Earnings Call: Q3 2014

Oct 23, 2014

Thank you for standing by, and welcome to the Q3 2014 results call. At this time, all participants are in a listen-only mode. There'll 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'd now like to hand the call over to your speaker today, Mr. Ulf Grunnesjö. Please go ahead. Thank you very much. Welcome to this conference call for our third quarter earnings. Annika Falkengren will start with the presentation, our CEO. The Q&A will be conducted together with myself and Jan Erik Back, our CFO. Please, Annika. Thank you. Well, I think we should turn to slide two immediately. The highlights of the quarter was that we do continue to attract a large number of customers, both corporates and private individuals also this quarter. All business divisions and all of our home markets, the Nordics, the Baltics, and Germany, are growing. The high activity level during the spring decreased somewhat over the summer. Financial markets have shown low turnover and low volatility, especially during July and August. Activity levels increased though in September. It is clear though that the economic recovery remains fragile. We continue to keep a firm cost control. We are also becoming more effective with regards to capital. In this quarter one, capital core level 3 improved to 16.2%. Our asset quality remains high. Credit loss levels continue to be low. Looking at the financial summary on slide three, the only comment there is the operating income for the first nine months of the year was SEK 34.2 billion. Operating expenses was SEK 16.4 billion. That means that our operating profit to SEK 60.8 billion. On page four, in the third quarter, we did divest our shares in Mastercard. The capital gain was SEK 1.3 billion. These holdings relate to a time when Mastercard was a member-owned organization. Today, they are listed on the New York Stock Exchange. 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 SEK 5.3 billion or by 16% compared to the third quarter of 2013. Let's turn to slide five. Net interest income increased by 7% compared to the first nine months of last year. Compared to the same quarter last year, the increase was 9%. Customer-driven net interest income increased during the year due to higher lending volumes 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 back 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 third quarter after decreasing early this year. We are now at the same level where we were a year ago. Maturing expensive sterling funding from 2009 and improved efficiency in liquidity management during the quarter were the main reasons. Page six, net fee and commission income was SEK 11.8 billion for the first nine 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. SEB has today more than SEK 1,600 billion in assets under management and close to SEK 7 billion in assets under custody. Compared to the second quarter, fees are lower due to third quarter seasonal effects, mainly in securities lending. On slide seven, NFI decreased 10% in the first nine months of the year and fell about 20% versus both the previous quarter and the third quarter of last year. Activity in the markets 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 eight we continue to show the stability of our business. We will continue to work on attracting new customers, cross-selling and keeping costs flat. As a result, improve bottom line further. On page nine, we show the operating leverage is materializing in all divisions. They all increased their operating income while keeping costs under control. Operating profit increases between 18% and 25% during the first nine months of the year. In the third quarter, merchant banking delivers an 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&A transactions during this period. Our expansion in the other Nordic countries continues to develop well, and we see a good momentum in Germany. Retail banking continues to grow in both the corporate and private segments. Operating profit is up 12% compared to the third quarter last year. Our mortgage portfolio increased by 3% during the quarter, 7% annually, while corporate lending was unchanged. Wealth management and life together increased our operating profit with 40% compared to the third quarter last year. Wealth management has taken in more than SEK 25 billion in net new money, two-thirds from institutions. In life, sales were very strong in Sweden and Denmark. In the Baltics, net interest income continues to trend up from repricing of lending. We see relatively limited effects in our business from the Ukraine-Russia crisis, but if existing sanctions are extended for a longer period of time, the possible negative effects for growth in the region need to be taken into account, and we continue to follow the development closely. On page 10. An interesting development in the third 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 2008, driven mostly by high demand for credit lines, up SEK 50 billion in relationship to, for instance, M&A. Lending fell by SEK 15 billion in the quarter as corporates repaid some bridge financing. We're also proud to be ranked third as the sole Nordic bank among many large global investment banks in the table, showing completed M&A deals in the different Nordic markets. On page 11, where I wrap up here with a quick overview of our financial situation. Asset quality remains strong. The uptick in credit losses in the third quarter 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, and we have more than SEK 800 billion, with 30% 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 first nine months of the year, excluding the sale of Mastercard, 14.6% including Mastercard. In the quarter, return on equity was 13.8%, excluding Mastercard. We maintain the 15% return on equity long-term ambition and are working on the 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. 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. If you wish to ask a question, please press star one and wait for your name to be announced. To cancel that request, just press the hash key. Okay, the first question is from the line of Nicholas Davey. Please go ahead. Yes, good afternoon, everyone. Nicholas Davey 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 is a contributor above 10% of quarterly NII. I just hoped 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 NII which can still yet get passed out to the various business divisions through FTP 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. The second, a similar-ish question on the trading income line. You talked about having about SEK 1 billion 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 one or two 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 to start with, let's divide it up on customer-driven and other NII. I know you asked about the latter, but let's run through this. I think on the customer-driven NII, we saw a decrease from Q2 in the region of some SEK 20 million, which is not a lot. I think there the margin squeeze on the deposit side following the 50 basis point rate cut in July has been compensated, even though not completely, by larger volumes on both the lending side and on the deposit side. The back book on the Swedish mortgages continued 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. I suppose the volume effect there is a little bit more positive than perhaps we saw when we stood in London and talked to you last time in Q2. If I move to the other NII, just to say there's been a combination of effects. One effect was the fact that a fairly expensive sterling loan from 2009 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. Will be with us going forward. I think the third effect is, of course, that Treasury were positioned for the lower interest rates and got more of an effect than we anticipated, perhaps since we got 50 basis points rather than 25 at the start. I think that position for shorter rates is with us and will support Q4 as well if we were to get another cut. Further out in time, that very last component, of course, won't help much. I think pretty much all of what we talked about is sustainable in my mind, apart from that last one. I think, Nick, on the NFI, as far as maybe on page seven, I guess we should never have said that around one is what it should be. As soon as we said that never happened again. I guess one can say that's why we try to be transparent on what happened on the monthly turnover in the Swedish corporate bond market. For example, seeing that the issuance and the turnover went really down to almost close to nil. Of course, that is painful for us because we are very much of a market maker, and we do need the turnover. It's no position taking. It's really that the market dried up completely. It has picked up a little bit since then. I'm not sure this is completely a structure move, but the volatility is still very low. Of course, that has been costly for us. That's very clear. If I could just make sure I understood it correctly. On the NII side, 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 2015. Is that the right- Yeah. That's right. 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. One 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? How do you think about either the need or the opportunity to be more aggressive on costs? Thanks. I think it has been now for the last years, we have been growing revenues with a CAGR of 5%-6% consistently for a long time with a broader base of clients. We kept our costs flat. I guess as hopefully we see that continue, we don't really see a need to cut, but to keep costs flat and to work with the continuously revenue growth. If the revenue growth wouldn't come, of course, we will need to start to focus even more on the cost. Where I see where it is today, this is a very stable corporate bank. This is how we work at SEB. I think we were the only bank, the only Swedish bank, that did show continuously revenue growth also in this quarter. We will continue to do that. Okay. Thank you. Thank you. The next question is from the line of Omar Keenan. 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 SEK 1 billion number is relevant. If I could just check that. Secondly, could you just describe some of the moving parts in treasury? Were there any own debt effects or other one-offs that were in the moving parts there? 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, that aim to reach an ROE target of 15%, is it still based on current rates, and do you think that's feasible given 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 SEK 1 billion on NFI market is still valid. Of course, we need some volatility to make that happen. Omar, on the other NII or the treasury component, as you saw that, I think if we take them again, basically three components. One is the replacement cost of funding where we swap the expensive pound or sterling funding. That's going to stay with us at a lower level, so to speak, going forward. The revised methodology for the mortgage lending, that ISTB charge 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 a way up. That one is sustainable as well, therefore. The third component I was referring to was the fact that the risk mandate in treasury has been positioned towards a rate cut in July, and we made some money off of that. That's going to continue to support us again if we have a rate cut in December. We haven't put numbers to the individual component parts of those three. It's obvious that the combination of those three was helping us out, and I think I was just trying to make the point that the last one, there's an end to it, obviously. I think rates won't go lower than an additional perhaps 20 basis points or so next week if and when they cut again. You had a third question on the ROE target. Can you repeat that, please? Yes. 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 you get to a 15% ROE? Just thinking about the target philosophically, is the long-term ambition to get to a 15% ROE, is it whatever the rates environment? Do you think that's possible given the amount of capital that you have to hold in the bank today? I think, Omar, again, we'll come back to the holistic answer on the financial targets in Q4. Broadly, the answer is yes. If I'm allowed to 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've got. We can't sit around and wait for a different environment. We have to try to build plans to do that here and now. I think the assumptions we use will be the same as we've used for the past few years, and you'll find them in our Nordic Outlook. You'll see over the next three years that there's a projection in there that looks for slightly increasing interest rates, for example, but not until 2016. You'll see GDP numbers improve even though slowly as well. The answer broadly is yes, but how we will build that bridge to a 15% positively, we'll have to return to. 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. In terms of the contribution of improvement in spreads, is there more to go in the next quarter? Can you talk us through that? What would be the outlook 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 are extremely aggressive, it's still a very interesting market. We have a slightly slower pace now, I think we are very cautious regarding the spread as well. I think slowly but steadily you will see that margins increases, we do it in an orderly way. Of course, on the discussions also domestically today regarding a bank tax in Sweden, the prices will also increase even further. There are a lot of discussions going on now. I do think that there is a pressure slowly but steadily on margins going up. At the same time, it's a very 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 that we worked on the revised model for how we calculate the funding cost, moving to an average cost of funding instead of the marginal cost of funding or the daily price of long-term funding. Of course, when we rolled over our mortgage portfolio on the floating side in September, it only had an impact of two weeks. It means that we get the next 10 weeks of fourth quarter having that new and higher level. From that point of view, it is Q4 loaded more than Q3 loaded. Can you quantify how much that could have 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, the internal fund transfer pricing in between treasury who had that cost already because they have long-term funds that we already have raised, the retail side and the price they use in order to price the customers. The margin Annika 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 Ghose. Please go ahead. Hi. Yeah, just a short, small question. 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. I know this can be a very volatile line item, but it's up SEK 150 billion quarter-on-quarter. Could you just remind me what it is? Secondly, can you tell us where your NSFR ratio is right now, please? Sorry, Ronit, can you just say the very end of your sentence? You sort of broke up there. Oh, sorry. Yeah, I was just asking about the NSFR ratio. Are you disclosing that? Okay, sorry. Well, let me start with 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 a time like that. We have got some $35 billion sitting with the Fed at the moment, making a small margin out of that. Right. I know you had this in the past, you're not the only bank to do it, of course, 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'll come down a bit towards year end. Okay. I should assume that most of the 150 billion Q on Q change is U.S. deposits in your New York branch? Well, I won't speak to a number, but it'll come down, I suspect. Okay. On the NSFR, no, we don't disclose it. 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. We're today awaiting the final definition of NSFR. We thought we would have had it by now, but I think they're holding onto it until the Brisbane meeting has been held. Once we have that definition, we can talk about that perhaps. Okay. We don't see that as a major game changer for our business plan at all. It's something that we've factored in in all our previous thinking and around financial targets, and we'll do that again. Right. You might be disclosing it from the Q4 numbers? Well, we'll see. It depends on the requirements and what the definition looks like. I think we'll certainly make sure we're compliant when we need to be. Sure. Okay. Thank you. Thank you. Once again, that's star one if you would like to ask a question. 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 are 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 first nine months. 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, or maybe it's going to go lower eventually, do you think there is any way to compensate that somehow? Do you think deposit margins is something that is going to stay there in 2015, there is nothing to do against it? Riccardo. I think the answer to that is probably yes. I think the rate cut we just saw was compensated for, 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. Just as Annika said earlier, the competition is fierce in the mortgage market, We'll just see how the market overall behaves. Certainly that's our ambition. If I understand 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. Well, 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. I think competition was just as fierce then, I think we're compensating now for what happened in July. I suppose I'm saying that I think we'll do our very best to compensate once again, if that helps. 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 showing some improvement. Is this an improvement versus the exit rate of the quarter or the average for the quarter? Thank you. You probably heard that well No, I think we were making reference to the end of the quarter where September was better than July and August. In the past few years, we saw a drop 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? Look, it's a little bit better, as we said before. The thing is that the turnover all in all, volatility is extremely low in all Nordic markets. I think that is the point. 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. You said you had, I guess, two weeks benefit in Q3 and 10 more to come. 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'll take time for this to flow through. In SEK measured, isn't Q4 mortgage result going to be lower or maybe flat this, whereas it would've been even worse had you not changed your model and been forced to price it on spot funding cost? Hey, 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 used as a pricing on customers. 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. Therefore, we saw that in order to manage SEK 400 billion of lending, you need to have much more of an average cost of looking at life. Accordingly, we changed that. You're right in the way that it's a cost we had, but of course, if we hadn'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. If you take a three-month floating note, it has maybe a price of, let's say we have SEK 270 billion of that or something. It's not something you can refinance every third month anyway. You need to have much more of an average cost. Sometimes it's cheaper, sometimes it's more expensive. We issue covered bonds all the time continuously at different levels when we need to. The way to look at it is that it will increase Treasury's NII. 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 treasury 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. That's the reason why we needed to change now. I'm right in that it's the absence of a negative. It's not that you will all of a sudden see a big increase on the level of profitability. On a consolidated basis, then we can argue about the splits between retail and treasury later. No, I don't follow that. It is an increase in the absolute level of net interest income that the bank will get. It is not the absence of a negative. It's not an alternative cost we would have had. This increases the income we charge to our clients and the cost we charge our clients, and therefore it increases the overall SEB Group's net interest income. Thank you. Thank you. 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 fireside meeting. Until then, please take care. Bye. That does conclude today's conference call. Thank you all for participating. You may now disconnect.