Earnings Call: Q3 2014

Oct 23, 2014

Welcome to the Q3 2014 Results Call. At this time, all participants are in a listen only mode. There will be a presentation followed by a question and answer session. I'd now like to hand the call over to your speaker today, Mr. Urs Groenso. Please go ahead. Thank you very much, and welcome to this conference call for our Q3 earnings. Annika Falkinger will start with the presentation, our CEO, and then the Q and A will be conducted together with myself and then Jan Erik back, our CFO. Please Annika. Thank you. Well, I think we should turn to Slide 2 immediately and say that the highlights of the quarter was that we do continue to attract a large number of customers, both corporate and private individuals also this quarter. All business divisions and all of our home markets, the Nordics, the Baltics and Germany are growing. And the high activity level during the spring decreased somewhat after the summer. Financial markets have shown low turnover and low volatility, especially during July August. Activity levels increased during September, and it is clear though that the economy sorry, that the economic recovery remains fragile. We continue to keep a firm cost control and are also becoming more effective with regards to capital. In this quarter, Core Tier 1 CapEx of 1,000,000,000 in Q3 improved to 16.2%, and our asset quality remains high and credit loss levels continue to be low. Looking at the financial summary on Slide 3. The Omicron commented the operating income for the 1st 9 months of the year was 34,200,000,000 and operating expenses were €16,400,000,000 That means that our operating profit to €16,800,000,000 percent. On Page 4, in the Q3, we did divest our shares in Mastercard. The capital gain was 1,300,000,000 dollars These holdings relate to a time when Mastercard was a member owned organization. Today, they are listed on the New York Stock Exchange, and the sale was purely a financial transaction and has no effect on our card business. Excluding the sale of Mastercard shares, we increased operating income by 10% versus last year and by 2% from the already strong Q2 this year. Operating profit increased to $5,300,000,000 or by 16% compared to the Q3 of 2013. So then turning to Slide 5. Net interest income increased by 7% compared to the 1st 9 months of last year. And compared to the same quarter last year, the increase was 9%. Customer driven net interest income increased during the year, due to higher lending volume, but also due to growing deposit base, which together offset the effect from lower short term rates on deposit margins. Lending margins increased slightly in the corporate segment. The best book of our mortgage lending increased another one basis point. In the Baltics, margins have also improved somewhat. Net interest income from other activities recovered during the Q3 after decreasing earlier this year. We are now at the same level where we were a year ago. Maturing expensive sterling funding from 2,009 and improved efficiency in liquidity management during the quarter were the main reasons. Page 6, net fee and commission income was SEK 11,800,000,000 for the 1st 9 months of the year. Compared to the same quarter last year, the increase was 2%. Overall, fees held up well on back of the growing customer base, higher activity within Investment Banking and higher assets under management. SCD has today more than $1600,000,000,000 in assets under management and close to $7,000,000,000 in assets under custody. Compared to the Q2, fees are lower due to 3rd quarter seasonal effects, mainly in securities lending. Slide 7. NFI decreased 10% in the 1st 9 months of the year and fell about 20% versus both the previous quarter and the 3rd quarters last year. Activity in the business area drives more or less 95% of this income line. Looking at this business area as a whole by including other income lines, operating income has increased by 4% year on year. However, as a result of the low interest rate environment and low volatility, fixed income trading decreased substantially during the summer. As you can see on this slide, both turnover and issuance of corporate bonds decreased during the quarter. We observed the same pattern in the other Nordic markets. Page 8, we continue to show the stability of our business. We will continue to work on attracting new customers, cross selling and keeping costs flat and as a result, improved bottom line further. On Page 9, we show the operating leverage is materializing is percent during the 1st 9 months of the year. In the Q3, Merchant Banking delivered some unchanged operating profit versus last year. The underlying business was strong, but credit losses increased due to a specific case in Denmark. Income has been supported by several large M and income has been supported by several large M and A transactions during this period. Our expansion in the other Nordic countries continues to develop well, and we see good momentum in Germany. Retail Banking continues to grow in both the corporate and private segments. Operating profit is up 12% compared to the Q3 last year. Our mortgage portfolio increased by 3% during the quarter, 7% annually, while corporate lending was unchanged. Wealth Management and Life together increased their operating profit with 40% compared to the Q3 last year, and Wealth Management has taken in more than SEK 25,000,000,000 in net new money, 2 thirds from institutions. In Life, sales were very strong in Sweden and Denmark. In the Baltics, net interest income continues to trend up from the repricing of lending. We see relatively limited effects in our business from the Ukraine Russia crisis. But if existing sanctions are extended for longer period of time, the possible negative effect for growth in the region needs to be taken into account. We continue to follow the developments closely. On Page 10, an interesting development in the 3rd quarter has been the strong growth in the corporate credit portfolio, which grew by 6% in the quarter, up 20% this year. This is the largest increase since 2,008, driven mostly by higher demand for credit lines, up CLP 50,000,000,000 in relationship to, for instance, M and A. Lending fell by CNY 15,000,000,000 in the quarter as corporate repaid some REIT financing. And we're also proud to be ranked 3rd as the sole Nordic bank among many large global investment banks in the table showing completed M and A deals in the different Nordic markets. On Page 11, when I wrap up here with a quick overview of our financial situation. Asset quality remains strong. The uptick in credit losses in the Q3 was, as I said, related to a specific event in Denmark. We do not see any signs of a general deterioration. To SEB, the Danish situation was unique. Funding and liquidity is well balanced. We have more than SEK 800,000,000,000 with 30 percent now of our balance sheet in liquid resources, and we continue to build capital strength. On Page 12, you can see that return on equity was 13.3% for the 1st 9 months of the year, excluding the sale of Mastercard, 14.6 percent including Mastercard. In the quarter, return on equity was 13.8 percent, excluding Mastercard. We maintain the 15% return on equity long term ambition and are working on their financial targets to be communicated at year end. When we know the capital target, we can talk about how to get to 15%, which we will do in Q4. So to conclude on Page 13, as we mentioned already during the summer, when we presented the Q2 results, we saw a number of warning signs. The global uncertainty has come back to life during the recent weeks. In this environment, we continue to execute on our business plan. We have a strong position and are well equipped to support our clients. We have fantastic and engaged employees, cooperating and looking after joint solutions to be there for our clients and they notice it. We see that our clients want to do more business with us and that we can continue to increase cross selling further. With this, I will now hand over to the operator and open for questions. Thank you. We will now begin the question and answer session. Okay. The first question is from the line of Nick Davy. Please go ahead. Yes. Good afternoon, everyone. Nick Davy from UBS. Two quick questions, please, both revenue related. The first on net interest income and the shifting contributions to NII this quarter. Funding and Other has obviously picked up and now, I think as a contributor above 10% of quarterly NII. I just hope you could spend a bit of time elaborating on the drivers there. I know you've changed the pricing model mid quarter and that's had an impact. But if you could just help us to understand what in here is sort of NII, which can still yet get passed out to the various business divisions through FPP? Or how much of this is a temporary response to falling interest rates? Just help us to work out the sustainability of that number, please. And the second, a similar ish question on the trading income line. You talked about having about EUR 1,000,000,000 as the normal run rate that you would aspire to clearly this quarter, well below that. Is there some kind of temporary valuation effects coming through the trading income line? Any kind of cumulative mark to market positives in the past that are unwinding here, something that we should be aware of for future quarters? Or is this just 1 or 2 individual marks or a very quiet quarter? Some more color there would be helpful. Thank you. Hi, Nick. Jan Erik here. I think if I start off on the NII question, I think I'll pass to start with, and that's divided up on customer driven and other NII. I know you asked about the latter, but that's one fewer. I think on the customer driven NII, we saw a decrease from Q2 in the region of some SEK 20,000,000, which is not a lot. And I think there the margin squeeze on the deposit side following the 50 basis points rate cut in July has been compensated even though not completed by larger volumes on the vertical lending side and on the deposit side. And the back book on the Swedish mortgages continue to increase as well, but slower only one basis point in the quarter, 36 basis points, which means that customer driven NII is virtually flat. And I suppose the volume effect there is a little bit more positive than perhaps we saw when we spoke in London and Taltzky last time in Q2. If I then move to the other NII, just as you say, there's been a combination of effects. One effect was the fact that a fairly expensive sterling loan from 2,009 matured in July, and that's, of course, sustainably lower now. Another effect is the revised methodology of the pricing for mortgages and that one is also here to stay and we will be with us going forward. And I think the third effect is, of course, that treasury were positioned for the short term sorry, for the lower interest rates and the cost more of an effect than we anticipated perhaps since we got 50 basis points rather than 25 at the time. So I think that position for shorter rates is still with us and will support Q4 as well if we were to get another cut. But further out in time, that very large component, of course, won't help much. But I think pretty much all of what we talked about is sustainable in my mind apart from that last one. And I think, Nik, on the NFI, as Christ explained on Page 7, I guess, we should never have said that around 1 is what it should be, but because as soon as we said that, that never happened again. So I guess one can say that that's why we try to be transparent on what happened on the monthly turnover in the Swedish corporate bond market. So it's obviously that the issuance and the turnover went really down to almost close to nil. And of course, that is painful for us because we are very much of a market maker and we do need to turnover. So it's no position taking it through that the market dried up completely. It has picked up a little bit since then. So I'm not sure this is completely kind of a structured move, but volatility is still very, very low. So of course, that has been costly for us. Okay. That's very clear. So if I could just make sure I understood it correctly. On the NII side, then the bulk of the funding and other you think is sustainable, certainly if there's another rate cut to come in Q4, not much to roll off into 15%. Is that the right? Yes, that's right. Yes. Okay, perfect. Thank you. Thank you. The next question is from the line of Matthew Clark. Please go ahead. Hi. Just asking the obvious cost question. 1 of your peers has come out with a new cost cutting plan. Do you see any opportunity to do more than your flat cost objective? And how do you think about either the need or the opportunity to be more aggressive on costs? Thanks. I think in it to be now for the last years, we have been growing revenues with a CAGR of 5% to 6% consistently for a long time with a broader base of clients, and we kept our costs flat. I guess as hopefully, we see that as that continues, we also see a need to cut but it's to keep costs flat and towards with the continuous revenue growth. If the revenue growth wouldn't come, of course, we will need to start to focus even more on the cost. But where I see where it is today, this is a very stable corporate bank. This is how we work at Nesteby. I think we were the only bank, the only Swedish bank, at least, that did show continuously revenue growth also in this quarter, and we will continue to do that. Okay. Thank you. Thank you. The next question is from the line of Omar Kinan. Please go ahead. Hi, good afternoon. Thanks very much for taking the questions. Just a follow-up question from Nick's question on trading. I think if I understand right, you still think the €1,000,000,000 number is relevant, if I could just check that. And then secondly, could you just describe some of the moving parts in treasury? Were there any own debt effects or other sort of one offs that were in the moving parts there? And then I just had a second question on the return on equity target. I think you mentioned that once we know the capital target, then you'll talk about how we build the bridge to the 15% ROE or how we get there. Philosophically speaking, is that aimed to reach an ROE target of 15%, is it still based on current rates? And do you think that's feasible given kind of the level of capitals that we're at? Thanks very much. I can just start to comment and say yes, I do think still that around €1,000,000,000 on NFI market is still valid. But of course, we need some volatility to make that happen. Yes. And then Omar on the other NII or the treasury component as you saw that I think if we take them again, basically 3 components. 1 is the replacement cost of funding where we dropped the expenses down to or sterling finance funding. That's going to stay with us at the lower level, so to speak, going forward. The right methodology for the mortgage lending that IFP charge to from Treasury to the retail bank is going to stay. And let's see what happens with that going forward. I don't think that there's a way down on that. The way things are moving, it's possibly way up. And the 3rd component and that one is sustainable as well, therefore. And the 3rd component I was referring to was the fact that the risk mandate in treasury has been sufficient towards a rate cut in July, and we made some money out for that. And that's going to continue to support us again if we have a rate cut in December. But we haven't put numbers to the individual component parts of those 3, but it's obvious that the combination of those 3 was helping us out. And I think I was just trying to make the point that the last one, there's an answer obviously. And I think rates will go lower than an additional past 20 basis points or so next week, if somewhere near cut again. Then you had a third question on the ROE target. Can you repeat that please? Yes. So you mentioned I think earlier that when we're talking about the long term ambition of reaching a 15% return on equity, Is it a case that once we know the capital target then you will come back with more clarity about how we or how you get to a 15 percent ROE? And just thinking about the target kind of philosophically, is the kind of long term ambition to get to a 15% ROE? Is it kind of whatever the rate environment? And do you think that's possible given the amount of capital that you have to hold in the bank today? I think, Omar, with the again, we'll come back to the sort of holistic answer on the financial targets in Q4. But broadly, the answer is yes. We have if I may ask, would be a little bit philosophical as well. I think the view we've taken over the past few years is that we need to produce a competitive return in the environment. We can't sort of sit around and wait for a different environment. We've used over the past 2 years and you'll find it in our Nordic outlook. And you'll see over the next 3 years that there's a projection in there, as I look to say, for slightly increasing interest rates, for example, but not until 2016. And you'll see GDP numbers improve even though slowly as well. So the answer broadly is yes. But how we will build that bridge to 15% profitability, we'll have to return to it. That's very clear. Thank you very much. Thank you. The next question is from the line of Alvaro Serrano. Please go ahead. Yes, hi. I just wanted to talk about the mortgage repricing. I know you've already referred to some changes in how you factor that in. But in terms of the contribution of improvement in spreads, is there more to go in the next quarter? Can you talk us through that? And what would be the outlook on under the new reporting in the retail NII? Thank you. I think I can briefly comment saying that the mortgage market is highly competitive at the moment. Some of the banks were not present some time ago or extremely aggressive. So it's still a very small market. We have a slightly slower pace now and I think we are very cautious regarding the spread as well. So I think slowly but steadily you will see that margins increases, but we do it in an orderly way. But of course on the discussions also domestically today regarding a bank tax in Sweden, the prices will also increase even further. So there are a lot of discussions going on now. But I do think that there is a pressure still but steadily on margins going up. At the same time, it's a very complex competitive market. Is it fair to say that your repricing is more back end loaded, more Q4 loaded than your competitors given you've changed the pricing during the quarter, how you price it? Is that fair? No, I think we as you know, we worked on the sort of revised model for how we calculate the funding cost moving to an average cost of funding instead of the sort of marginal cost of funding or the negative price of long term funding. And of course, when we rolled over our mortgage portfolio on the floating side in September, it only had an impact of 2 weeks. And it means that we would get sort of the next 10 weeks of Q4 having that new and higher level. So from that point of view, it is Q4 loaded more than Q3 loaded. Is it can you quantify how much that could have that been a factor in NII being down 6% quarter on quarter in retail? No, because it doesn't really show up in retail because it was part of the funding cost internal funds transfer pricing in between the treasury who had that cost already because they have long term funds that you already have raised. And then the retail side and the price they use in order to price the customers. So the rate the margin Anika discussed is the margin that retail will get when they price the customer. The higher cost of funding is something that will show up in treasury and you can see part of that effect as Jan Erik explained in the NII already this quarter, but you will see more of that in the next quarter. Okay. Thank you. Thank you. The next question is from the line of Ronit Ghosh. Please go ahead. Hi. Yes, just a short small question. I might have missed the you might have given the answer already. But when I look at the balance sheet, you've seen a big jump in what you classify as corporate deposits. It's up I know this can be a very volatile line item, but it's up €150,000,000,000 quarter on quarter. Can you just remind me what it is? And secondly, can you tell us where your NSFR ratio is right now, please? Sorry, Ryan. Can you just say at the very end of your sentence, you sort of broke up there. Sorry. Yes, I was just asking about the NSFR ratio. Are you disclosing that? Okay. Sorry. Well, let me talk to the balance sheet question and the corporate deposits. These are primarily U. S. Related. We do attract quite a bit of deposits into our New York branch and our treasury there from time to time. And this is time like that. And we have got some $35,000,000,000 sitting with the Fed at the moment netting a small margin after that. Right. I know you had this in the past and you're not the only bank to do it, of course, but it's just the scale of the change Q on Q that surprised me unless something special happened in the quarter that I missed? No, not really. It's just volatile, as you say. I suspect it will come down a bit towards year end. Okay. So I should assume that most of the $150,000,000,000 Q on Q changes U. S. Deposits in your New York branch? Well, I won't speak to a number, but it will come down, I suspect. Okay. Okay. On the NSFR, no, we don't disclose But I suppose we've said on NSFR in the past that we, of course, look to be compliant in 2018 when the requirements will be there. And we're today awaiting the final definition of NSFR. And we thought we would have had it by now, but I think they're holding on to it until the Brisbane meeting has been held. And once we have that definition, we can talk about that perhaps. But we don't see that as a major sort of game changer for our business plan at all. It's something that we've factored in, in all our business thinking and around the financial targets, and we'll do that again. Right. So you might sort of be disclosing it from the Q4 numbers? Well, we'll see. It depends on requirements and what the definition looks like. But I think we'll certainly make sure we're compliant when we need to be. Sure. Okay. Thank you. Thank you. The next question is from the line of Riccardo Rovere. Please go ahead. Good afternoon to everybody. Just one question from my side. The short term rate in Sweden today something like 80 basis points lower than the average of 2013 and the level today is 40 basis points lower than the average of the 1st 9 months. So I would suppose this is putting some pressure on your deposit margin. Do you think going into 2015 assuming this level of rates remain where it is and maybe it's going to go lower eventually. Do you think there is any way to compensate that somehow? Or do you think deposit margins is something that is going to stay there in 2015, there is nothing to do against it? Yes, Ricardo. I think the answer to that is only yes. I think the rate cut we just saw was compensated for. And I think the rate cut that we see this time around in 20 basis points, if it happens, that's our assumption, Happens next week, I think we will certainly work to compensate as well. But just as Anika said earlier, the competition is fierce in the mortgage market and we'll just see how the market overall behaves, but certainly that's our ambition. Okay. So if I understand it correctly, let's say, the decline has been so the magnitude of the decline is so large and the competition is so fierce that there is nothing actually you can do to compensate 100% of that? That's not quite what I said. I think I was just making the reference to the last quarter that we had the same debate then. And I think competition was just as fierce then. And I think we're contemplating now for what happened in July. And as I'm saying that I think we'll do our very best to compensate once again if that helps. Okay. Okay. Got it. Right. Thank you. Thank you. The next question is from the line of Adrian Cighi. Please go ahead. Hi. This is Adrian Cighi from RBC. One further question on NFI, if I may. You mentioned the turnover in corporate bond market is showing some improvement. Is this an improvement versus the exit rate of the quarter or the average for the quarter? Thank you. No, I think we were making reference towards the end of the quarter where September was better than July August. We in the past few years, we saw a trough in July. This year, it's been the lowest in August. And I think we're just making the comment that September picked up a bit. Thank you. Any chance you could comment on what the activity level continues to be into Q4? No. But it's a little bit better as we said before. But the thing is that turnover all in all volatility is extremely low in all Nordic markets. I think that is the point. But I mean hopefully it will pick up again, but it is very low and that's why we try to show you the graph. Okay. Thank you. Thank you. The next question is from the line of Johan Ekblom. Please go ahead. Thank you. I just wanted to come back to the change in the mortgage pricing model. And you said you had, I guess, 2 weeks benefit in Q3 and 10 more to come. But aren't we talking about the absence of a bigger negative that would have happened had you not changed your model? Because as I understand it, the price you actually charge your clients has dropped this fixing versus the last fixing. And presumably given you don't fund your book extremely short, it will take time for this to flow through. So in Swedish krona measured, isn't Q4 mortgage result going to be lower or maybe flat this whereas it would have been even worse had you not changed your model and been forced to price it on spot funding costs? Johan, I think the way to look at it is that we've always been tracking the difference between the average cost of funding that treasury has in their book and the marginal cost of funding that we have used in order to be transparent to the market about pricing and then use that for pricing on customers. And as the interest rates have fallen so quickly in this year, the difference between the cost that we already had in the book and what we were using to price it towards the customers became bigger and bigger. And therefore, we saw that in order to manage €400,000,000,000 of lending, you need to have more of an average cost of looking at life. And accordingly, we change that. So you're right in the way that it's a cost we had. But of course, if we haven't changed the model, we would have had to stick with that cost. Now we are able to price more correctly to the customers because it is a so if you take a 3 month floating note, it has maybe a price of let's say we have €270,000,000,000 of that or something. It's not something you can refinance every third month anyway. You need to have much more than average cost. Sometimes it's cheaper. Sometimes it's more expensive. And we issue carry bonds all the time continuously at different levels when we need to. So the way to look at it is that it will increase treasury's NII. And if you look in the fact book on Page 31, you can see that the treasury NII has been falling since Q4 last year because of this and it came down to a negative number in the Q2 of 2014. Of course, we can't have a treasure that runs negative because it's supposed to be priced according to the market and they also have an interest rate risk mandate, so they should make some money as well. So that's the reason why we needed to change now. But it's the absent but then I'm right in that it's the absence of a negative. Not that you will all of a sudden see a big increase on the level of profitability you saw on a consolidated basis, then we can argue about the splits between retail and pressure related. No, I don't follow It is an increase in the absolute level of net interest income that the bank will get. It is not absence of the negatives. It's not an alternative cost we would have had. This increases the income we charge to our clients and or the sort of cost we charge our clients and therefore increases the overall SEB Group's net interest income. Okay. Thank you. Thank you. And there are no further questions from the phone lines. Thank you, and thank you all for participating in the call. Management will be presenting tomorrow morning at Cannon Street and have an analyst or sell side meeting. Until then, please take care. Bye.