Earnings Call: Q3 2011

Nov 1, 2011

Summary

9M net profit was DKK 1.5bn, but Q3 swung to a DKK 384m loss on weak trading and Danica investment results. Margin increases and a DKK 2bn cost plan aim to improve earnings as funding and impairment risks persist.

Welcome to the Danske Bank conference call Q3. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. Please note that this conference is being recorded. I will now turn the call over to your host, CEO Peter Straarup. Sir, you may begin. Thank you, operator. Welcome, and thank you for taking the time to attend this presentation of Danske Bank's financial results for the first nine months of 2011. With me today are Chief Financial Officer, Henrik Ramlau-Hansen, and Head of Investor Relations, Martin Gottlob. Please go to slide 2. In today's presentation, we will focus, of course, on our financial results for the first nine months of 2011 and for the third quarter. We will also comment on today's announcement of a cost-cutting program to raise our profitability, as well as the results of a recalibration of our IRB model, and we will give you an overview of our current liquidity and funding positions. I will conclude by looking ahead at the outlook for Danske Bank in the remainder of 2011. After the presentation, as usual, we will be open for a Q&A session. Please go to slide 3. Our net profit for the first nine months of 2011 was DKK 1.5 billion. This is lower than expected and was caused by a loss of DKK 384 million in the third quarter. These results are clearly unsatisfactory. The main reasons for the decline were low trading income and a loss from our insurance business because of the difficult capital markets in Europe. In July, we announced the first initiative to improve the group's earnings, higher lending margins in our banking activities. The first results from this measure can be seen in the improved net interest income in the third quarter, and this initiative will bring further gains in the future. In addition, today, we announced a cost-cutting program that will take out DKK 2 billion in expenses over a three-year period. Impairment charges for the first nine months came in 23% lower than last year. Impairments in the third quarter was more or less unchanged from the second quarter. We have now completed the recalibration of our advanced IRB model, and it has been approved by the Danish FSA. The result was an increase of DKK 34 billion in risk-weighted assets, which is within the expected range. The entire European banking sector has been distressed, but Nordic banks are faring better than average, even though the funding markets have been more or less closed since July. Danske Bank has done well given the situation. We have maintained a strong capital base and our liquidity is also strong because we have had access to short-term funding throughout the quarter. Last week's capital exercise by the European Banking Authority stated that Danske Bank's core Tier 1 ratio under the transition rules is calculated at 11.5%, which was well above the 9% threshold. Once again, it was confirmed that Danske Bank is one of the best-capitalized banks in Europe. Please go to slide four. A closer look at the numbers for the third quarter shows that total income declined DKK 3.2 billion, mainly because trading income fell more than DKK 2 billion and net income from insurance fell DKK 1 billion. These factors were partly offset by a drop in expenses of DKK 1.2 billion, mainly due to seasonality and a net reversal of payments to the Danish Guarantee Fund for depositors and investors. Impairments came in more or less at the same level as last quarter and stood at DKK 2.8 billion. Losses in Denmark and Northern Ireland increased, while losses in Ireland declined somewhat, but impairments there are still very high. Please go to slide five. In the third quarter, net interest income continued the positive trend from Q2 with an increase of 4%. The main reasons for the rise were higher deposit margins and a higher return on allocated equity because of hikes in central bank rates, and other reasons for higher lending margins in Denmark from a general increase on the 1st of August, and finally, one additional day in the quarter. The higher margins and return on capital produced DKK 200 million of the expected effect of DKK 500 million for the second half of 2011. The rest will come in the fourth quarter. The Danish Central Bank lowered its policy rate by 10 basis points in both August and September, and this will weigh on deposit margins. Still, the higher lending margins will continue to improve net interest in the coming quarters. In Denmark, we implemented another increase of up to 50 basis points on the 20th of October, and the margins on residential mortgages will increase on the 1st of January. We have also implemented or are about to implement increases at several other banking activities units. Altogether, these increases will lift our net interest income by around DKK 2.5 billion annually with full effect in 2012. This is one important initiative to improve the group's returns. We cannot rule out the necessity of further increases. We have not included any hikes, coming hikes, or reductions of the central bank rates in the forecast. Please go to slide number six. Fee income declined slightly in 2011 and also in the third quarter in comparison with the second. The nine-month fee income was DKK 223 million lower than it was last year, and DKK 209 million of the difference was owing to fee expenses for our state-guaranteed senior debt in 2011. Fee income declined 5% in the third quarter. The main reasons were lower activity, partly because of the summer season, and the lower value of the equity portfolio of Danske Capital because of the decline in markets. We do not book most of Danske Capital's performance fees until the fourth quarter. Still, we do not expect to repeat the record-high performance fees of DKK 251 million we achieved in 2010. Please go to slide seven. In the first three quarters, trading income amounted to DKK 5.7 billion or DKK 1.9 billion per quarter on average, which is within our guidance of DKK 1.5 billion to DKK 2 billion per quarter. Trading activity was strong throughout the first half of the year, but the unrest in the Eurozone changed the agenda in the third quarter. This caused net trading income to decline to DKK 267 million. The main reasons for this were risk aversion in the market, lower liquidity, extreme volatility in certain periods, and higher funding costs for short-term liquidity. On the other hand, customer-driven income held up well during the difficult quarter. The results on our exposure to sovereign bonds in the so-called PIGS countries were insignificant. The net exposure, excluding holdings at Danica, was DKK 3.3 billion at the end of September, all marked to market. Please go to slide eight. Danica's earnings were also hit by the capital markets. They amounted to a loss of DKK 407 million for the first nine months and a loss of DKK 735 million for the third quarter. The reason was mainly mark-to-market losses on the equities and credit bonds that reduced the investment return of customers' portfolios in Danica Traditionel. At the same time, declining long-term interest rates meant that life insurance liabilities had to be strengthened. This obligation should normally be covered by the investment return and the existing bonus reserves. But for two of the four interest rate groups, high and medium, the reserves could not cover the drop in value. Danica therefore had to strengthen the reserves with DKK 692 million. On top of that, the full risk allowance had to be postponed. In sum, we transferred DKK 1.6 billion to the shadow account for the first nine months. This amount is not lost, however. To the extent that the investment return recovers in the fourth quarter, we can reverse the transfer. In 2012 and onwards, a transfer from the shadow account requires that the undistributed reserves on paid-up policies have been reestablished. The unit-linked business is still doing well. In the first nine months of 2011, premiums increased 21%, and earnings were up 17%. The third quarter result was a little lower because of a weak risk result in Norway. Please go to slide nine. Total expenses for the first nine months came in at DKK 19.5 billion, in line with 2010. The big drop in expenses in the third quarter will thus offset the 6% growth at the half-year stage. The main reasons were lower payments to the Danish Guarantee Fund and seasonality. If we look at the underlying trend, expenses increased 4% in the first nine months. This was mainly because of higher wages due to collective agreements and higher IT and marketing expenses, which together accounted for around DKK 800 million. Payments for distressed Danish banks showed a net reversal in the third quarter because a haircut on Amager Banken declined to 16%. A DKK 172 million charge for Max Bank, which failed in the beginning of October, was booked in Q3, making the net reversal DKK 183 million. One element of the new Danish Bank Package IV is a change in the Danish Guarantee Fund from a pay-as-you-go scheme to an insurance scheme with fixed annual payments that do not depend on actual losses from banks that go under. This change has not been established yet. Please go to slide 10. Loan impairment charges for the first three quarters came in at DKK 8.4 billion, down 23% from the 2011 level. From Q2 to Q3, however, charges stayed more or less the same at DKK 2.8 billion. Impairments at National Irish Bank and Northern Bank stayed high as expected, but they were a bit lower than last quarter. In Denmark, impairments increased whereas Danske Markets had reversals of DKK 750 million in the third quarter, primarily due to a settlement on part of our Lehman exposure. Of the individual segments, SMEs continue to show the largest proportion of losses. Impairments on personal customers were still low, but they increased in Denmark. Please go to slide 11. Impairments in Finland, Sweden and Norway remain low, although we saw a few larger cases this past quarter in Finland and Norway. In general, we still see good rating quality, but a potential slowdown in these economies could lead to a decline in ratings in the coming quarters. As mentioned, impairments increased in Retail Banking Denmark, raising the loan loss ratio from 31 to 46 basis points. Please go to slide 12. Let's have a closer look at the Danish impairments and the increase in the third quarter from DKK 0.7 billion to DKK 1.1 billion. The largest segment was personal customers, followed by commercial property and agriculture. Combined, these segments accounted for around 75% of the charges. In the commercial and residential property market, we saw increasing vacancies and the decline in consumer spending hit retailers hard. The challenges that pig farmers are facing did not improve in the past quarter either. For personal customers, increasing impairments were caused by weak housing market with declining prices and a record number of homes for sale. On the other hand, arrears remained low and have declined slightly in recent quarter. The number of repossessed properties also declined and now stands at 153. At Realkredit Danmark, our residential mortgage book is DKK 417 billion. Of this, loans for DKK 8 billion have a loan-to-value ratio above 100%. This is very low, given the price drop of around 20% from the peak. Furthermore, DKK 2 billion of these loans have a public guarantee. Please go to slide 13. At Northern Bank, impairments increased to DKK 719 million. Some 60% were related to the Land Bank loans and were caused by low building activity. This means that many projects will be delayed or in some cases abandoned. In order to reflect this situation, we've increased the haircuts and this caused the high charges in this segment. Impairments on personal customers are still very low, less than DKK 20 million. Impairments in Ireland declined to DKK 1.6 billion, which is still very high, corresponding to a loan loss ratio of close to 10% annualized. Commercial property accounts for two-thirds of the losses, and as in the second quarter, investment property was the largest segment because of lower cash flow. The reasons were lower rental income and a loss of tenants. The decline in property value has slowed down somewhat lately, indicating a slightly better market. The remaining charges were spread over a number of sectors, consumer staples and materials being the largest. Impairments on personal customers increased but remained below 10% of total impairments. Going forward, we expect the fourth quarter to be difficult, but we still hope to see a turnaround in Ireland in 2012. Both the Baltic countries and our Nordic CIB unit showed small net reversals. Please go to slide 14. The wholesale market made funding very difficult in the third quarter and in October. We managed to meet the objectives of our funding plan for 2011, and we also began our 2012 funding. Our current assessment of funding in 2012 is DKK 50 billion to DKK 60 billion, and we have funded the first DKK 5 billion in October. It is our goal to meet this funding plan by a combination of covered bonds and senior unsecured loans. However, we have enough potential collateral to issue covered bonds for some DKK 50 billion. This means that the senior funding for 2012 can be replaced by covered bonds without reducing the liquidity in the funding plan. Our cost for long-term funding were fairly stable in the third quarter because the new issues were covered bonds, whereas the maturing loans were mostly senior loans. Short-term funding costs have increased somewhat, and this is reflected in the lower trading income. Please go to slide 15. We completed the recalibration of our internal risk-weighted asset model in the third quarter. The result was an increase of DKK 34 billion. The main changes were an increase of DKK 56 billion from a new loss given default model and a decline of DKK 22 billion from a new through-the-cycle probability of default model. The reason for the change was that the old model showed that a number of customers had broken the terms of their loans without being in trouble. These defaults were included in the old model's PDs, but there were no losses because they were defaults only in a technical sense. When these customers, without any losses, were eliminated, the LGDs increased. The largest increases in risk-weighted assets were in corporate lending in Ireland, Sweden, and Norway, and in retail lending in Sweden, Norway and Denmark. On the other hand, risk-weighted assets and corporate lending in Denmark declined. This increase in risk-weighted assets and the loss in the quarter reduced the core Tier 1 ratio to 11.8%, which is still healthy. In our next report, we will incorporate Basel 2.5, which will increase our market risk by DKK 40 billion or so, depending on our exposure at year-end. From what we know today, CRD 4 will further reduce our core Tier 1 ratio by 0.9 percentage points because of our solvency in Danica. Please go to slide 16. A closer look at the changes in our risk weights and model shows only marginal changes at the group level, but a number of changes for sectors and countries. The main changes in the input came from the conclusion of data from the early 1990s, as well as from the most recent years. The largest effect was 100% increase in the risk rating of the corporate sector in Ireland. Although this did not come as a big surprise given the losses the sector had seen in recent years. Swedish and Norwegian corporates also showed substantial increases because of the data from the early 1990s. On the other hand, risk ratings in Denmark and the CIB segment offset these increases, bringing the total corporate risk weight down 3%. On the retail side, the number is smaller, but the overall change was an increase of 5 percentage points. The risk weights on residential mortgages are now over 14% in Sweden, 15% in Norway, 17% in Denmark. In Realkredit Danmark, the risk rates was 13%. Please go to slide 17. Let me conclude this presentation by looking a bit forward. The macroeconomic scenario is not very encouraging. GDP growth is falling in many countries, and we expect growth rates next year of 1%-1.5% in most countries in Northern Europe. Norway and the Baltic countries are exceptions, but the market forecasts modest economic growth. We already see low consumption and low activity. House prices have fallen in Denmark, and the record number of houses for sale suggests we haven't seen the bottom yet. Please go to slide 18. Most of 2011 is behind us, so the outlook for the remainder of the year is another short-term view. We are not expecting significant growth, and our activity also looks to be modest during the rest of the year. Net interest income should continue the growth from the past two quarters because of the increase in lending margins implemented in several countries. The trading income is very dependent on the handling of the European debt crisis. A sustainable solution could change sentiment quickly. So far, in the fourth quarter, we have not seen any worsening. A recovery on the equity markets, credit fund markets, is a prerequisite for improving Danica's result. As it stands now, we do not expect to book the risk allowance for any group in 2011, and this will reduce our earnings considerably from the level in 2010. We have not changed our full-year guidance on expenses, which we expect to rise 3%. The development in Europe in general and in Denmark in particular, as well as lower reversals in Danske Markets, should contribute to making the group's loan impairment charges higher in the fourth quarter than the third. The figure for the full year is still expected to be lower than the 2010 figures. Please go to slide 19. It's more important to look further ahead. It is Danske Bank's goal to ensure that we have a sound long-term business model. The current outlook tells us that we will have some years of low economic growth. At the same time, we face increasing costs for maintaining higher capital and liquidity, and funding costs will also be higher than before. These factors will reduce our income and thus our earnings. Add to this that loan impairment charges will probably be at or above the average over a business cycle. They're expected to come down somewhat, but maybe not as much as we had hoped. Another important change is customer behavior. More and more of our customers are using the group's services through electronic media rather than by visiting the branches. They're moving from bricks to clicks. This is not new, but the process is accelerating. Clicks are cheaper than bricks for us and for our customers. The response to these two trends is twofold. We need to increase prices and to reduce expenses. We began earlier this year on the income side, implementing and planning increases in the prices of various products. Lending margins are the main objective, but we will review some other fees and prices as well. Now the time has come to do something about expenses. Today, we announced a three-year plan to reduce expenses by around DKK 2 billion. Please note that the 2 billion is in current prices. This means that inflation will offset part of the savings. Assuming modest inflation of 2%, total expenses should stay flat-ish or close to over this period. On fully implemented, the combination of increasing net interest income and reduced expenses should improve our underlying earnings by DKK 4.5 billion. Of course, some of this will be offset by the extra cost I mentioned. It is impossible to say how much, but we expect that these initiatives will be important steps in ensuring that we have a sustainable and value-creating business model. Please go to slide 20. That concludes our presentation of Danske Bank's financial results for the first 9 months of 2011, and we are now ready to take your questions. If you are listening to the conference call on our website, you are also welcome to ask questions by email. Please, operator, we are ready for the Q&A session. Thank you. We will now begin the question and answer session. If you have a question, please press star then 1 on your touchtone phone. If you wish to be removed from the queue, please press the hash key or the pound sign. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star then 1 on your touchtone phone. Jakob Brink from Handelsbanken is online with a question. Hi, it is Jakob from Handelsbanken in Copenhagen. I have three questions, if I may. The first one is regarding net interest income. I was just wondering if you could maybe elaborate a bit on the net impact of the initiatives you have carried out this fall, that is, the lending margin increases and the announced decrease in RD in 2012. Basically, how much of this should we expect to be eaten up by higher deposit margin pressure? I understand that many of the smaller banks in Denmark are quite aggressive on deposits, and also led by higher wholesale funding costs in general. That was my first question. Then the second question is, you have this slide with economic growth targets for Denmark and the Eurozone. If, let's say, that growth will not be 1%-2% in the Nordic countries, but rather closer to 0%, for example, in Denmark, what would that mean to growth and to loan losses compared to your own targets as they are today for 2012? My third question is regarding your funding. You have this slide showing that you have a funding need for next year of DKK 50 billion-DKK 60 billion, but maturing funding of DKK 90 billion. Should we read this as you will be selling a lot of financial assets, or should we read this as you are planning on shrinking your loan book? Thank you. Your first question related to the impact on net interest income, and there I would refer to slide 5, where you have a description of how the increase from Q2 to Q3, and there you have impact both from RD deposit margin, lending margin, and also the impact of higher interest on the equity. The total combined effect there is roughly DKK 200 million, and that is why we have stated that then probably DKK 300 million will come in Q4, and then you have the DKK 500 million we previously had communicated, and it is also in line with the full 2012 year impact of DKK 2.5 billion we previously have communicated. You also asked to the RD's margins. The RD's margin increases are taking place from the first major part is taking place from the 1st of January 2012, and there we have communicated an impact of around DKK 500 million for full year impact starting from the 1st of January 2012. You asked about also whether there could be an impact from funding or a negative impact funding, and yes, there can be a negative impact from funding. We have communicated, as you also mentioned, the funding need next year from somewhere between DKK 50 billion and DKK 60 billion, and it is hypothetical what the impact could be. But given the current extra spreads, that if you just assume, let's say, extra 50 basis points, then there could be some hundred millions impact going into next year. But we will take that quarter by quarter and evaluate as we are going forward. Finally you asked towards our loans of around DKK 90 billion that comes due next year. But that is actually already included in the funding strategy we did this year because we are always looking one year ahead. So the funding need for next year, the DKK 50 billion-DKK 60 billion, is actually depending on what is maturing in 2013 because we want to have a decent funding capacity at the end of 2012. So we are in our funding communication and the way we look up funding, always one year into the future. Finally, you asked about growth impact if growth should not be 1%-2%, but perhaps even lower. And yes, that may impact the loan losses, but it is very difficult to assess the impact here from our side. That's 1% growth or 7% growth. We still hope that loan losses continue to come down in 2012, but as was mentioned in Peter's speech, it may take a little bit longer for things to come down than we anticipate. Okay, but just getting back to the margin question, I guess I was just, after having seen a lot of banks results so far, especially the Danish ones, it seems as if part of the margin increase that has been announced has been eaten up by the fact that deposit rates have had to be kept high not to lose deposit to the small aggressive banks, and also has maybe not been transferred quite as announced, given that the competition on lending still seems to be quite fierce on best clients. My question is basically, do you believe that after having done those margin increases that you'll have a net positive or is this just to offset negatives? Jacob, it's Martin here. If you look at the numbers for the third quarter, you can see that the average lending margin has gone up in the quarter. That is because of the short-term rates from the central bank were raised in June. The increase we saw from that has not been fully offset by increased competition. But you're right that there are some competition in that market, but it's too early to say whether it will offset the full. We don't expect that it will offset the full effect on the second increase we have made here from the 20th of October. Okay. Thank you. Andreas Håkansson from Exane BNP Paribas online with a question. Yes. Hi. I have two questions to start with. The first one is on your trading line, given that we see a difficult funding environment. What I am asking, do you still believe that 6-8 is going to be, or that is the normalized run rate for trading given that we saw that the increased funding costs were impacting you in this quarter, and if funding cost remains elevated also in 2012, or you are expecting to scale down your portfolios and we should actually get down to a little bit lower level? Second question is really coming back to the loan loss provision side. You say that you expect an increase in the fourth quarter, but I guess we are more focusing on 2012. If we ignore Ireland for a second and think about Denmark, if we are now looking at rising unemployment as you say in your GDP forecast, we are looking at falling property prices, as you say, and fairly rapidly slowing GDP growth. Is it not more likely that loan loss provision is going to be up rather than down? Or what levels are you looking at for next year? Thank you. First on the trading. Our trading activities for the first three quarters were actually within the guidance we have had before. Even though third quarter was a terrible quarter, we managed to stick to our guidance. So I think we have to see some more quarters before we start changing that. The trading for the first part of the quarter here has been a bit more normalized. So that will have to wait. On the loan loss provisions, I think it needs to be said that the bank has not made forecasts on expected loan loss provisions into 2012. We are looking at an economic environment which might slow down, and that would have some effect on loan loss provisions. One has to say, though, that Danish consumers have deleveraged quite a bit and handled themselves well. Even though we have seen this crisis for a period and even seen unemployment go up, arrears in the mortgage program are still quite low. How dramatic it would be, I can't tell you, but no doubt a lower growth rate would cause higher impairment charges in all markets. Sorry, that's very good. Could we just follow up with one very quick one. We had the Swedish bank being out today saying if they have any exposure to MF Global. Have you got any comment on that today for us? We don't. You don't. More questions? Chintan Joshi from Nomura is online with a question. Hi, good afternoon. I have got a few questions here. Firstly, just a follow-up on that Q3 lending margin chart that you show us in the presentation. I am just wondering how much of the lending margin benefit was because you refinanced senior unsecured with covered bonds as you mentioned in your comments. Getting onto my questions on the funding slide. Obviously about DKK 90 billion, most of which is senior unsecured, is getting refinanced with what you say will be covered bonds. I am just wondering this refinancing whether it will be a net negative or a net positive for NII. Again, the next question is again on NII. If I look at consensus numbers, your guidance is of about DKK 2.5 billion. On consensus, we have probably half that number going into 2012. Clearly there is an expectation of higher funding cost built in. I just thought if you could comment on whether that looks a bit too bearish looking at the current market spreads that you see. Finally, the last question is you highlight in Swedish mortgages 17% risk weights. I am just wondering if you had any discussions with the Swedish FSA on it or it was purely with your own regulator. Thank you. To take your last question first, the risk rate we had in Norway and Sweden, we have only had a dialogue with the Danish FSA regarding that. Our RWA review has only been a dialogue with the Danish FSA that has approved our changes. There has been no dialogue in that respect with the Swedish FSA. You had a number of questions, our lending margins. You asked about the funding cost, and if you look at slide 5, you can see that the funding cost in this third quarter increased by DKK 24 billion. That is the impact we had. That is mainly coming from the funding we made, the senior loans we made in June that had a full quarterly impact here in the third quarter. The covered bonds we made in late August has only immaterial impact in the third quarter. They will be more visible in the next quarter. Then you asked about the funding cost for 2012. If you can tell me what the spread will be when we are going to issue those loans next year, then we can tell you what the impact will be. At current levels? At current levels, but it's difficult to ask about the current level for senior debt. There's actually not a real market for that at the moment. So it's difficult for us to say at this point. Covered bonds is, of course, more expensive today than they were half year ago, so there will probably be a little bit on the increase. But we have not given any guidance of how much we expect in funding cost will increase in 2012. Then final question was whether you thought we as sell-side analysts are being too bearish on the funding cost going into the next year. I just said that we have not given any guidance on the funding cost next year, therefore it is also difficult to Got it. whether it is bearish or not. Yeah, I realize it is a difficult question. Thank you. Jan Walter from Deutsche Bank is online with a question. Yes, good afternoon. Jan Walter here, Deutsche Bank. Couple of questions. First on the cost there, the DKK 2 billion cost-cutting program. Could you give some details whether or not that will have an impact on 2012 already, and if so, roughly by how much? Number two, do you foresee a restructuring charge for this program in the fourth quarter already? The third question is about the technical reserve strengthening. What must happen for you to write that back? Is it enough that equity markets are at present levels and that bond yields are unchanged, or do we have to see a material change in capital markets for that to happen? Thank you. For your first question relating to our cost-cutting program, whether that will have an impact in 2012. We have just decided about the program, so it's a little bit early to say about any impact in 2012 because there may also be restructuring charges impacting the 2012 results. Definitely, we expect it to have a full year impact in 2013, but we'll probably come back to that in connection with our communication around our Q4 results. It's also too early to say whether we'll make a restructuring charge in connection with our Q4 results. The program is still at an early stage. Then you asked about Danica, the extra strengthening of the provisions of around the DKK 700 million. For that to come back, we need equity prices to go up. We need credit spreads to come in. The loss is mainly a result of equity prices that went down and credit spreads that went out during Q3. So we need these changes to be reversed. Of course, the current development until, let's say, the last two days have been positive in Q4, but it's too early to say whether there'll be a real impact in Q4. But you need equity prices to go up and credit spreads to come down in order to get a reversal of the DKK 700 million that has started in the right direction in Q4, but it's still too early to say anything definite about that. Thank you. Just to follow up, if I may. In the EBA capital exercise, the announcement has been that your Q1 falls from 12.3% to 11.5%. Yes. But without the transitional floors, the Q1 must be around 9.5%. What is the explanation for the difference there? Thank you. Could you try to I don't think we- The difference into the transitional period? That is because the risk weight, the 20% of the Tier 1 risk weight is higher than the current risk weight under full Basel II. Yes. I guess the question is the Danish FSA has flagged that your Q1 post the test is 11.5%, but the transitional floors should be in place. So I thought that- The 11.5 that was communicated in connection with the EBA stress test. The 11.5 based on the transition rules includes also the state hybrid. Okay, thanks. That explains it. Okay, thank you. Johan Edzon from Bank of America is on line with a question. Thank you. I just want to come back to the change in risk weightings, and I am a little bit surprised by some of the moves. For example, to see that corporate risk weights are between 50% and 150% higher in Norway and Sweden versus Denmark, I would assume with what asset values have done in these countries, your LGDs should be lower in Norway and Sweden, not higher. You state that LGD is sort of the negative impact on risk weight and the PD has had a positive impact. Can you just talk to why we are seeing so much higher risk weights in markets where asset values generally have performed a lot better? The simple explanation is that during our dialogue with the Danish FSA, it was very important for them that we also included a loss experience back to the early 1990s, where, especially in Sweden, there was very high losses. We were asked to include that in the way in our LGD modeling. That is the reason for why the LGD and also the risk rates on the corporate side goes up in Sweden. The similar reasoning applies to Norway. Okay, thank you. Ronnie Ren from KBW is online with a question. Yeah. Good afternoon, together. Just a few questions. First, on the cost side, could you explain to me the holiday payment reversal in the third quarter? Secondly, on the deposit insurance system kind of changes, could you confirm what your expectation is as to when the Ex-ante scheme will be introduced and what cost might be associated with that? Thirdly, on the maturing sort of senior funding next year, could you give us an indication as to what the average cost of this paper was? Lastly, could you just quickly review the solvency position of the insurance operations? Thank you. Could I start with the cost side? Then you ask about the holiday impact. That is actually a reversal we have in Q3. During most quarters, we set money aside for the holiday vacation. In the accounts, we set it aside, and then we cash it in the third quarter. That is why you get this positive effect on the cost in Q3, where people have their vacations in Q3. Clear. Okay. Then you asked about the deposit schemes, which will be more on the insurance side, but I think Torp has most information about that. That is a change that we do not expect to be in place until next year. At this point in time, if there is any issues with any bank, it would be pay as you go. The deposit insurance scheme will be modeled, I think based on the insurance structure, but also such that there will be some accumulation of a fund over a period of time, which I think should be completed in accordance with EU in about 2027 or something like that. If you look at the figures some have indicated, but this is really a wild guess, that for the sector, a figure in the ballpark of DKK 2 billion annual payment could be in order. It can be 50% more or less, possibly not 50% less, but the ballpark is around DKK 2 billion and do not hold me responsible for it. Hence, Danske Bank would then expect to pay about 34% of it. Okay, clear. Then you ask about the funding cost of the maturing loans. We do not have the average cost for that here with us. I will come back to you on that. But I can tell you that at least a good part of these loans next year, namely DKK 37 billion, is loans with a state guarantee on which we at the moment pay a fee which is equal to 80 basis points. That fee cost will of course be saved when that has been repaid. Maybe just a quick follow on this because the question came up before. Your covered bond costs have gone up, but it is still fairly okay. You are not going to issue any major senior next year, then it should have a net positive impact, shouldn't it? If it is so that we do not issue any senior debt, then you only do covered bonds, then you are right that there could be a positive impact on that, yes. Okay, clear. It is our plan to do both, depending, of course, on the market situation. We have enough material to cover most of our plan for next year with cover bonds. As we said in the speech, around DKK 50 billion in material we can use for covered bonds. Mm-hmm. One question just on the composition of the funding requirement. Obviously, it reflects to a certain extent what expectation you have in terms of the business that you originate. Is there basically not much of an expectation to originate business which require senior funding? We don't foresee any major growth in our loan book. That's our expectation for 2010. We may be positively surprised that the demand is higher than we anticipate, but we are cautious here. Okay. Clear. Then you asked about the solvency of the insurance operation. You can see in our Ins core that we have allocated capital of DKK 8.8 billion to our insurance operation, and that's the internal capital allocation. If you look into the legal entity, Danica Pension, they have an equity of around DKK 16 billion, DKK 17 billion. So there's definitely no need for capital injection to our insurance as well. If that was what you were trying to say. What's your solvency level now? I can have a look. Sorry. DKK 8.8 billion. 8.8. What is it in percentage, the solvency? That must be close to 200%. 200%, okay. That is fine. Thank you. Claire Kane from RBC Capital Markets is online with a question. Well, good afternoon, everyone. I just got a follow-up on some of your guidance. The DKK 2.5 billion incremental from the initiatives you've already announced, should this be against the 2010 full year base? Is that the gross amount that you picked out for excluding funding? Based on your outlook for funding next year, though it may be a net positive, could we assume that we should expect that all to come through by the end of 2012? That's the first question. On the costs, could you maybe give us some guidance on where you expect the staff costs to come out and the timeline for this? Is the implicit guidance just for flat cost for the foreseeable future through to 2014? Just trying to tie up the DKK 4.5 billion additional to earnings, and if these are actually absolute numbers or just underlying. Finally, on the risk weights, how do you think you now compare to other Nordic banks that are putting in advanced models? Would you say those LGDs are quite flexible? If we get a recovery in Ireland and more so in Denmark, those risk weights could come down quite quickly. Thank you. First, you asked about our guidance of around increased net interest income of around DKK 2.5 billion. Actually, it was communicated out in connection with our Q2 numbers. So it's actually an annual figure compared with our annual run rate at the end of Q2. That's incremental net interest income in 2012 compared with our annual run rate at the end of Q2 2011. You're right, it excludes any potential negative impact from more expensive funding, as we just have talked about, but that depends on how the split will be between senior funding and cover bonds as we have just commented on some of the other questions. Then you asked about our cost program, how that will impact our 2012, 2014 figures. You are to some degree right that that could lead to us having in 2012, 2013, and 2014, roughly flat cost in nominal terms. But of course, there may be ups and downs in the individual quarters. That is the correct interpretation of that. Then you asked about our risk-weighted assets, how we compare with other Nordic banks. We think we are very much in line, broadly speaking, with other Nordic banks, but you should still expect our risk-weighted assets to move with dampened curves. There will not be any big changes from quarter to quarter. There will come the impact from new regulation. But just because we have one quarter with few impairments would not mean that we will reduce the risk-weight assets to the last degree. It will be small incremental changes over time and not any big reversals or decline risk-weight assets going forward. Thank you. That is very clear. Jacob Cluse from Autonomous Research is in line with a question. Hi. Thank you. Just a couple of questions, I guess. Firstly, on the issuance, just to be clear, you are saying that you have roughly DKK 50 billion of covered bond capacity to issue to cover your funding needs for the coming year, if I understand it correctly. Could you just tell me where that puts your OC, and if you see any problems with rating agencies or ratings from doing that aggressively in the secured market. Then just secondly could you talk at all about your succession plans for the CEO if you have any policies or any thoughts around that? Thank you. Let me begin with the cover bonds. The way it works at Danske Bank is that we have material that is not included in the current cover pools we have which you can read upon on our website. So we have additional loans, additional material we can add to the current pools, or we can establish new pools if that's what we want. The OCs, when we do this, will be in the same magnitude as we have currently. So we would not going to stress our issuance of cover bonds in any way. It will be just done in the same prudent way as we have done up until now. On the succession issue on Chief Executive, what has been communicated today is that the CEO, Claus, will be due to go on pension, and now starts a process, and the process is undertaken by the chairman and the deputy chairman, and that includes evaluation of candidates internally and externally. That is basically as far as I can take it. There is not much more to say about it. It is for the board to decide which candidate should have the job offered. Timing is expected to be 2, 3 months. Would it be fair to say that is typically recruited internally in these circumstances? Historically, Danske Bank has recruited internally. I do not think that history necessarily is going to determine what is being done this time. The communication that has come out is that the board will look both at internal and external candidates, and that is where we have put it. So it could be both. Okay. Thank you very much. Sure. Simon Christensen from Nordea Markets is online with a question. Yes, good afternoon. I only have two questions. The first one relates to Danica. I read that you have DKK 3 billion of shares and DKK 7 billion of credit bonds related to the two interest rate groups, which are now underwater in terms of collective and bonus potential on paid-up policies. Will there be a one-to-one relationship between losses and gains on this portfolio and the cash that the shareholders are expected to pay on this? Secondly, you have a reversal in markets on Lehman. How much unsettled business are there with Lehman as of today? Thanks. In relation to Danica, it is mentioned in our interim report on page 21 that the loss of around DKK 700 million came from two interest rate groups. Those two interest rate groups at the end of September 2011, they had equity and credit bond exposure of respectively DKK 2.9 billion and DKK 16.8 billion. At that date, at the end of September, there was a one-to-one exposure also to the bank's profit and loss account if things deteriorated beyond the level at the end of September. So you are right. For this exposure, there was, to say, a direct 100% impact also on the bank's profit and loss account going forward. On the Lehman exposure, the remaining exposure relates to a couple of properties that the bank has taken over. These are up for sale. I would not expect the bank to release any significant value from those. Good returns from Lehman, I don't think you could expect going forward. You should not expect the opposite either. Okay, thank you. Jan-Erik Gjervan from DNB NOR is on line with a question. Good afternoon. It's Jan-Erik Gjervan from DNB NOR Markets. I have some questions as well. The first one is your dividend policy versus the stated level from the EBA now of 9% on transition rules versus potential growth you will have on your risk-weighted assets. Secondly, I would wonder about your covered bonds pool level versus what you would like to have as a senior pool in the split between those two bond types. If you have any talks to the rating agencies about those two issues. Thirdly, on your loan losses in retail, it says something in your report that is due to this CDS buybacks or something like that. If all of the retail losses in this quarter is related to that item only, and that underlying is it better? Finally, on your risk-weighted assets, the internal model then going back to the early 1990s and potentially earlier than that is really taking the risk weights up to these levels. Could you elaborate a little bit about then potential changes to loan losses and impairments going forward? Will then those just have a 1/20th impact or one to 21 impact, or will you have a 20-year rolling basis or something to look at on your LGD model going forward? Thank you. First, you have a question which I did not 100% follow. You asked about our dividend policy in relation to the EBA stress test and the threshold of 9%. We came out of the EBA, the most current stress test with a Core Tier 1 ratio of 11.5%. That is quite a distance to the 9%, so that is not an issue. Absolutely not, but it includes your state hybrid, as I understood from your answer to any question. So it's about- That's also how the EBA interprets things. The evaluation of this threshold, whether you are on which side of the 9%, the EBA threshold, the most current threshold of 9%, that their calculation method includes the state hybrid. That was also the case in the summer stress test that was published in, I think, late July. Yeah. My thinking there, sorry. Sorry. My thinking was just about when you look then at your dividend policy going forward versus your potential then payback later on in 2014, isn't it? Whether or not if this current transition will soon be just be on an ongoing basis as regulators tend to jump around these days. It is more about, would you then look at the dividend policy for some years now just to confirm with those 9% also going forward, if that should be a running level? Yeah. We would, of course, look at that going forward. Our declared dividend policy is to pay one third of our earnings out. Of course, this year it is something that will have to be decided in the annual general meeting and also made a decision by the board in connection with the full-year accounts. There is a limit in the state hybrid we have how much we can pay out as dividends. I think currently we are far away from that limit. So we don't expect any dividend policy to be a real restriction in the next couple of years. Of course, we'll have to look at refinancing the state hybrid when there's a possibility of repaying it 2014. Then you had a question about our covered bond pool levels, and currently we are saying that we are, in broad terms, could expect to do 50% covered bonds and 50% senior funding. We actually, currently we have, let's say, 40% that is covered bonds and 60% that is senior funding. So we are quite a way from that target level. Perfect. Thank you. Then you had a question about our risk-weighted assets and whether there would be any impact in the future and how we do it. We are calculating both the PDs and the LGDs using pretty long time series of up to 20 years. As I mentioned, we have also data including back to the most of the financial crisis that took place in the early 90s. But again, you shouldn't expect any big changes in our way we do the PDs and LGDs going forward. Just to follow up on that last one. Would you then have 1990 as a base and just add on the years, or will you have then when we now go into 2012, we then leave 1990? We will have a starting point around 1990, and then we'll add one more year each year. Okay, so you will then get an even better or more diversified book as times prolong. Yes, that's correct. Okay, thank you. The final one on the CDS then just if you could mention those, please. What was the question on that? The retail losses in the quarter look to be some kind of buyback of a CDS or something like that, if I read it correctly. No, there's nothing to do with any CDS this quarter. You can say that we have reverted some of the collective impairments we had on private individuals to be individual in this quarter. Okay, the underlying level is deteriorating then in the retail or personal customer parts as you mentioned in the interim report. I'm not sure I follow you. The retail personal business is then deteriorating, as you state in your report. The CDS has nothing to do with the underlying levels. Exactly. Yes, that is true. Thank you. Andreas Håkansson from Exane BNP Paribas online with a question. I had two more questions, actually. First one was on the flat cost target. Could you tell us what is the starting point? Because I think you look at the 3% cost growth from last year, that gives us 26.8. Could you tell us if that is the starting point? Will some of the one-offs fall out from that? Just to clarify that. The second point, just to follow up on Shintan, he was asking something about consensus considering funding costs and so on. Could you also remind us what is your sensitivity to falling interest rates? Let us say you get a 50 basis point rate cut from ECB. What is the negative impact on your NII then? In terms of the cost program, your first question, the starting point will be our annual cost for 2011. Of course, we will make some adjustments for one-offs, which will not be part of the, so to say, when we communicate that we reduce our underlying our cost base by 10%, then it is our underlying cost base, excluding one-offs, like the fees we have paid to the state guarantee schemes for banks going under. Also may be some amortization items which will not be subject to the 11% cost reduction target, et cetera. So it will be our underlying cost base for 2011 that is, so to say, the starting point. That is also why we are mentioning the 10% being rough DKK 2 billion, which is obviously less than 10% of the DKK 26 billion we just mentioned. On the interest rate sensitivity we have on site, number 5, it is said that the 25 basis point drop in the central bank rates across the board in the countries we are active will cost us around DKK 750 million. Perfect. Thank you. Matti, I see some Credit Suisse online with a question. Hi. Two questions for you. Firstly, on the Irish mortgage book, have you done any changes to your valuation of the collateral there, i.e. what is the current LTV of the Irish mortgage book, and how large share of that is above 100%? The second question is on slide 32. You have a figure there of the exposure to pig farming of DKK 2.2 billion. In the quarter report, I think in the text it says DKK 14 billion. Those two figures reflect two different exposures, or could you explain that, please? Thanks. Regarding the LTV in Ireland, I do not have any updated figure on the Q3 numbers, mainly because we have not got the statistic yet. As the price of property has gone down a few percentage points, the LTV probably has increased, so we will be close to 100 in Ireland. The part of the book that is above 100 now is probably in the area of DKK 2 billion. Again, I do not have the exact number with me here. Pigs farm. Could you tell me? The pig farm. Yes. If you look at the pig farmers, the amount of pig farmers in Realkredit Danmark is percentage-wise pretty much the same as it is of the retail bank. So around 20% of that exposure is to pig farmers. In the table there, it says DKK 2.2 billion in exposure, but I guess 20% is more like DKK 14 billion, isn't it? No, but the DKK 2.2 billion is out of the DKK 9.7 billion of Retail Banking Denmark. You said Retail Banking Denmark is DKK 9.7 billion. Of that, DKK 2.2 billion are pig farmers. Okay. Then you have another DKK 12 billion in Realkredit. Yes, that's true. The one we have in Realkredit Danmark is not causing us the same issues as the one we have on the banking book. Okay. Thank you. Jan Walter from Deutsche Bank is online with a question. Yes. Hi, Jan Walter here on Deutsche Bank. A question again on the agriculture book. The DKK 14.7 billion, which are booked in other business units there on page 32. What is that, and what kind of collateral does it have? Is it secured or unsecured, first and foremost? Thank you. This is exposure in other countries, Sweden, Ireland, Northern Ireland. As you can see that the impairments we have made there is quite low, so we don't see any big issues here. Of course, we also have collateral on a big part of that. I don't have the amount of that. Okay, very clear. Thanks. Omar Keenan from Nomura is online with a question. Good afternoon. Omar Keenan, Nomura. I just had a few questions, please. I just wanted to ask your general thoughts about what you think is a sensitivity to a further 10% and 20% decline in house prices in Denmark, given your view that there's still some way to go before the bottom is reached. Could you discuss whether you think there's any implications for the mortgage bond-issuing entities? Secondly, just on your discussions with the regulator, when do you think the insurance scheme will be put into effect? Do you have any idea of what the cost related to that scheme would be? Would it be a percentage of your deposit base? Just lastly as well, your two rate increases of 25 basis points. Was there any pushback from the regulator? I'm just asking that because if the funding cost does turn out to be worse next year, is the door open for further rate increases on your lending book? Thank you. Thank you. You asked about the impact of a further house price decline. I think you mentioned 10%-25%. It's difficult here just to give you a simple answer to that. Of course, it would lead to more loan losses. Internally, we are making stress test scenarios along some of these lines, but that's not something that we have published. I can mention for you that we can, in our mortgage rate in Denmark, we can deal with a substantial house price decline. Of course, it could lead to further losses, but we can deal with a substantial house price decline and still live up to lower collateral requirements in our mortgage institutes. Of course, it impacts our impairment levels. I can refer you to look at the presentation from the Q2 conference call, where we had a slide telling you the result of a stress test of Realkredit Danmark. You can look at that, and you can eventually call me if you need some explanations for that. On the deposit insurance scheme and the restructuring of that, turning it into an insurance-based structure. We mentioned a bit back that we think that that will not be put in place until 2012. We do not have precise information about how much the sector will have to pay. Some have voiced a number around DKK 2 billion, but it's really a guesstimate. Danske Bank would expect to pay about 34% of the sector's contribution. Okay, thanks very much. What about the likelihood of further- There was a third question. Yes. There was a third question, which we didn't get. Can you just repeat that, please? I just asked about the likelihood of further rate rises on your non-mortgage lending book in Denmark if funding costs are worse than expected. We are continuously monitoring the development, and I think we also demonstrated what we have already done, where we have raised rates in our Danish banking book twice during this year. If things become more expensive, we'll have to look into our prices towards the customers. That is something we are continuously following. Okay, thank you very much. Sofie Peterzens from JP Morgan is online with a question. Yeah, hi. I had a question regarding the Lehman bankruptcy claim. Last week there was an article saying that you have reduced your claim against Lehman from DKK 700 million to DKK 580 million. How is that recognized? Do you only recognize if you actually get the claim back, or have you already somehow provisioned somewhere for the original claim of DKK 700 million? That was my first question. My second question was regarding the tax rate. You've had a quite high tax rate in all the quarters this year. How should I look at the tax rate for 2012? My final question is on the trading and prop trading book. How is it split between prop trading and customer-driven activity? Thanks a lot. On the Lehman exposure, our claim has now been recognized, and for that reason it's been reversed in. Part of the claim has been sold on. So now we have certainty that our claim is being fulfilled in the precise amount, and that's why we reverse it. Okay. In terms of your question about the tax rate, we have a backup slide on page 22. There's a backup slide where you can get more information about our tax rate on page backup slide 22. Basically, the idea is that due to the losses we have in Ireland, we're not accounting-wise activating the loss we have in Ireland. So that's the main reason why we have a really high tax rate. Therefore, also the tax rate gradually come down as the losses in Ireland also comes down. Okay. Tax rate question. When the break-even are reached in Ireland, then you should assume that the tax rate in Danske Bank will be back to normality, which is around 26%. Okay. What about the final question on the trading split between customer and prop trading? Normally we divide it between customer and market making, non-customer-driven part of the book, and that differs quite a lot from quarter to quarter. This quarter, the customer-driven was the majority. Actually, it was more than the whole. In other quarters, it has been the other way around. On average, you should say that not far away from around between 40% and 50% should be customer-driven. Okay. Thank you. Ronnie Wren from KBW is online with a question. Yeah, just a quick follow-up on the Basel III guidance you gave. You said 90 basis points. Has this in any form or shape changed from the last quarter? No, the 90 basis points was in the communication related to the impact of the Danica where we assume that the solvency part of Danica, the DKK 8 billion I mentioned previously, will be deducted in our quarter one ratio. So that's what we have communicated. Okay. We have DKK 40 billion higher risk-weighted assets for Basel 2.5. That is, I do not know, 50 basis points. That is the stressed VaR effect. Yeah. Yeah. We have 90 basis points on the Danica. If and when that becomes a reality some years down the road. Okay. What else do we need just to round up the calculation? I remember 160 basis points for some reason. There will also be a credit risk counterparty, CVA effect. Okay. We haven't communicated anything about that in details yet. But 160 that we used to talk about, is that still roughly the benchmark we should look at? That's still roughly the Okay benchmark, yeah. Thank you so much. Jan Erik Gjerland from DNB NOR is in line with a question. I also have one follow-up question, please. The market value adjustment on your mortgage loans, which brings it up by some DKK 13 billion in Denmark, could you explain that a little bit more? Is it just a normal lending growth or is it something value adjustment you actually do or because interest rates have dropped or something like that? That is exactly that. It's something to do with the interest rates has dropped because part of our book, namely the fixed rate 30-year loans in our mortgage division are mark to market. When the interest rates go down, the value of that goes up. If you look at the fact book, you can see the nominal value, and that has increased by, I think it's DKK 3 billion in this third quarter only. Is it an P&L effect from those mark-to-market effects? Nope. It's both assets and liabilities that are reevaluated every quarter. Okay, thank you. As a reminder, if you have a question, please press Star then One on your touch tone phone. Okay. Operator, it sounds as if we are- Sorry. Excuse me. Reaching. Did you have an additional question? Sorry. Sorry, yes, we have Mats Andersson from SEB on the line with a question. Sorry. Yes. Thank you. Mats Andersson here. Just a quick question, so I understand thoroughly on the distribution of dividend policy. You mentioned before here that it was one-third of EPS. How does the board look upon this? Are they looking at underlying earnings or the balance between underlying earnings and of course this year's earnings when deciding on this, the dividend for 2011, if you could elaborate a little bit on that, please. I think the disclosure the board has given out on this is that it would look to about a third of the bottom line, and that is a nominal exercise. But I think we should leave it to the board to make firmer decisions on precisely how the dividend policy should be, once we reinitiate dividend payments, which the bank hasn't made for a couple of years. Thank you. Okay. It sounds as if we have reached the end. We thank you all for your interest in Danske Bank. Thank you for your questions. As always, you are welcome to contact us if you have more questions after you have had time to look at the accounts in detail. As usual, we will be ready to talk to you until 9:00 P.M. this evening, Central European time, and of course, again tomorrow morning. A transcript of this conference call presentation will appear on our website shortly, and a transcript of the Q&A session will be added within a few days. Thank you. Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.