was driven by income from mutual funds and life insurance.

This brings me to Page #24, income from the financial operations. The overall reported profit here is CZK 588 million that is higher by 3% year-over-year. Basically, there are 2 offsetting factors — effects behind. The first one is that client’s demand for hedging of financial risk increased with the increased volatility of interest and exchange rates. This is one thing. The second one is that increase in risk premia at the end of March, after the start of the COVID crisis, led to higher CVA, partly offset by higher DVAs. What contributed negatively as well partially were gains on FX from payments due to decrease in foreign transaction activity. Anyways, I can say that, without CVA and DVAs impact, Q1 results will be at the level of roughly CZK 770 million. It is basically in line with our long-term run rate.

And finally, before passing the floor to Didier, is OpEx. So it went up significantly by plus 5.2% year-over-year, and there are 2 main reasons behind. First, CNB adjusted the target volume of the Resolution Fund in 2024 and raised significantly 2020 contributions from all Czech banks by almost 10%. The price or costs for — extra costs for KB here was almost CZK 100 million. And second reason, also briefly touched by Jan, is that in order to ensure safety of our employees and continuity, the banks had to purchase some protective equipments, notebooks; invested into IT support and so on, all in all worth roughly CZK 60 million, out of which roughly 2/3 are already in the Q1 books. The rest in — will come in Q2 books. Without these 2 effects I was mentioning right now, the growth of the costs will be at the level of 2%, maybe in — probably a bit lower than 2 percentage points. Last point is that average number of employees went down and continued in trends. And the number of employees in Q1 is by 40 FTEs lower despite the fact that our [QIT team] was partially further boosted.

So that’s all on my side, and now I’m passing floor to Didier.

Thank you.

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Didier Luc Marie Dominique Colin, Komercní banka, a.s. – Senior Executive Director, Chief Risk Officer & Member of the Board of Directors [4]

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Thank you very much, Jirí. Good afternoon, everyone.

So we’re turning to Slide 27, where you have in front of you a picture that is quite familiar. And this is the picture of our credit risk profile prior to the and into the COVID period and crisis. So as said, a familiar picture to you. We do not present here the default trade by segment or by product, but they are at — or they were, as of the end of March, at historically low level.

Probably make a couple of comments. The first one is that you see a moderate increase of our exposures classified under IFRS 9 standard S2, going up from 5% of the total lending exposure to 5.5% from Q4 to Q1. And in fact, this is the first impact from the COVID turbulence on one single corporate client situation as well as following the requirement from the Czech National Bank to reclassify our exposure under the private moratorium and this before the public moratorium law was activated. And following that, the Czech National Bank aligned its position, as Jan mentioned before, to the position taken by the EBA in terms of not reclassifying exposures under this moratorium law. That’s the first point.

The second point I wanted to briefly mention is the slight decrease of our coverage ratio of NPL or S3 exposures, which went slightly down from 61% at the end of the fourth quarter last year, down to 56% at the end of the first quarter. And in fact, this is just the simple consequences of 2 favorable elements, one being the resolution of an historical default situation which we finally closed, and this mechanically produced some small decrease in the coverage ratio. And there is another relatively large default situation which — for which we reduced the coverage — provision coverage ratio. This is because of positive evolution and return of this situation back to normal business condition probably in the third quarter, and these 2 factors or drivers explain this small decrease of our provision coverage ratio.

So now I propose to turn to the next slide, 28, where you have the main elements regarding the cost of risk we recorded for the first quarter 2020. And as it was mentioned before, the impact of the COVID turbulence is only marginally reflected in those figures. And I will come back to this COVID impact in a few minutes with our full year guidance. So as you see, the cost of risk was posted at slightly over CZK 150 million in net creations or almost 10 basis points. And this is made of 3 components. The first one is for the same amount, roughly CZK 150 million, in fact, some net provision creations related to 5 client situations impacted by the COVID pandemic. So that’s the first component. The second component is that we — and this is what I just mentioned a couple of minutes ago. We finally closed this — one of our old default situation. And here, this created this positive impact of roughly almost CZK 90 million, so 5 basis points going the other way. And the third component is the expected normalization of the cost of risks recorded on our retail exposures, and here, it’s for an amount of roughly CZK 90 million or 5 basis points. And probably what is worth mentioning is that in the first quarter, we did not perform any NPL portfolio sales like we did in the previous quarters, and this also is one of the explanation behind this normalization. So this is the main points for this Q1 pre-COVID cost of risk figure.

And now I invite you to go to the next slide, 29, where you have here a few elements of explanation or illustrations regarding the resilience of our credit risk setup. And I will probably draw your attention on 3 of them. The first one is related to anything that concerns our loan origination and monitoring activities, and I would like to mention a few things. First, we are known to have kept in the last 10 years some underwriting standards which were quite prudent, especially for the nonretail activities. And this is going to be definitely a strength going into the COVID turbulence. The — maybe the second illustration, still related to this loan monitoring and underwriting activities, is the ongoing implementations of some more advanced risk management techniques such as the extended use of some external or new types of data into our monitoring and granting models, the activation of open-banking channels as well as the implementation of some AI-based techniques. All those applied into our granting and monitoring activities for both retail and corporate segments. And this is nicely supported with the implementation of our new service-oriented architecture risk management platform, which in fact will give us in this COVID challenging period navigation flexibility that we didn’t have before, and this will be very helpful.

Now I’m going to spend just a couple of minutes on what we call the monitoring of our COVID-19-sensitive sectors. And here, basically, what we’ve performed is a sector risk assessment, which produced, in fact, the identification of 4 sectors, which are a little bit more COVID sensitive, if you will. And these 4 sectors measured in the total of our corporate loan portfolio, weight for something like 17% of the exposure. And when we compare this to the same weight of those 4 sectors in the Czech economy or the Czech GDP, we’re at a level that is near 20%. So here, the point is that we do not enter into this challenging time with some overexposure towards those sensitive sectors.

And the last point, illustrating the readiness is, in fact, the situation of our NPL portfolios, where, in fact, we, as you’ve seen in the previous slide, have NPL ratio in the range of 2% both for retail and nonretail. And if I zoom a little bit more on the nonretail NPL portfolio, in fact, the NPL portfolio that is still active with some asset recovery potential represents roughly 1% of our total corporate exposure. So it tells you that as of the end of the first quarter, we are in the position we wanted to be in vis-à-vis this asset recovery situation or NPL situation. And the other point I mentioned already is the ongoing introduction of some AI-based retail collection techniques such as voice bot capacity. New collection models are automated and improved interfaces with our clients under collection supervision. So all this will put us in a position to, at the same time, contain the cost of risk table as well as put us also in a position to continue to support the economy in this challenging period.

Now moving on to the last slide dedicated to the credit risk situation of the bank, Slide 30. This slide, in fact, gives you the cost of risk guidance. And I would just start with a reminder of what we exchanged with you at the end of the last quarter or in February for fourth quarter of last year. We had a guidance of roughly 10 bps for an equivalent of almost CZK 1 billion in net project creation. And so this guidance has been increased, as you can see, to a level of — range of 70 basis points for an equivalent of CZK 4.8 billion.

Now what is worth mentioning is the breakdown of this. There are 2 main components. The first one is this forward-looking factor impact, which is a one-off acceleration of our cost of risk recognition on nondefaulted exposure, reflecting this recently revised macroeconomic scenario. This is for an estimated 25 basis points or CZK 1.8 billion. This estimate is done when it comes to the macroeconomic projection horizon. The horizon is of 12 months. So it’s probably a prudent estimate being at 12 months and missing the recovery part of the economic cycle. And the second component is what we call the underlying cost of risk, meaning the cost of risk creation as our portfolio will migrate from lower risk profile intensity to higher-profile risk intensity. And this is for an amount of 40 to 50 bps or around CZK 3 billion.

Now 2 last points before I hand over back to Jirí. The first one is that the materialization of this guidance along the time dimension is probably an exercise that is very delicate to do for at least 2 reasons. The first one is that those government measures to support the economy, we have the effect have already, to some extent, started to have the effect to postpone the COVID-19 impact into the economy and, hopefully, also partially neutralize those impacts. So that’s the first, the timing, postponement impact. And the second one that makes it quite complex is also the IFRS 9 standards — provisioning standards, and it’s well-known for cyclicality, which we need to somehow manage in the best way we can. Having said that, when we try to benchmark a little bit this guidance, we do 2 things. The first one is that we try to remember what happened in the previous crisis. And even though this is not, as we all know, a comparable crisis, it’s always interesting to do this comparison exercise. And we also benchmark this guidance through our stress-testing activities that we have to do twice a year to the — our ICAAP framework, and both of those benchmarks, in fact, gives us the feedback that this guidance is relevant or is consistent with the benchmarks.

So now having said that, I will hand over back to Jirí for some brief overview of the 2020 full year outlook.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [5]

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Thank you, Didier. So maybe it’s worth to mention that given the circumstances, the level of uncertainty and risk is higher than as usual. I think this is worth understandable. Jan already mentioned some of our macroeconomic assumptions as a baseline scenario. So let me only mention 2 very important [from them]. First one is that the key assumption is that the economy is going to decline by 6.5% in 2020. And the second important piece of our baseline scenario is that we are assuming it is starting from 2 models. The repo will go down, cut to 50 basis points and will be there by the end of the year.

Then let me focus on our financial outlook, so what we are guiding is the following. In terms of revenues, we are expecting high single-digit drop, mainly due to drop in net interest income. And the reasons are, I think, obvious, it’s very much linked to the rate environment and overall slowdown. While fee income is going to be hit by regulation, I already commented on that. And we are expecting that financial operations income will remain resilient and will be year-over-year stable.

In terms of costs, they are and will be tightly controlled and will not grow in 2020 anymore, despite some unexpected impacts. And I also mentioned 2 of them, resolution and COVID-19 have extra costs. And also some structural measures to prepare so that tends to be rather costly in a year of implementation. Exploration of the branches was the first one, and the others will follow throughout the year. Cost of risk, that’s commented in a very big detail by the year. So only summarizing at the level of 70 basis points. It’s obvious that the biggest risk to this prognosis or to this outlook is potential second pandemic wave, prolonged shutdown of the local economy and also global trade factors. So that’s regarding outlook. That’s all on my side, and I’m passing floor to Jan. Thank you.

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Jan Juchelka, Komercní banka, a.s. – Chairman of the Board & CEO [6]

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All right. Thank you, Jirí. That was all from our side as far as the presentation is concerned. Now we are ready to take all your questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is coming from the line of Gabor Kemeny from Autonomous Research.

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Gabor Zoltan Kemeny, Autonomous Research LLP – Research Analyst [2]

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My first question is on the cost of risk guidance. Can you give us a sense of what impact does this guidance assume from the fiscal stimulus measures you detailed at the start of the presentation for 2020? And then as I understand, you assume that the stimulus measures would push out some of the potential credit losses. Would this mean that the cost of risk guidance could be similar for 2021 to this year’s guidance?

And the second issue on asset quality, would it be possible to break down this provision guidance for segments like corporate, retail? I’m asking because one of your close competitors guide for a significant — a more retail-heavy bank guide for significantly higher provisions for 2020.

Final question is on net interest income. Can you elaborate on how you get to this high single-digit drop for this year? Because based on the sensitivity you — the NII sensitivity you gave us from the last call, which I think was CZK 600 million to CZK 700 million NII impact from a 100 basis point rate cut, it would imply a significantly lower drop in your NII, closer to 3% by my estimate. It would be useful to understand how you get to high single digit.

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Didier Luc Marie Dominique Colin, Komercní banka, a.s. – Senior Executive Director, Chief Risk Officer & Member of the Board of Directors [3]

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So I will take the — your first 2 questions. So it is — yes, it is quite clear that those governmental measures will have the effect to postpone in time the materialization of the cost of risk. Now if your question is by how much and to split this by time period, this is something we cannot really do because as you know, this situation is a little bit unprecedented. But for sure, this guidance we say that it’s a 2020 guidance but with the precaution that, in fact, part of it could be — there could be a postponement. So in other words, we could be a bit lower in 2020 and a bit higher in 2021. But the precise quantification of this is quite difficult to do.

As to the split between — by segments, in fact, I will start with this one-off forward-looking factor for 25 bps and anywhere between around CZK 1.8 billion. What this — the breakdown of this one-off is, in fact, in one instant impact coming from the stressed PDs and LGDs. And this is probably 80%, 90% of it. And then coming with it, 10%, 20% of instant portfolio shift under this IFRS 9 staging methodology.

As to the split by segment, I would say it’s roughly 50-50 between retail and nonretail. But you can be sure that we will refine this first estimate as we go through this COVID turbulence and as we learn from it. And you mentioned the recent communication of one of our peers. In fact, if you dig a little bit into the figures, you will see that what was communicated by this peer of ours in terms of magnitude, we are more or less in the same range, i.e., in the range of 20 basis points for, again, this first one-off entering COVID under IFRS 9 provisioning standard. So I did not mention it, but you mentioned it. It was one additional element of benchmarking we used, and it proved that we were not completely off or misaligned. So that’s some preliminary answers to your very good questions but quite tough to answer in the current circumstances.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [4]

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Let me continue. Thank you, Gabor, for the question. Let me start with the clarification of our sensitivities. Currently, through the impact of parallel shift of the yield curve by 100 basis points, and that’s what you are referring to for upcoming 12 months, is roughly CZK 700 million, if the rates go up. On the other hand, if they go down, it’s even more due to the fact that — due to flooring of interest rate on client deposits, simply the rates are already so low that there’s no space to go into negatives. So the 100 basis points per our shutdown goes more up to CZK 1 billion for 12 months horizon. So this is one thing.

Other thing is — and that answers to your question why high single-digit drop. There are basically 3 main reasons. First one, as mentioned, market interest rate environment. Maybe you remember that exactly during our Q4 2019 earnings call, the CNB increased their key rates to 2.25%. Now the rates are at a level of 100 basis points. So on top of that, the yield curve is invested. I mentioned already that 5-year interest rate swaps are at levels of 78 basis points. And on top of that, we are expecting further cuts by 50 — another 50 basis points tomorrow. So the rates are basically down by 175 basis points. So this is, I would say, majority of the impact. And then, there are some others. And first one is what’s — for that overall slowdown of activities. So the loans and deposits are still expected to grow further but slower than expected. And third one worth to mention is that simply pressures on retail loans — mainly on retail loans, and I have to say that still a margin or spread on corporate loans are above 100 basis points of levels, but pressures on our retail loans, without any doubts, will continue further.

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Gabor Zoltan Kemeny, Autonomous Research LLP – Research Analyst [5]

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That is extremely useful. A small follow-up on the cost of risk guidance, please. Did I understand correctly that, depending on the timing of the fiscal stimulus measures, you see room for a slightly lower than 70 basis point provisioning in 2020 and slightly higher in 2021?

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Didier Luc Marie Dominique Colin, Komercní banka, a.s. – Senior Executive Director, Chief Risk Officer & Member of the Board of Directors [6]

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In fact, while Jirí was answering the other of your question, I was really looking for a crystal ball in my office. But unfortunately, I couldn’t find any. I’m joking. But jokes put aside, it’s — this is a reasonable, I would say, not mechanical, but almost mechanical assumption. It’s — I think it’s fair to say that a reasonable expectation is that some of this higher default rate that one should reasonably be expecting this kind of environment. Thanks to the government measures. We’ll be postponing to the future. But what is really difficult to perform as an estimate is also the part of the economy that will be, in fact, really saved and helped with those measures. And this is why it’s difficult. But if we are going to be at 80, 90 next year, maybe yes, maybe no. I mean it’s not completely — I would say it’s reasonable to forecast that, but at the same time, there could be so many other possible combination.

So again, your question is very relevant, but it’s still today a bit tough and premature to answer.

And there is another piece of the question, which I didn’t answer, which was answered regarding the split return on retail for the forward-looking factor, where I said it’s roughly 50-50. For the underlying, it’s more or less the same. This underlying of 40 to 50 bps. It’s something like maybe 50-50, a bit higher on the retail side and a little bit lower on the nonretail side. But again, this is to be said with a lot of — with much precaution.

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Operator [7]

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The next question is coming from the line of Samuel Goodacre from JPMorgan.

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Samuel Magnum Goodacre, JP Morgan Chase & Co, Research Division – Executive Director and Head of Emerging Market Europe, Middle East and Africa (CEEMEA) Banks [8]

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Just continuing the rate sensitivity. I mean if some — I think some in the market forecast rate to actually go down to 0. And so could you give us some degree of guidance of NII in that scenario? Because as you’ve said, your deposit beta decreases as you approach 0. So I wonder if actually the impact going from 0.5% to 0% policy rate could have an even larger impact on NII?

And then my second question is about costs. Obviously, you’ve outlined that you expect costs to be flat this year. My question specifically is on the significant number of branches you think you will be operating at or taking out rather by August. What would the full year cost kind of reduction be from that? Because we’ll obviously only see part of the impact this year, but it does seem like a material number of branches that you are closing.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [9]

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Okay. I will start with the risk — or impact of the risk that indeed goes even further to 0. Based on our calculations, the impact of one cut is something between CZK 200 million and CZK 250 million. So while this — on 12-month basis. So if this happens, it’s almost mid of the year, so this would lead to the impact roughly of CZK 250 million in 2020. This is one thing. Regarding the cost, of course, immediately, once the crisis started, we took the needed measures. So we got, let’s say, not maxed out cost type of training, recruiting costs have been reduced. We can sort of staff in — staff cost rates, we made some reductions of building repairs, maintenance, completely cut staff travel cost, office suppliers, and we are seriously thinking about impact into variable compensation, but that’s kind of quicker difference. On top of that, and that’s probably behind your question, we started to prepare more structural points and closing of the — or acceleration of reduction of the branches is fast. And as you were mentioning, very correct words, it generates also costs. So we are currently seeing these measures in a way that the savings generated already in 2020 will also cover these, let’s say, one-off costs related to these staff cost measures. And so that’s potentially about severance payments. That’s about costs related to closing of the branches, in some cases, some minor write-offs, so let’s say, closing of renting contracts and so on. So this is the impact [management]. But at close, this is going to generate a full year positive impact starting from 2021. I believe it helps.

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Jan Juchelka, Komercní banka, a.s. – Chairman of the Board & CEO [10]

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If I can complement with one sentence, Jan Juchelka is speaking, we are not abandoning on our strategic targets to make on longer-term basis, this bank lighter, faster, more agile, and we are helping ourselves in these days to lower the cost base on permanent basis for the future and accelerating some of the digitization initiatives, which were either already ongoing or were planned for a more distant future and we would like to accelerate them. This is why we take the position on reduction of the network of branches, as you have rightly mentioned.

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Operator [11]

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The next question is coming from the line of Robert Brzoza from PKO BP Securities.

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Robert Brzoza, Biuro Maklerskie PKO Banku Polskiego, Research Division – Research Analyst [12]

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I have 2 additional questions on the NII. First, is there any additional impact this year from the downward adjustment in the NPV related to the moratorium-covered loans? So that’s the first question on NII.

Second, how would you estimate what percentage of the NII adjustment, assuming that there would be no rate cut tomorrow, is likely to take place during 2020? And what further adjustment on the NII from the rate cuts that did happen so far will fall on to 2021?

And third, I’ve noticed that you have quite positive GDP growth assumption for 2021 compared with just today published, for example, European Commission outlook of 5% GDP growth in 2021. My question is should — in time, maybe by the end of this year, should we find out that we are not going to hit almost 10% GDP growth recovery in 2021 that you’re assuming? Will this have any negative implication on the IFRS 9 provisioning that you already provided?

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [13]

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Thank you for the questions. I will take the first one. So the first question was what will be the impact of moratoria in terms of NPV. Yes, based on our quantifications and taking into account some assumptions because the key assumption is how the manager of clients will ask for full moratorium. So our assumption is that it will be up to 10%. So if this is concern, the impact into our NII, which is going to be booked probably in Q2 is available of CZK 150 million, CZK 170 million, so it is not anything material. Of course, if more clients would ask, it’s more and vice versa. For the time being, we are at the level of 5% to 6%. And that’s true that in the last 2, 3 weeks, the growth slowed down relatively significantly. This is the first question.

Second question was — I’m not sure I fully understood. It was about adjustment related to the cuts of a…

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Robert Brzoza, Biuro Maklerskie PKO Banku Polskiego, Research Division – Research Analyst [14]

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I mean whether the full adjustment on the NII or say 70%, 60% would be realized in 2020 or perhaps due to slow reset, for example, on mortgage book outstanding, the downward adjustment would continue in 2021, meaning that there will be, again, a similar impact from lower interest rates or, I don’t know, 30% versus 70% placed 2020 to 2021.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [15]

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I would say it is basically linear. So if there is a cut by 50 basis points tomorrow, it will hit the bank by roughly CZK 400 million to CZK 500 million in upcoming 12 months, basically linear. It’s simplification, but there are no, let’s say, linear impact.

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Robert Brzoza, Biuro Maklerskie PKO Banku Polskiego, Research Division – Research Analyst [16]

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Okay. And the GDP forecast versus IFRS 9 provisioning?

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Didier Luc Marie Dominique Colin, Komercní banka, a.s. – Senior Executive Director, Chief Risk Officer & Member of the Board of Directors [17]

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So I’ll get that — yes, Jirí, I’ll take that one. In fact, I touched it a little bit when I said that the forward-looking factor estimate, which we produced is, in fact, with a time horizon, which is 12 months. So what it means basically is that it captures the first part of the economic scenario and not so much the right leg of the whether V or U or something else. So this means that having this approach, which is, in fact, dictated by the IFRS 9 standard, we are coming up with a forward-looking factor, which is rather conservative. So I do not answer your macroeconomic question, but I answered the IFRS 9 aspect of it, at least for 2020.

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Operator [18]

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The next question is coming from the line of Olga Veselova from Bank of America.

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Olga Veselova, BofA Merrill Lynch, Research Division – Equity Banking Analyst [19]

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I have 2 questions — 3 questions. The first question is the amendment of BTI, DSTI and less LTV requirements by the regulator, at which time period were they amended? And is this a temporary measure, or there is no time frame set for now? So this is the first question.

My second question is, can you help us to understand a little bit better? The best knowledge of your local regulator, what needs to happen for the local regulator to remove a ban on buybacks and dividend payment? Do you think that the strong GDP dynamics, which you do anticipate next year would be enough for this ban to be removed?

And my third question is, again, on NII. Thank you for detailed sensitivity of net interest margin, NII, to the policy rate cut. Do you have any other meaningful factors for margin dynamics in the next quarters? Or this will be the one deciding factor for margin evolution?

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Didier Luc Marie Dominique Colin, Komercní banka, a.s. – Senior Executive Director, Chief Risk Officer & Member of the Board of Directors [20]

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I can take the first — this is Didier speaking, the first question you asked by saying that it’s probably a little bit difficult to try to imagine what is in the mind of the Czech National Bank when it’s relaxed this macroprudential policies on the housing loan activities. What we probably can say is that those measures which were implemented in 2017 and ’18 were implemented to address some systemic risk at the level of the entire sector and produced the result. Now adding to that positive results, the COVID-19 situation. I think it doesn’t answer directly your question whether it’s going to be temporary or not so temporary measure. But we can still be comfortable to say that it’s not just a temporary one-off, and it will be reversed quickly. So that’s for the first of your questions.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [21]

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I can take the third one. So that’s about NII sensitivities and the guidance for NIM. So you can recall that in 2019, we were able to maintain our stick to exactly the same NIM, like was the case for 2018. Given circumstances and given what I was describing 10, 12 minutes ago, we are close or we tend to guide a decrease of our net interest margin in the level of 10 to 20 basis points in 2020. And the third one, probably my colleagues will complete me, it’s about both expected reaction or needed evolution leading to the fact that the local regulator would be more open for payment — for better payment of dividends. So it is really difficult to judge. I can imagine that the GDP, it’s a real and one of key inputs, but sorry, as Didier mentioned, I don’t have my crystal ball. But maybe my colleagues will complete me.

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Jan Juchelka, Komercní banka, a.s. – Chairman of the Board & CEO [22]

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Let me complement again with short comment from my side. I’m just looking at complete text of measures taken by Czech National Bank in the field of BTI, DTSI and loan to value parameters, and they say that this measure took place after the assessment of risks for financial stability in the period of time until 31st of March, 2020. In case of identification of material changes of risks for financial stability in the future, Czech National Bank is ready to change those parameters and step in ahead. So one could — I’m not a lawyer, but one could perceive this as permanent measures until they are changed again. That’s the first one. And don’t forget that Czech National Bank doesn’t have anybody to agree with. They can unilaterally decide on changes of these parameters.

Speaking about the dividends and buybacks limitations, we had quite intensive interactions with Czech National Bank in recent. You are probably not surprised as we have had the dialogue through Czech Banking Association on various measures adopted by Czech National Bank as a reaction on the COVID situation. And let me express my subjective and personal point of view here that the first measure or the first indicator, which Czech National Bank is observing here, is the stability of the banking sector. Once they will have enough inputs on being able to assess the stability is not under material risk, I would expect they will also send a signal that things are getting back to normal, i.e. the dividends and buybacks would be, sort of, “allowed” again.

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Operator [23]

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The next question is coming from the line of Marta Wasilewska from Wood & Co.

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Marta Jezewska-Wasilewska, Wood & Company Financial Services, a.s., Research Division – Co-Head of Research & Head of Research Poland [24]

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I would like to have a bit more dive into the lending outlook and volumes outlook. Could you comment a little bit more what was the underlying assumption for the sector in terms of key lending categories? And how do you see maybe a rebound or no rebound coming through in ’21?

And my second question is, could you share a little bit with us what is your outlook in terms of the new production of the new loans through the 2020? Maybe you can share with us anything that you’ve observed during the April lockdown, how it can affect the volumes of mortgages of retail of cash.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [25]

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I will start this with overall — our lending outlook and from that, my colleagues, please, complete me on new production — I mean on retail. So as we are sort of mentioning in our presentation, we are guiding the growth of loans to low single digit. It seems that it will be driven mainly by business loans. I mean a small business and SMEs financing where we are comping partially on a positive impact coming from all these COVID programs. So financing, probably you noticed that the government is going to cover up to CZK 150 billion of guarantees, which means that the total frame for financing under this guarantee programs is up to CZK 500 billion. We think that this will come fully, but definitely, it will have a positive impact. So for business loans, we are sort of guiding, I would say, mid-single-digit growth. So for retail loans through, there will be decline both in mortgages and consumer credit cards, but the sales are still on high positive sellside, meaning the assets still are growing. It was about outstanding, now passing the floor to [Carlos Midek].

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Operator [26]

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The next question is coming from the line of Simon Nellis from Citibank.

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Unidentified Company Representative, [27]

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Can you hear me? I was starting to answer.

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Operator [28]

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Sorry, I couldn’t hear you.

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Unidentified Company Representative, [29]

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Okay. Am I heard now? Is it better?

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Operator [30]

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Yes. I can hear you now. Sorry about that.

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Unidentified Company Representative, [31]

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Okay, Excellent. Just to complete the answer of Jirí Šperl, to say that on housing comps and consumer loans, best guess for this year, is decrease of total production, new production between 10% and 20% for both categories of loans but this is providing that there will be no second pandemic wave coming. And honestly, for 2021, there are so many unknown factors that it’s extremely difficult to estimate or forecast anything at this moment. All on my side.

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Operator [32]

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Are you ready for the next question?

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [33]

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Yes.

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Operator [34]

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The next question is coming from Simon Nellis from Citibank.

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Simon Nellis, Citigroup Inc. Exchange Research – Research Analyst [35]

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Just one last question from me. I see that you didn’t accrue any of your capital in the quarter to CET1. Are you expected to do that every quarter going forward? That would be my only question left.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [36]

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Yes, Simon. The question is whether we are going to continue with no including of profit 2020 into regulatory capital, right?

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Simon Nellis, Citigroup Inc. Exchange Research – Research Analyst [37]

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That’s right.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [38]

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Yes, we are going to continue in this sort of practice, at least, until October. Or in other words, until we — the bank management would decide about dividend payment for 2020.

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Operator [39]

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The next question is coming from the line of Stefan Maxian from RCB.

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Stefan Maxian, Raiffeisen CENTROBANK AG, Research Division – MD & Chief Analyst [40]

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Yes, 2 questions remaining. One regarding actually dividends. When you said you will return earnings for the last year, you also said that you are committed to redeem excess capital at a future point in time. What do you have in mind with that? Would you have in mind an interim dividend on that, like one-off dividend or a share buyback? So that would be the first question.

And the second question, I mean, regarding the current government spending, obviously, the budget planning of the government is also changing. So do you already see signals reappearing with regards to a new bank tax discussion, which then would go directly into budget?

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Jan Juchelka, Komercní banka, a.s. – Chairman of the Board & CEO [41]

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I will start with the second one. No, we don’t see any discussion related or ideas related to implementation of banking tax. What we do see though is — and you can see that in the structure of the state-guaranteed loans, that state is encouraging the banks to put their own exposure in place because they are guaranteeing on a portfolio basis, the loans with the limitation — with the limit on 30% of the total exposure. I will let Jirí to elaborate on the question related to dividends or potential share buyback in the future.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [42]

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Yes. Thank you. Let me summarize and [Carlos] to add a context. So as we announced end of March in order to comply with the regulatory instruction of CNB to the banks, the Board of Directors decided to propose to retain a profit in 2019. So we — and from the end of March. We have also confirmed at that time now that KB intends to take the management capital buffer back to an adequate level once the health and the economic situation normalizes. As we have discussed on previous occasions, KB targets a total capital ratio of 50 to 200 basis above the overall capital requirement. We have also noted ECB’s recommendation for banks not to pay dividends for the financial year 2019 and 2020 until at least October 1. In order to make goods to the strong regulatory guidelines, we have decided to postpone also further deciding on the 2020 dividends at least until October. This also means that at this moment, we do not comment explicitly on the method of how, but I can ensure you that, as always, the future payout proposal will be based on the assessment of current as well as expected or likely regulatory capital requirements and expected growth of the risk-weighted assets. Management intends to balance further remuneration of shareholders with maintaining safe capital adequacy with capacity for profitable growth. So that’s what I can say now and more information will come in October. Thank you.

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Operator [43]

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There are no further questions in the queue.

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Jan Juchelka, Komercní banka, a.s. – Chairman of the Board & CEO [44]

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All right then, if there is no other question, it’s time to thank you very much, all of you, for spending with us the time related to this Q1 2020 Komercní banka financial results. We are appreciating very much your attention. Please keep your fingers crossed for us. We will do our best to navigate the bank through this crisis in a positive way, i.e., to come out of this not only with good results but also enriched by new experiences and new lessons learned. What we are committed to do is to keep the bank ongoing, to keep it strong and stable and be a good partner for our clients in order to provide the sufficient comfort for investors and shareholders. Thank you very much for today, and thanks also to my team, which made a tremendous piece of job during the first weeks of the crisis. Thank you very much, everyone.

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Operator [45]

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Thank you for joining today’s call. You may now disconnect.

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Jirí Šperl, Komercní banka, a.s. – Executive Director of Strategy & Finance [46]

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Thank you. Bye-bye.

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Jan Juchelka, Komercní banka, a.s. – Chairman of the Board & CEO [47]

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Bye.

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