Ladies and gentlemen, thank you for standing by, and welcome to the Q2 2016 Results Conference Call. At this time, all participants are on 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 one on your telephone. I must advise you that the conference is being recorded today, Thursday the 14th of July 2016. I would now like to hand the conference over to your first speaker today, Annika Falkengren. Please go ahead.
Thank you. Welcome to the presentation of our results for the second quarter of 2016. Today we present an operating profit of SEK 5 billion, excluding a positive one-off item for our membership in Visa via our Baltic operation. Turning to page two, market conditions have been challenging both for our customers and for us. The quarter was marked by increasing market uncertainty relating to the British referendum, the Brexit, which put great pressure on equity markets and interest rates. This contributed to customers becoming more cautious. This is reflected in the low propensity to invest and the continued strong demand for risk management services. We continue to have strong balance sheet and asset quality, even this quarter is very good. Page three. To make it easy to follow our underlying results, I'd like to remind you of the three one-offs we've had in recent quarters.
Number 1, the Visa transaction from the Baltic share amounted to +SEK 520 million in Q2 this year. We also have the impairment of goodwill and restructuring effects in Q1 this year of SEK 5.9 billion. Then we had the SEK 900 million of negative impact in Q2 last year, Q2 2015, related to the Swiss withholding tax. For the sake of simplicity, we continue to present results for the underlying operational results, i.e., excluding these one-offs. In a challenging business environment, income decreased by 11% compared with the first six months last year. Costs decreased by 2% and operating profit fell by 20% compared with last year to SEK 9.5 billion. Return on equity was 10.9% and our Common Equity Tier 1 capital ratio increased to 18.7% versus 17.2% a year ago. On page four, we take a look at the second quarter isolated.
Income increased by 4% versus the first quarter this year, costs were down 2% and operating profit increased by 12%. I can now briefly comment on the different income lines on slide five. NII decreased by 4% compared with the first six months of last year, but was unchanged from the first quarter of this year. Customer-driven NII increased by 1% compared to the previous quarter, mainly due to higher lending volumes. The lending volumes increased in all of our customer segments by a total of SEK 40 billion in the second quarter, despite continued low demand for investment-driven lending from the large corporates. Albeit, about half of the increase is due to the weakening of the krona. The challenges with negative interest rates on deposit margins and within treasury still remain.
We now see that risk for operating in a more protracted period of negative interest rates have increased after Brexit. On page six, we see the NFC. Sorry, the Net Fee and Commission Income. It fell by 19% for the first six months, but increased 5% from the previous quarter. The reason is primarily that both asset values and business activity are lower this year compared to the very high activity in the first half of 2015. In addition, our income from securities lending declined as we have adapted to new liquidity and capital regulations. Assets under management increased marginally during the quarter, and we had net inflows of SEK 14 billion. Aside from few IPOs, there has been little activity within corporate segments, and large loan transactions have again been lacking in this quarter for us. On page seven, we see the NFI.
It fell 12% versus the first six months of last year. The main reason is that we've had mark-to-market valuations, or the so-called leveraged positions, working against us this year. During the first six months of last year, we had a positive mark-to-market valuation effects of SEK 476 million, while the corresponding period this year was negative SEK 358 million. That difference is actually SEK 800 million. However, the result increased by 24% versus the first quarter of 2016. The quarter was marked by concern and large volatility, both before and especially after Brexit, which meant that customers were active within seeking hedging for a change. I think this is proof that our customer-driven business model shows good results amid volatile markets.
Even though volatile markets often lead to lower business activity like investments in M&A, which negatively affect fees, this is a clear example of the importance of our well-diversified business mix. You need to look at all three lines. Turning to slide eight that you've seen many times now. The first six months of the new three-year plan has been challenging as market conditions have changed. We closely follow developments both in the world economy and how our clients are acting. Depending on the outcome, we review our assumptions, and we also look at measures to compensate. The business plan that we announced earlier this year remains intact, as does our cost cap. I'll just briefly comment on the divisions on, let's see, what page? Page nine.
If we look at Large Corporates & Financial Institutions, the result is down by 14% compared with the first six months of last year, excluding one-off effects. In addition, the negative mark-to-market valuation I mentioned earlier also impact this division's result. Client demand for risk management services was strong across all asset classes. However, the number of corporate transactions has been few, and credit demand has been held back by uncertainty, just as in the first quarter. Among financial institutions, client activity was high, driven in particular by concern before and after Brexit. Earnings for the second quarter amounted to SEK 2.3 billion, which was 26% better than the first quarter of this year. If we look at Corporate & Private Customers division in Sweden, was adversely affected by negative interest rates as well as new rules on the card interchange fees.
Operating profit dropped by 5% versus the first six months of last year, but actually up 3% from the previous quarter. On the corporate side, we continue to see both the number of customers and loan volumes increase. For private customers, the trend is clear in terms of how people interact with us at the bank. Customer wants more contact with us, but in new ways. Customer interactions with our mobile banking solutions are now four times as high as via the internet bank. Looking at the savings area, we see how customers are choosing to reallocate. People are generally reducing the equity portion of their savings to the benefit of savings with lower risk, such as traditional insurance, deposits as well as mixed funds, strategy funds, which had a positive performance year to date while equity markets are down.
We continue to be active in our advisory towards our customers. Within private banking, we attracted new net inflows of capital SEK 13 billion so far this year. Life and Asset Management, they report a lower result, down 19% versus the first half of 2015. Equity markets downturns hit asset values here, and both base commission and performance-related income decreased. The stock of AUM changed the past 12 months has fallen by 14%. Life operations show stable results compared with the same period last year, and the weighted new sales within Life have amounted to SEK 27 billion to date in 2016. New sales of traditional insurance have now reached over SEK 1 billion and are appreciated by customers in this uncertain economic environment. Baltics also show slightly lower earnings compared to last year, but we see continued increase in loan demand now in all three countries.
Credit quality remains good, and we made write-backs this quarter. On page 10, I'd like to put some flavor on the decrease in the Core Tier 1 ratio from 19.1% to 18.7% in this quarter. Please remember our stated sensitivities on the Core Tier 1 ratio, namely the foreign exchange and the discount rates. In this quarter, the krona has depreciated against the euro and also depreciated against the dollar. These two currencies represent 50% of our total RWA assets. About half of the increase in RWA this quarter comes from the weaker krona. On top of the foreign exchange move, we also saw another underlying increase in the credit volumes, which also increases the RWA further. The discount rate in Sweden remained flat but was lowered in Germany.
However, since we still have a surplus that had a minor impact on the Core Tier 1 ratio in this quarter. If you then go over to the balance sheet on slide 11, it has been further strengthened during the quarter. Credit quality remains very good, and the credit loss level is seven basis points. We still have around a quarter of our balance sheet in liquidity reserves, and our Common Equity Tier 1 was 18.7% compared to the 17.2% a year ago. To round up before we take your questions, customer expectations and behavior are changing rapidly. Our starting point is always to have relevant products and services for our customers. We want satisfied customers who do feel that we are creating value for them at all times. During the first half of the year, market conditions have been challenging both for our customers and also for us.
Brexit was not expected and came to greatly increase the volatility in the otherwise fairly quiet quarter. In the current climate, the need for resilience increases, and we have that resilience, and we are well-positioned to support our customers at all times. With this, I'll give the call back to the operator, and we are ready for questions.
Thank you. Once again, if you wish to ask a question, please press star 1 on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the hash key. Your first question comes from the line of Willis Palermo of Goldman Sachs. Please ask your question.
Hi. Good morning. Thanks for the presentation and taking my question. I have two on the income side. The first one is on the fee income. I was just wondering how to think about it for the second half of the year, as last year, obviously, we saw that the second half was quite lower compared to the first. This year, we also suffer from the interchange cap fee. I was wondering what were the areas where we could see some resilience and also how you were thinking about the custody and wealth fund parts, if we should expect some lower level as we saw in the first half, in the second half as well. Secondly, on the NII, how should we look into the volumes going forward from here as you had some strong volume growth and despite the NII was kept flat.
Should we expect some more volume going forward and how do you think about margins for the end of the year? Thank you.
On fee income, I think what you've seen in this quarter, it's a typical quarter where I think we've seen more volatility and still fairly subdued demand on the loan side. I think we don't have the crystal ball for the second half of the year, obviously. If that pattern with the upcoming American presidential election perhaps were to continue, this is pure speculation, obviously, but we could see a scenario where volatility remains fairly high and loan demand continues to be slow. Fee income will be perhaps a little bit like it was in H1 where the net financial income will continue to be stronger. I think that's a testament of diversification in the business model so that all income lines have to be looked at, like Annika said. On NII, I think the volume has been there to support NII.
We've seen it across the different segments, the mortgage book continues to grow even though it grows a bit slower than the market, but it's also supported by margin gains. We raised the mortgage margins by five basis points in Q1, an additional five basis points in Q2, so the back book is now at 114 basis points, I think that development will continue.
Please also remember that when it comes to the volume growth, that is calculated on end of quarter currency rates and the income on NII is on average rates. That is also since we had quite a large weakening of the krona following Brexit, that has a bigger impact on the balance sheet and on the P&L in this quarter.
Thank you very much.
Your next question comes from the line of Omar Keenan of Deutsche Bank. Please ask your question.
Hi, good afternoon. Thanks very much for taking the questions. I've also got a question related to net interest margin and the margin outlook if rates currently stay unchanged. Just looking at the fact book, if I look at the cost of deposits, it looks like something like 33 basis points, where I would have thought a lot of your deposits come from corporates and institutions. I was just wondering that given the negative interest rate environment looks like it's being sustained for now, is there any more scope for, if not passing more of the negative cost of deposits onto retail customers and maybe to corporate? I just wanted to check if there were any repricing angles that perhaps we were missing. Thank you.
Hi, Omar, Annika here. No, I think, we are charging now. We are charging all professional institutions and large corporates above the cash management level, so this is individual charge, but that has actually been in effect now. Of course, it might be able to improve it slightly, but this is where it is. We will not be able to charge private individuals. I think we have decided on that. That won't work here, at least not here. I don't think so. It's rather on the lending side that we hope that we can show that margins will slowly but steadily improve in the future, but it's been highly competitive also at the moment. This is where it is. I think what you will see is probably hopefully more demand and also slightly more growth, broadly speaking from all customers.
Great. Thank you very much. I was just wondering if I could also ask a follow-up question. Could you briefly summarize for us a timetable for the SREP process and getting the SREP ratio from the Swedish regulator and the decision on the corporate risk weights as well? Is there any particular dates we should be watching out for?
Jim, you can touch upon that.
Sure. Hi, Omar.
Hi.
The SREP, we've received the preliminary SREP letter from the regulator a couple of weeks ago, I said, nothing out of the ordinary or nothing unexpected, so to speak. Very much in line with expectations. Our statement from Q1 that our best estimate of the effects of, or combined effect, I should say, of the LGD and PD factors is below 100 basis points. That holds. We will continue our debate, and we are obviously building and refining our modeling to the regulator, that debate will go on until approved by the regulator, the final SREP should be with us sometime towards the end of September, I imagine. That's the normal timetable, and I don't see that it should be different this year. When will those rules then come into effect? That's a little bit unclear, actually.
It could be, I suppose, anywhere from Q3 to the end of Q3 to year end. We will just have to wait and see, I think. It's something we're ready for, and that's nothing out of the expectation level that we had already in Q1.
That's great. Thank you very much.
The next question comes from the line of Anton Klyuchnikov of UBS. Please ask your question.
Good afternoon, thank you for the presentation. Just two questions on revenues, please. The first one on net interest income. We continue to see pressure on NII in the treasury part of the bank. Can you give us some sort of an indication whether we've seen most of this pressure playing out, or do you expect to see further negative development there? The second question, please, on fees. Would you be willing now to quantify the negative impact from having a smaller securities lending business on the fee line on an annual basis? Thank you.
Hi, Anton. On the NII pressure, what you're seeing there in treasury is just a result. I was almost jumping in to say that when Omar asked his question on deposits, here we go then. What we're doing is that from treasury, we're supporting the deposit gathering a bit by subsidizing, in effect, to an extent, the gathering of deposits in both Corporate and Private Clients and in Large Corporates and Financial Institutions, so that we don't, in this period of time when interest rates are so low, start to say no to deposit volumes. They are important for the NSFR and the LCR and for the funding base of the bank long term. That's what you're seeing there a little bit. It's really a reflection of the negative interest rates. I think that will reverse once we go back to normal interest levels.
Unless deposit growth resumes or accelerates, we shouldn't expect further deterioration in treasury?
No, I don't think so, no.
Thank you.
In terms of the fees and the quantification of sec lending, we didn't quantify any of that earlier, and I won't now either. I think you can draw your conclusions from the disclosure. It's relatively easy to see what the approximate amounts are, I won't quantify it further.
Okay, thanks a lot.
Your next question comes from the line of Adrian Ciki of RBC. Please ask your question.
Hi there. This is Adrian. Thank you for taking my questions. I have one question on capital and one question on cost, please. On capital, the estimate of the 100 basis points impact from the corporate risk weight proposal, is this in addition to the 35 basis points or the SEK 10.6 billion increase you're holding for this purpose? On costs, on the press conference earlier, as I understood it, you mentioned that there might be some flexibility on the cost gap, assuming the continued pressure on the top-line environment. Could you give us an estimate on how much of your costs are variable or dependent on the top-line delivery? Thank you.
I can start with the cost to say that the variable part is actually quite small nowadays. What we meant by that is that we're keeping some leeway to reinvest. Of course, we could probably have a cost cap lower than 22, and we all see now that we are at 21.5. We want to continuously aim between this in digitizing and automating the processes. At the moment, our IT department have some really big launches during autumn and early 2017 that we need to get out before we can see how much more we can do. We want to have some leeway in that. Also, of course, if we're going to stay in this environment for a very long time, and we do think that there are some strategic changes, we will need to look at it.
We don't feel that we are there yet. We still think that we should not make any short-term cost cuts just because the macro environment has become a bit more challenging. We still have a lot of more clients on board. We have good products. The bank is in really good internal shape. Everybody knows what they're supposed to do. We should increase the services to every single customer to make sure that every single customer is more satisfied with us, and we know all that. I don't think we should make any short-term decisions on cost-cutting just because the macro is slightly more challenging. We are not blind, so of course, we need to adjust if we start to see that this will long-term actually also change.
The variable part is not a big element, so I don't think that that one Of course, we do have some variable pay, but it's not big anymore, so I don't think it will make a big change.
Then Adrian, on the capital question, I think when I pay less than 100 basis points, that's meant to be sort of the net effect at the end of the day. It's difficult to say. Maybe we get to below 100 basis points without using the buffer, and then it'll be even lower than that. We'll see, but combined effect should be lower than 100 basis points.
Super. Thank you.
Your next question comes from the line of Yafei Tian of Citi. Please ask your question.
Thank you. It's Yafei from Citi. I have one question on capital and the other on deposits. On the capital, in this quarter, we obviously had a little bit of RWA inflation from the currency effects, et cetera. I wonder how do we think about RWA inflation going forward, especially from the implementation of risk weight. Do you have an indication of the timing as well as the magnitude of RWA inflation from that? Secondly is on the discount rate that you use for the pension liabilities, do we have a level and how does that compare with peers? On the deposit side, I see there's a big inflow in the private customer segment. How should we think about the impact from higher deposit level in the private segment, given that you're not charging the customers?
How is that going to affect NII going forward, and what's your strategy of keeping deposit level at a reasonable level for these customers? That's it.
Right. Well, on capital, on the risk-weighted assets, just remember that half of the risk-weighted assets increase is from the FX effects on the krona against dollar and euro, and half of it is underlying volume expansion. I think if we assume that in the near future, at least the volume demand is going to continue to be a bit subdued, then we can all speculate on the FX movement. But perhaps after that quite sharp change after Brexit, that won't move so much further. That gives you a little bit of guidance, I suppose, on risk-weighted assets. You may have a different view, but that's probably how I would think about it. In terms of discount rates and what we use there, we have applied the same methodology now for a long period of time. I think if anything, we're on the conservative end of competition.
We have a surplus in our pension trust. I think that's under control. In terms of deposits, yes, we do see inflows, and that goes a little bit back to what I just said on, I think, Omar's question. We do subsidize a little bit from treasury to hold on to those volumes. I think it's interesting that even though we're going to negative territory, there's a certain element of flight to quality on deposits, and there's also, I suppose, a result of a very weak equity market, which means people reallocate into deposits.
Thank you.
The next question comes from the line of Jacob Kruse of Autonomous. Please ask your question.
Thank you. Just two questions. Firstly, on your oil exposure, you say you haven't really taken any losses there, but could you talk a bit about the migration of rating or PDs that you're seeing in those books? Do you know why your oil losses look so different than some of your peers, like DNB reporting a couple of days ago? The second question was just on SMEs. I think you say you took 6,000 new clients this year or this six months. Could you say anything about what's the base there? How many did you have before that, and what's the average revenue and profits of an SME client once they are fully integrated or cross-sold into? Thank you.
Let me see. What was the first question? Oil and gas. I think the big difference with some of our peers is that they are a truly universal bank, and that means like we are in Sweden, that you work with private individuals who are large corporates. Then, of course, in that you have everything from single boats to fishermen to private individuals and households in Farange or whatever. While we have approximately 70 large customers that we've known for 30 years that we believe are strong counterparts. We also think, as we've said now for a long time, there will be restructuring. We've seen a little bit of restructuring. We think that the owners will put in more equity, and we will also, in some cases, of course, need to restructure what we have.
We haven't changed our view, and we have stress tests and looked through our exposures, and we still feel very comfortable with what we have. I think it's a big difference from being a local universal bank for being a bank like SEB. There's really no change in that. When it comes to the SME and mid-corporate, we have at the moment, in December, we had 158,000, and half-year later now we have 164,000, 165,000. We are having a market share of 15%. When we started, I think five years ago, we had a market share of 10.5% or something. Slowly but steadily, approximately one percentage increase in market share every year.
Of course, this group of larger SMEs are highly attractive to all banks, but I think SEB has a great positioning client offering here, also our internet and digital offering to these corporates. Also partly how we've been, since the last 10 years, been focusing heavily on entrepreneurs, supporting them from the very beginning. I think we have a good offering. This usually starts with a loan and some cash management, and then hopefully it ends up with quite a few of them doing IPOs and doing M&A and investments. I think we haven't really tracked them because on the SMEs, they usually have maximum two banks, while on the large corporates, we can see, well, you have many banks. On large corporates, we can really track.
We know that between zero and three years, they take one to two product clusters, and after three to five years, they can increase up to seven to eight product clusters. We had an average a couple of years ago that still holds of 7.8 product clusters per large corporate, and that was the highest that Greenwich Associates has ever measured. Exactly what that leads to in revenue per client, it's extremely difficult to say because it really differs and depends on what kind of product clusters they have used. It's difficult to say, but I think when you follow Corporate and Private Individuals, that division in the future, you will sort of see a difference because Private Individuals is where the mortgage book is there, and the corporate is the rest.
We'll think about we can present this in a more open way in the future, but we haven't done that so far.
Okay. Thank you very much.
Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the hash key. Your next question comes from the line of Adonis Katich of Swedbank. Please ask your question.
Yes. Good afternoon, everyone. I have two detailed questions on the net commission income line. If we start with the income side, then I can see that for the last two quarters, a part of either deposits or guarantees fees has been roughly SEK 200 million higher than if I go back to Q4 and earlier. Is there anything in these figures? Is there a new business or is there something that we could extrapolate? That was my first question.
No, Adonis, it's nothing extraordinary. It's in the normal business model and from time to time, customers tend to use different products, so it ends up in different lines, especially within the transaction banking that you're referring to now. It is no change in that.
You see that level as sustainable?
That's not what we're saying. We're seeing that maybe you have a higher volatility on that line. That's what we're saying.
Okay. To my second question, if we look at commission expenses, then also for the last two quarters, they have been somewhat higher than compared to historical levels, and especially the securities commission expense line. Should we get used to higher expenses on this line, or is that also temporary?
I think we'll see about whether it's temporary or not. If you look about there, Adonis, you'll see the securities income, it's about the same number higher. It's just reflecting a little bit more activity there, but in terms of the income and expense and the net is what it normally is, roughly.
Yes. I was looking at more the margin side, cost income ratio there. It could be Okay. I see. I will dig deeper to these numbers. Thank you.
Once again, if you wish to ask a question, please press star one on your telephone and wait for your name to be announced. If you wish to cancel your request, please press the hash key. Once again, that's star one if you wish to ask a question.
Okay. It seems that we don't have any further questions on the line.
We've had a question come through. The question comes from the line of Omar Keenan in Deutsche Bank. Please ask your question.
Sorry, I thought I'd just get one more question in. I know mortgages is the smaller business at SEB, I guess, not so true as it used to be. Just wondering, given the slowdown in the housing market, what is the SEB house view on what house prices in Sweden could do over the next year or two? What potential impact on mortgage growth it could be? Thank you.
I think we see now that the mortgage market is settling down. It's cooling off a little bit, which we think is very healthy. I think the reason for us not growing in the same pace, almost less than half the pace of some of our peers. Some of our peers, they come certain quarters and they're back again. It's been more scattered, I think. I think the reason for that has not been that we're not interested. I think we have a very good offering. We have very competitive rates. It's rather been our cautiousness on the skuld och kapital, the leverage of five times the household income. Also that we, since five years back in 2011, we implemented strict recommendations to amortize, and that has changed, of course, for many customers.
I think on the other hand, the customers have stayed with us and are happy with us. They have benefited a lot from that. I think now with first of June, when everybody's forced to amortize due to the new regulations, SEB might participate a bit more. When it comes all in all, cautious view on the mortgage market is cooling down a little bit. We don't think it's going to be a crash. Not at all. We think it's just going to be cooled down a little bit. We also see that there's lots of building that has started, lots of construction, and that's also half of the volume in corporate and private. So half of the corporate lending has been into construction in the SME sector across Sweden. We're participating in that.
We feel comfortable, and hopefully our competitive position will actually improve a bit now when everybody's applying the same rules.
Okay, great. Thank you.
Thank you.
Your next question comes from the line of Adrian Ciki of RBC. Please ask your question.
Hi there. Thank you for taking my question. I thought I'd try my luck with one more. On dividends, in the past you've commented on a preference to increase the nominal dividend year-on-year. Assuming a relatively limited rebound from H1 into H2, this would likely imply a mid to high 70s payout ratio. Can you comment on that in theory management would be comfortable with this type of payout? Thank you.
Hi. Well, the dividend policy remains the same, and our views on that hasn't changed at all. Then we'll see towards the end of the year. That's a board decision rather than for us in management to say, but there's no change in policy or view on that.
Thank you.
We have no further questions at this time. Please continue.
Okay. Thank you everyone for participating in today's call. We wish you all a happy ending of this week. Thanks a lot.
That does conclude the conference for today. Thank you for participating. You may all disconnect.