Ladies and gentlemen, thank you for standing by. Welcome to the SEB Q2 2019 results call. At this time, all participants are in listen-only mode. There will be a presentation followed by a question-and-answer session, at which time, if you wish to ask a question, you will need to press star and one on your telephone and wait for your name to be announced. I would now like to hand the conference over to your speaker today, Johan Torgeby. Thank you. Please go ahead, sir.
Thank you. Welcome everyone to today's phone conference. I'll just start with a quick summary of this quarter, then we'll open up for Q&A. We characterize this quarter as driven strongly by high client activity, we saw it being a broad-based activity lift. Particularly, we saw higher demand for borrowings and higher demand for capital markets financing. On the mortgage side, not to be mixed up with the general market, which has come down in growth rates over the last six months, we have performed a little better in the last five months and are now back on track, where new sales are in line with our natural market share.
We definitely got helped this quarter by strong equity markets, all the AUM-related business areas benefited from that, continued high fee and commission generation coming from high activity within payments and credit card activity. The weaker area during this quarter was particularly the business area fixed income, which meant that the markets activity contributed a bit less to this quarter's result than Q1. That was predominantly driven by the flattening of the yield curve and some of the stressed VaR kicking up also the capital consumption for that business area. All in all, a solid quarter. I think I'll stop there and just open up for questions, please.
Yes, sir. Thank you. Once again, for those who want to ask a question, please press star and one on your telephone keypad. Star and one for questions. We have a couple of questions that came through. We will now take our first question, and this comes from the line of Sophie Lund-Yates. Your line is now open. Please go ahead and ask your question.
Hi, here is Sophie from JPMorgan. Thanks very much for taking my question. My first question would be on a divisional level. How should we view net interest income in the large corporate division as well as in the retail division going forward, given that you mentioned on the press conference that most of the funding was just due to internal transfers and accounting. I was just wondering, is the second quarter now the right run rate for the different divisions to think about going forward? Should we assume that there will be another correction in the third quarter and net interest income in these divisions will be higher? How should we think about net interest income going forward? My second question would be on AML. The FSA is going to publish a report in November.
What do you expect from this report, and how concerned are you about this report? Thank you.
If I start with the NII, and I'll ask Masih to fill in, and then I'll take the AML. We don't really give any forward guidance on NII, but I think that the current market dynamics when it comes to margins and volumes, we have no strong change in our opinion for the short-term future. I'll give through some of those dynamics. The margins in all material aspects in the NII for LC&FI is flat. There's not a meaningful direction on margins. If anything, there might be slight margin pressure in one or two small areas, but we can't even get them to matter on the whole. We have a very good volume momentum at stable margins, and the pipeline looks unchanged and strong going forward. On retail, there is two. The first, the overall market growth has come down.
We've probably gone from 8%, 9% of annual growth in household mortgages down to something around 5%. That is, of course, in our opinion, a level that probably going to be stabilizing here or maybe a little bit lower given that we have a flat house price projection for the short term. There has been margin pressure both coming from competition but also from the hike that we saw from the central bank in December. It's as good of a guess as anyone's what you think about rates, but it's definitely the last hike here did really change the price equilibrium for mortgages and deposits. Very positive for deposits, where margins more or less equaled the rate hike. Cautiously optimistic on volumes. Margins looks flat right here and now, but there will be many changes potentially coming given the rate outlook. Masih?
Yeah. Hi, Sophie, it's Masih here. Just adding on NII. Obviously, there is some sort of money going back and forth between Treasury and the divisions, and the main volatility there is how much Treasury compensates divisions for deposits. The way that works is that we compensate the divisions based on the value of those deposits, and we use our senior unsecured funding price to do that. So when the marginal cost of senior secured funding goes up and down, the compensation for deposits goes up and down as well. It's very difficult to know how that's going to develop going forward. It just depends on the spread development in the market. Going into Q1, spreads went up, and therefore, the divisions got more paid for the deposits. Q2, they went back down again, so they were compensated less than.
We'll just have to wait and see what happens in Q3 and Q4. I think if you want to make a good assessment of the total NII development of the bank, just look at the overall picture, adding Treasury to the divisions, and I think that gives you a good guidance of how the bank is performing.
On FSA, we have the same expectation as you outlined, that we will get something from them this fall in a statement or a summary of their view of the state of affairs when it comes to SEB's history in the Baltic. We don't now speculate in what that will be. We are, just like we always are, openly and transparently working with them in this situation. The practice is very common here. The first thing we get is probably, we get something of a preliminary sounding of what their findings are, then we complement and give more information or clarify any questions they might have. They give the final recommendation or status report. That will come this fall. Right now, I would just be guessing. You asked me if I'm worried about it.
This is a very common. We have in Sweden, I would say, 20-30 of these open and ongoing at any point in time, always. This is the way we work with our financial regulators, so we get many of these all the time, every week. There's no change in. Of course, you regard every such report as super important and what the findings are. Sometimes you agree, sometimes you disagree, but regardless, you need to conduct yourself in a manner in line with whatever comes out. What is unusual is that this one of these that are so commonly done in a bank, was published by the Finance FSA. They went out saying they conducted and gave a timeline. We will just wait to comment and speculate until we don't need to speculate and can comment on what the facts are.
Most likely, we assume that to be made public in this instance.
Okay. Thank you very much.
Thank you. We'll now take our next question, and this comes from the line of Adrian Cighi. Your line is now open. Please go ahead and ask your question.
Hi there. This is Adrian Cighi from RBC. Two questions from my side, please, on capital. The big move quarter-on-quarter is in large part driven by the increase in the market Risk-Weighted Assets. How much of this is reflecting a potentially higher risk you're taking in your markets operations, and should this lead to a higher training run rate? The second question, still on capital, is the proposed regulation from the Swedish FSA on Commercial Real Estate exposures. Do you have any estimates on the potential impact on SEB or even a range? Thank you.
Hi, Adrian. It's Masih here. Starting with the first questions on market Risk-Weighted Assets. It was a spike this quarter, which was mainly due to the fact that parts of markets within the bank were expecting yield curves to steepen when they actually flattened. What happened there is that VaR goes up, and what we do internally is that we apply a very stressed scenario on the increased VaR, which led to stressed VaR going up and capital requirements for market risk going up. That is based on the positioning you have at that point in time. Positioning in markets can change depending on their outlook. What I said in the press conference this morning is that our expectation is that the elevated level you saw in Q2 will come down again to more normalized levels.
If you follow the Risk-Weighted Assets for market risk over the last few quarters and look at the normalized level there, we do expect that capital consumption to go back to that level. I wouldn't say that there is anything structurally within the bank or in the market that has happened that should lead to that level being higher than it's been historically. On the CRE, no, unfortunately, we don't know what the scope of that really is, and I don't think the FSA has decided either, to be honest. I think they will start their analysis now, and then by the autumn, they will come out with the scope and also the changes they plan to do. Our expectation is that by probably mid-next year, this will be implemented. It's not going to apply on us until mid-next year.
Unfortunately, it's just impossible at this point in time to give any estimates on the impact.
Perfect. Thank you very much.
Thank you. We will now take our next question. This comes from the line of Geoff Dawes. Your line is now open. Please go ahead and ask your question.
Yeah. Hi, good afternoon, everyone. It's Geoff Dawes here from Societe Generale. A couple of questions from myself. First of all, on capital and distributions, obviously, when you come back to us after the summer for third quarter results, I think we'll all be thinking quite heavily about distribution policy and everything else. With that in mind, your 150 basis points buffer that you run, you're obviously ahead of that. How do you think about that going forward? If you paid out to the 150, would you be happy going below that if FX moves, if pension accounting changes, and so on, or do you want to maintain a buffer to the buffer, as it were? Second question is on the large corporate division. It's nice to have the detail on new clients coming in and what their contribution to the group. I think that's very helpful.
Can you give us an idea, though, of the other side of the equation? Have you been actively exiting any customer relationships where it hasn't been profitable? Has that had any impact on the return on equity as well? Obviously bringing that a little bit higher, but what would the revenue contribution of those clients be? That would be very helpful. Thank you.
Thank you for that. On capital distribution, it almost feels awkward as we are about to take summer holiday to go through it, I'll still repeat where we stand. We've run the bank with a bit more buffer than the indicated 150. We described it quite at length in conjunction with this year's proposed and executed dividend. That was really that the best thing we can do with this capital is to try to deploy it at 15% return on equity or more. How we assess that ability is pretty much the most important question in management eyes. We still just do recommendations. It's the board that in the end decides these things. I would say these six months, even though we talked about planning for a bad market, this has been a pretty good market.
Still we've been able to deploy it just like we said we wanted to. You can see that in the market shares and, of course, the capital consumption goes up, particularly, immediately when you put these trades on. Then it takes a full year before the NII comes through the books and gives you even more return on equity through that channel. If you look at the what we call red zone, how we exited clients that have not been working, we always had an ongoing red zone strategy. That is big brush, three years into a new relationship or three, four, five years with a relationship that doesn't work, we have to go and motivate why we should put capital to work if it's not mutually beneficial to us and the client. We haven't done anything specific there. That's the ongoing.
Except for one, which has had an effect, that is Germany. The restructuring in Germany was, of course, before the restructuring, a drag of X on return on equity. In that process, downsizing it by 75%, creating a branch. That has, of course, helped the group ROE of having a much better or I should say, less drag from our German business. Those are client exits.
Okay. That's very clear. Thank you.
Thank you. We'll now take our next question, this comes from the line of Riccardo Rovere. Your line is now open. Please go ahead.
Good afternoon to everybody. Just one question from my side. I noticed that the amount of securities on the liability side has gone up substantially in the semester, SEK 140 billion or something like that. I was wondering whether you have taken the opportunity to pre-fund in the semester, exploiting maybe the current favorable rate conditions or maybe just the commercial papers with very short-term duration and might eventually reverse in the coming quarters.
Yeah. Hi, Riccardo. It's Masih here. Yeah, that's probably correct. It's mainly commercial paper. It has to do with a lot of different things. If we have more activity in markets, we have to fund ourselves more on the short-term end. Also, what's happened recently is that the Swedish FSA has introduced a plan to introduce a 75% LCR in Swedish krona and other significant currencies. On the margin, this leads to that we'll have to have a bigger balance sheet because we have to issue more short-term paper, and we have to invest that in liquid assets that are eligible to comply with the LCR requirements. Generally, this is what happens. We now in Sweden have a total LCR requirement of 100%. We have it separately also for dollars and euros at 100%, and now we also have it for other significant currencies at 75%.
This just basically means that the aggregate LCR level will be higher than 100%. We're at 149% this quarter. This is mainly what happens. There is opportunities within Treasury where they can find ways of funding the bank very cheaply and placing that in a liquidity portfolio and sometimes actually make money on that. There are different drivers for why the balance sheet or maybe that line goes or comes down. This quarter, I think it's very much linked to LCR.
Okay. What I understand is there has not been any particular pre-funding on the medium to long-term side. That is a fair point.
On the long-term side, you can see in the report how much we've done in the quarter. You can see that we've done quite a bit of a couple bonds, and we've done a couple of senior unsecured as well. You can see that separately in the report.
All right. Thanks a lot.
Okay. Thank you. We will now take our next question. This comes from the line of Marco Di Mateo. Your line is now open. Please go ahead.
Good afternoon, and thanks for taking my question. I just wanted to ask about the Baltic business. I think you highlight some improved lending margins. Could you elaborate what drove that? Can you remind us of what the sensitivity or the impact would be on the business if your rates were to decrease?
Secondly, on the FX impact on capital, would you consider hedging some of this FX exposure in RWA or do you see it as preferable to accept some volatility because of the cost? Thank you.
Thank you. If I start, we can fill in if required. In the Baltics, you probably need to just step back one first step and see that there's been an exit of financial institutions and banks for a long time, since the financial crisis. For the minority of banks that have decided to still be committed to that part of the world, including us, that has, of course, been a very good business environment. As many exit, these clients need to find new homes. It's actually been a luxury problem for the ones who have been established in order to get the right clients in, because it's been quite high demand to join one of the committed institutions in the country. That has been coupled with improving volumes and margins. That has been the result. We are actually a little bit cautious.
We don't want to grow too much. We want to have the right clients and do the right business. This doesn't lead to this opportune burn all cylinders and go and grab it. It actually leads to a little bit of conservatism and cautiousness so we do the right thing when the market accepts it. Right now, I find it to be very stable. It will not continue to improve to the same rate we've seen in the past because there is a limit. That's what I think about the Baltics. On FX capital hedging, no, we typically do not hedge. It's mostly a philosophy to rather have a cushion baked in so you can stomach any FX effects. They are not important in the long run, and we think that hedging is associated with the cost.
It's been better to have a stable balance sheet that can absorb those short and medium-term market movements.
Final on rate sensitivity. We basically have the same sensitivity going up as rates going down. The rate increase we saw in Sweden, we said that that's almost SEK 1 billion in terms of higher NII, if you exclude whatever happens to lending margins, only including the liability side and the reference rate floors we have on the asset side. If rates would be cut back again by 25 basis points, you would see as much of an effect going the other way. Now, when rates were increased, we see a pretty large decline of mortgage margins. Maybe if rates go down, you see that going the other way. It's very difficult to say what the aggregate impact is going to be, but only including liabilities, it will be the same sort of range as when rates went up.
Sorry, I was referring actually to the impact from rates going down for the Baltics business.
Okay. It's the big cap rates?
Yes.
I don't have that number, but it should be quite limited on a group level.
Okay. Thank you very much.
Okay. Thank you. We'll take a follow-up question from Riccardo Rovere. Your line is now open. Please go ahead.
Thanks for taking my follow-up question. In general terms, do you see anything in these set of numbers that you would consider as clearly one-off or by nature or just maybe by magnitude? If I may, also something related to my previous question, I also see that the stock of bonds on the asset side has gone up quite substantially. I would imagine it should be more or less for the same reason. Commercial paper is a short-dated bonds. Just to be 100% sure I get it correctly.
Okay. Riccardo, if I start with on the business side, there's nothing exceptional one-off about this quarter, which is different from other quarters. There are always some market movements, of course, and the strong equity markets have helped all the strategic holdings one have on the balance sheet. Of course, the lowering of interest rates also helped market valuations on inventory on those type of assets. Those are in the normal course of business. Otherwise, it's a very broad-based, fair representation from how our business has performed in this quarter.
On a very detailed level, obviously, we reserved too little for the resolution fund in Q1, and we had to adjust for that in Q2. We took about SEK 30 million extra compared to what we otherwise would have done. You can basically say that NII in Q1 was a bit too high, and NII Q2 is slightly too low if you adjust for that resolution fund fee. There's going to be a small tailwind on that in Q3. On the bonds, if you look at also cash at central banks, you can see that that has come down. For our liquidity management, we can basically hold very highly liquid assets, and cash at central banks or AAA-rated bonds have the same quality in that assessment.
I think what's happened in this quarter is that we have less cash at central banks, and we are holding more highly liquid government bonds.
I just want to say one more thing. If you, in the first question, are trying to assess what's the underlying sustainable performance in this quarter going forward, I also like to just highlight that the year-on-year numbers historically has been affected, that we had SEB Pension in Denmark in the first half of 2018. That is not a like-for-like when you do the comparison.
Very helpful. If I may, just a very quick follow-up on Masih's answer. Should I assume that the level of cash, let's say the switch between cash and short-dated bonds on the asset side is something that your liquidity management department is going to go on like that for the foreseeable future?
They always change how we should allocate our liquidity portfolio based on what makes sense from risk management, but also P&L-wise. In this quarter, cash at Central Bank is down. We're holding more bonds, and we have bought more reverse repos. That's the shift you see this quarter. It could go back to what you saw in Q1 next quarter. It's difficult to say. It just depends on how spreads move and what's most profitable for the bank to hold in combination with complying with the liquidity requirements and having a good risk management.
Thanks a lot.
Thank you. We will now take our next question. This comes from the line of Robin Ren. Your line is now open. Please go ahead.
Hi. Robin Ren, Kepler Cheuvreux. Just a clarification question. I think this morning you said that some of the net inflows status on the management were reclassification. This part of the net inflows doesn't affect the custody mutual funds fees, have I understood that correctly?
Yeah. If you would just assume that it is all new asset under management, then it would look like we have severe margin pressure in asset management. The SEK 60 billion extra that has been reclassified, it used to be asset under custody, now it's asset under management, and the fee level for that SEK 60 billion is very, very low. We wanted just to point that out so you don't think that we have very severe margin pressure within asset management. It's just a reclassification from custody to asset management.
All right. Makes sense. The margins going forward, everything else equal, is going to be a tad lower.
Yeah, if you do fee coming from asset management divided by AUM, it's going to be lower.
Yeah. All right. Thank you.
Thank you. Your next question comes from the line of Jacob Kruse. Your line is now open. Please go ahead and ask your question.
Hi. Thank you. Just wanted to double-check on the NII first. The movement in the corporate center, you say that's just internal pricing that affects that relative to the division. Then could I just also ask on the cost line, how comfortable are you that you will continue to deliver in line with your target level? Are you seeing projects that are popping up or new issues found that you may need to address, and I guess follow some of your peers in terms of pushing up the cost guidance this year? Thank you.
Yeah. It was difficult to hear you on the NII questions. We'll take that later. On the cost line, we always have parts of the bank that have higher cost inflation than expected, then we have other parts that have lower cost inflation expected. We're pretty used to that. We've had big projects previously in the bank. If you look at 2016, 2017, when MiFID II was introduced, that was a massive project, it costed more than we expected. It didn't lead to us not reaching our cost target at that point in time, there's really nothing happening at this point in time that has the magnitude that should lead to us not being able to reach our cost target. At this point in time, no, there's no change. We are comfortable.
I'm not sure if that's the right word, we still stand to the cost target that we have by 2021. It's never comfortable. You always have to work with it on a daily basis to make sure that you take out the efficiencies that you need. We're definitely sticking to that target. If you can repeat the NII question, please.
Yes. I just wanted to confirm that the strength in the center NII or your group functions NII and the relative weakness on some of the divisions, that's just the internal pricing model and that there are no other issues that affect that different.
Yeah. It's internal pricing to a very large degree. Some of the weakness in the divisions is the fact that we had reserved too little for the resolution fund fee in Q1. The delta Q on Q looks lower than what the underlying business has generated. It's mainly activity.
Okay, fantastic. Thank you very much.
Thank you. We will now take our next question, and this comes from the line of Richard Smith. Your line is now open. Please go ahead.
Hi, guys. Thanks very much for taking the question. Just two from me, just circling back on NII. The first was, I think in previous quarters, you called out any sort of unusual deviations that you've seen in terms of market net interest income. Just wanted to check that there wasn't anything
Surprising or different there this quarter. Then the second one, I think if we look at some of the sector stats data, it looks like some of the growth might have gone on in sort of the later months in the quarter that we have to date. I think if I understood your press conference comments, there was nothing particularly in terms of bridging finance and shorter-dated lending. Just wanted to check if there was any kind of effect in terms of timing where we should be seeing a stronger pickup going into the third quarter, given some of the lending that's gone on in the back end of this quarter, if that makes sense.
Thanks. On the NII, there's nothing unusual that we want to highlight or point out. That's nothing specific. Yes, you understood the press conference comment correctly. Just to elaborate a bit, when you have such high activity in corporate and investment banking, there is always a proportion of that business, and predominantly the event-driven business, which has bridge type of engagement put on. Those bridges are sometimes being converted into equity, if it's an equity underwrite or an equity facility, sometimes into bonds, but most often they are actually converted into long-term loans. You might have a bridge financing where the vast majority of that bridge in an M&A situation needs to then be converted.
Sometimes it's easy to go wrong and say the bridges are temporary because there will not be anything after. They are actually also a leading indicator for putting on more financing permanently in the capital structure later. I would also point out that there's nothing different. That's what we wanted to say in the kind of mix is broad based and the proportions all right. As I said also before, sometimes we have a quarter where you put some two or three or a few super large deals on. That's really what's happening. That we will also in the future point to that if that's the case.
Okay. Understood. Thanks.
Thank you. We have no further questions over the phone line, sir. Please continue.
I will thank you all for your attention and wish you all a good summer, and maybe some of us will meet shortly. Otherwise, have a great summer. Thank you.
Thank you. That concludes our conference for today. Thank you all for participating. You may now disconnect.