Thank you for standing by, and welcome to the Q2 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. At which time, if you wish to ask a question, you will need to press star one on your telephone. I would now like to hand the conference over to your speaker today, Ulf Grunnesjö. Please go ahead, sir.
Thank you. With me in the room I have Annika Falkengren, CEO and President of SEB, and Jan Erik Back, our CFO. Annika will start by running through the presentation and slides you have on the web, and then we will conduct the Q&A directly after that. Please, Annika.
Okay. Thank you, welcome to the presentation of our second quarter results. Today, we're presenting operating profit of SEK 5.3 billion. This quarter is characterized by higher activity level among our corporate customers and an increased breadth in our earnings base. Turn to page two. Business sentiment among our corporate clients has improved. Activity levels in the Nordic Capital Markets have been higher, and companies have also done more deals. Our long-term growth strategy is progressing well. We are welcoming more customers to the bank, both businesses and private clients, and the larger corporates especially are increasing their activity levels. The growth is happening in our home markets, and that means the Nordics, the Baltics, and also in Germany. We have increased the breadth of our earnings, which is the confirmation of our strategy as a long-term financial partner to our customers.
We continue to keep a firm control of our costs and are becoming even more effective also with regards to capital. The Basel III common equity Tier 1 ratio was 16% at the end of June. Turn to slide three. Operating income was SEK 21.5 billion, operating expenses was SEK 10.9 billion in the first six months of this year. On a quarterly basis, operating profit was up 10% compared to the same quarter last year. Credit quality continues to be high. Credit provisions were eight basis points, and non-performing loans continue to decrease. Our NPL coverage ratio increased to 74% this quarter, and return on equity in Q2 was 13.8%. On slide four, the net interest income increased by 7% compared to the first six months last year. Customer-driven NII was up by SEK 1 billion or 12% compared to the first half of 2013.
Higher volumes and stable lending margins more than offset the negative effect of lower short-term rates on deposit margins. NII from other activities fell, mainly driven by an increase in our long-term financing, and that the flatter SEK yield curve impacts the NII on our liquidity reserves. Compared to the same quarter last year, NII is up 6%. Net fee and commission income on page five was SEK 7.9 billion for the first six months. The increase of 12% was driven by several factors, and we believe demonstrates the breadth and stability of our franchise. We saw increased results from financing, advisory services, securities lending, our card business. At the same time, asset values are up driven by global stock exchanges, which has been strong during the quarter.
As you can see in the fact book, the expense side of fees is not allocated as a result of the gross income numbers were somewhat elevated. If you look at the net securities commission after expenses, they increased by 12% in the quarter, and net payments and card fees by 9%. Assets under management are now more than SEK 1.6 trillion, and assets under custody are above SEK 6 trillion. Compared to the second quarter last year, net fee and commission income was up 10%. As I said, it is not any single driver of the fee side. It is a result of a number of customers we have attracted the last four years getting a bit more active. Much more cross-selling is slowly but steadily taking place. As a result, we believe it is to large degree also sustainable.
On page six, the NFI was down 6% in the first six months of the year. To evaluate our trading business, one needs to look to the net commission income and the other income lines for the business area markets within Merchant Banking. That is what the gray bars above show. Together with the NFI, the blue bars, you can see that the market's total income was up both compared to this quarter and last year. This despite the fact that volatility in the market was at an all-time low, as you can see on the lower chart. Slide seven speaks for itself. We continue to track on the right direction. Average income continues to slowly but steadily increase. Costs are slowly but steadily falling, and operating profit is rising as a result. Average pre-provision profit has increased by almost 60% since 2010.
We turn to the divisional performance on slide eight, which have all seen better results year-over-year. We continue to allocate capital at 13% common equity Tier 1 level, but we have also added the effect of 25% risk weight for mortgages. With that add-on, the average allocated capital is at the 14% level. We start with Merchant Banking. They increased this up by 27% during the first six months of the year. Here several factors are involved, but we clearly have more customers and they are more active. In addition, we are growing where we said we would grow, in the Nordics and Germany. Return on equity increased to 14.3% despite the 50% more allocated capital than Merchant Banking had two years ago. Retail banking continues its positive development and is growing with both corporate and private customers.
Operating profit is up 26% compared to the same period last year. Our mortgage portfolio has grown with 6% on annual basis or SEK 6 billion in the quarter. This is in line with the market share. Lending margins are stable. As usual, our card business has a good result in the second quarter. SEB is the leading player in corporate cards in the Nordic with some 4 million cards issued under brands such as Eurocard, Mastercard, Visa, and Diners Club. In May, as earlier announced, we agreed to sell our acquiring business Euroline for SEK 2.2 billion. Wealth management increased its operating profit with 16% compared to the first six months 2013, driven by good inflows, including on the institutional side, higher asset values and more private banking customers. We have attracted over SEK 40 billion in new savings. We move to the life business.
They increased the half year result with 23%, That was also a difficult time for life insurance last year as higher long-term rates affected the traditional portfolios negatively. We are seeing renewed interest for guarantee products, especially in Denmark, premium income for life as a whole increased by 17% and asset values increased. Last but really not least this time, in the Baltics, operating profit for the first six months increased by 35%, driven by an improving NII line and a release of provisions in Lithuania. Return on business equity is now above 15%, or even 17% if we exclude the Baltic real estate holding companies. Moving over to page 9.
In the plan we presented the first time in 2010, the focus was on growing our corporate business in the Nordics and Germany, also ensuring becoming the leading universal bank in Sweden and the Baltics, as well as growing in the savings area. I will now go through some specific areas of the bank, starting with the development of our business in Sweden, which makes up about 55% of the group's result. Sweden has remained unscathed through the recent crisis, We can see an emerging optimism for our customers. We are investing and continue to grow our Swedish franchise. As you can see on the slide, the number of large corporates has increased by 7% during the last 12 months. Almost 10,000 new or 7% more SMEs have chosen SEB as their payments provider since last year.
The number of full service customers on the private segment has also increased by 5%. Within private banking, assets under management have increased by 24% during this period. The customer-driven operating profit for the business divisions as a whole has increased 19% during the last 12 months. We are also growing outside Sweden, as you can see on slide 10. The six-month operating profit in Denmark has increased by 42%. In Norway, 15%, Finland 27%, and Germany 46%. This is exactly what we have been working towards in our Merchant Banking growth initiative. In the Baltics, where we have a universal bank, the operating profit increased by 37%. Slide 11. Another area of the bank in which we are gaining ground is Germany. Ten years ago, our German bank was more focused on commercial real estate than corporate, and our income generation was substandard.
Today, our operating profit has increased by 46% during the last 12 months, 85% of these belonging to the corporate business. We continue to decrease the commercial property-related share to focus even more on corporate clients. More German corporate customers see SEB as one of the best corporate banks in Germany. On the slide, you can see some of the public transactions in which we have had a leading role year to date. Going forward, focus will be on increasing cross-selling to existing customers while we continue to attract the original prospects we identified, albeit at a slower pace than in previous years and focusing harder on cross-selling on existing clients. We see that German corporates are increasingly seeking international and export-oriented solutions. In comparison to Swedish companies, German corporates tend on average to do a larger share of their business outside Germany.
For example, our businesses or our branches in Asia, like Singapore, Shanghai and Hong Kong. Before I wrap up, a quick overview of our financial situations on slide 12. Asset quality remains very strong, funding and liquidity well-balanced, and we continue to build capital strength. The increase of 16% common equity Tier 1 ratio was due to retained earnings. 1 billion SEK upstreaming of earnings from Life, as we usually do in Q2, and a positive risk migration offsetting the foreign exchange effects from the weaker Swedish krona. IAS 19 effects did not impact our capital ratio as we continue to have a surplus in our pension trust. SEB stands strong and return on equity was 13.1% for the first six months of the year. If our capital ratio had been 13%, our profitability would have reached 15%.
This was the goal we set out to achieve when we communicated our financial targets after the annual accounts of 2013. To conclude on the last slide, improvement of customer satisfaction, operating profit, and profitability show that our long-term business plan remains viable. This means that it's about strengthening customer relations and growing in areas of strength. It's about being available for our customers and having a balance sheet that can take care of a growing customer franchise. The new regulations are falling into place after several years of uncertainty. We will get back to you with an update of our financial targets once all regulations are finalized and hopefully by the end of the year, i.e., Q4. Thank you.
Thank you, Annika. Operator, we are now ready to take Q&A.
Thank you. As a reminder, 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 the request, please press the hash key. Again, star one to ask a question. Your first question comes from the line of Ronit Ghose from Citi. Please ask your question.
Great. Thank you for taking the question. It's Ronit from Citi. I just have three questions regarding net interest income. The first question is in your Merchant Banking division, your NII was very strong quarter and quarter, about 10% up. I can see loans have grown, but this seems to outpace loan growth. Could you give us some color around margin trends? I guess margins are going up, but if you could give us some color around that would be great. The second question is one of clarification in your other division. Annika, you noted that the yield curve flattened and then you're terming out some debt. Is there much of that negative number in Q2 we should consider one-off because of double counting, or is it just that's the base and we should use that as the base?
The final question on NII is, could you give us some updated numbers on your short-term U.S. funding? I know we've talked about this in the past, and based on data we can see you're one of the biggest CP issuers of foreign banks in the U.S., and if I take all CD and CP, you must be up there in the top 10 or top 12 of the foreign banks issuing in the U.S. Could you give us some color around what the numbers are there, how that's trending, and if there's any color you can give us on how much of an NII pickup you get from that activity? Thank you.
Hi, Ronit. Jan Erik here. I think on the NII line for MB, I think the margin development Magnus Carlsson described earlier in Stockholm today as fairly stable. I think we see competition in certain segments, of course. But overall, I think we feel we can hold our margins quite well in the Merchant bank. I think for the immediate future, that should continue. I think in the other segment and when it comes to the short-term U.S. funding, perhaps I can put it all together and give you a little bit of an outlook on the NII line.
Sure.
I think rather than commenting on specific lines, the way we talked about it this morning in Stockholm was that on the positive end, there is volume expansion, there is stability in the margins in the Merchant Banking. There's probably over time an increase in the margins in the retail bank, and there is the release of some of the funding costs that has been quite expensive in the past. That's going to take more effect when we come into Q3. On the negative side, there is obviously the decrease in rates that took place just a couple of weeks ago or a week ago of 50 basis points in Sweden, and to a smaller but still an extent of terming out the duration of the funding as well.
All in all, we summarized that this morning as thinking that in Q3 and Q4, we should be able to hold the NII level that we showed now in Q2. I'm grouping all of those things together and giving that outlook.
Jan Erik, can I just have a couple of quick follow-ups on the Merchant Banking division. There's something else going on. It's not margin expansion in Q2. The NII looks like it's outpacing volume growth in Q2 quarter-over-quarter. Is there any chance you can give us the number for USD short-term CD and CP funding at the first half? Should I just look at the fact book and assume most of that is USD when I look at the relevant line item? Let me just find it
I think Ulf wants to come in here, I think I didn't say we had margin expansion. I'm more saying that we're holding our margins.
Ulf.
Yeah. As regards the U.S. dollar funding, I think to start off with, the position we have in dollar is from a loan to deposit point of view, more or less matched at 100%. The funding we do in the U.S. is used for two particular reasons. One is to put it into the Fed in order to have a liquidity reserve. As we have said before, the liquidity reserve isn't really on behalf of the bank, but rather on behalf of our clients, because if there were to be any problems or disturbances in the funding market, the clients we have would need probably to access the bank as a backstop solution rather than finding someone else to go to. Therefore, we want to have that liquidity already on the balance sheet.
We're holding around $22 billion or something in the Federal Reserve in order to meet that. We have probably another $10 billion or so in funding from the U.S. market that we then use in order to swap it back to Swedish krona to create cheaper money market funding that we can use for the trading book. The swap has played in our favor, we can create cheaper Swedish krona funding by having
dollar funding already. That is then giving us some benefit, which of course, has an impact on the trading side, but it's not really any big numbers. I wouldn't put that as a major driver. We're not really, I would say, opportunistically using the CP/CD market as such. What we're trying to do is to create funding in the market. We want to build the brand awareness. As you know, we have also prolonged the duration of the commercial paper program, and we have furthermore issued senior and covered bonds into the U.S. market. We feel that we have very good momentum in the U.S. market, therefore we are using that to tap it.
Just one final question. Just to clarify, the $10 billion that you raised in the U.S. and swapping back into other currencies, how much of that would be CP/CD? I guess the $22 billion in the Fed is mainly all money market funded.
If you take the Yankee CDs and the U.S. commercial paper program and put it all together, we're talking about something like $35 billion-$40 billion that we are having in total. That's taking both the CD program and the CP program.
Great. Thank you, Ulf. Thank you, Jan Erik.
Thanks.
Your next question comes from the line of Matthew Clark from Nomura. Please ask your question.
Good afternoon. A couple of questions. Firstly, on the cost line, it looks like there was a plus SEK 164 million other operating component this quarter. Could you just give a bit more color on what drove that and what we should expect it to be going forward? Secondly, on the corporate loan growth, just wondering how much of this is permanent. Are these buy and hold positions or is this temporary inventory that you will distribute and we'll see volumes shrink back down next quarter? Thanks very much.
I think on the cost side, that particular is sort of the other side of the cost one. I think we've said earlier that it tends to move very much with the IT cost because when we spend a little bit more on the IT and we haven't concluded the project, what we do is that we, of course, book it as an expense, but then we activate it on the balance sheet, and then it gets amortized or depreciated as we run through the life of that project. You accumulate the cost while the project is running that you put on the balance sheet. When the project is over, you start to amortize that out, and it hits that particular line.
This is an offsetting part of the spend we have on IT or data costs and, of course, a little bit on the consultancy side. There's probably a little bit more in there than that I don't know off the cuff, but it tends to move very much in line with what you see on the data side and the consultancy side as well. That's the reason.
Okay.
To your second question, please, could you repeat that?
The second question was just on the very strong corporate loan growth this quarter, just trying to understand whether this is temporary inventory, syndicated deals that you intend to sell down quickly and therefore will fall away? Is this buy and hold or hold to maturity positions that will still be there in a year's time, we should expect the volume to continue to grow next quarter from this quarter's level?
Okay. If we look at the corporate credit portfolio, if that's what you mean, the one-third of that increase has to do with the foreign exchange movements and the weaker krona. You may remember that the majority of our lending tends to be non-Swedish krona because the funding need for our clients in Swedish krona is relatively limited, particularly on the Merchant Banking side. Roughly two-thirds would have to do with commercial transactions. What we commented upon earlier today was that it's not really any general increase of funding needs of our clients, but it's more to do with a number of transactions. Not only a few transactions, but the number of transactions that have taken place tends to be a little bit more deal-driven and, for example, M&A and acquisition finance and so on, so more of that type of nature.
That may also come back a little bit to the question that Ronit had earlier regarding the margins. Of course, when you do that particular type of deal, the margins tend to be higher than if it was just a general credit facility used for traditional cash management. That's another reason why it looks relatively healthy in the Merchant Banking side and margins or rather NII going up a little bit more than the volume trend that you would see. It's a little bit of a mix effect in there. Other than that, we haven't really put ourselves into any sort of position on a buy and hold on the corporate side, no.
Just to come back to it, even if we take the 5%-6% headline corporate loan growth-
Yes
adjust it down to 3%-4% for the FX effect, that's still a very high annualized pace of growth. Should we expect that to continue? Do you have appetite to grow at that pace?
If you look at league tables from the Nordic markets, you can see that we have been relatively active in helping our clients to conduct certain transactions. Some of them are public, some are not, so we don't never really disclose the names of what we've done. From that point of view, it's part of the business. Will we have another few of those in the next quarter? We don't know for sure, it's part of our business franchise that when they do these transactions, we tend to help them to lead it, sometimes we do the funding and financing for it may get amortized down over a period of time, we do the next transaction and so on. It's not that I would take the 3% and annualize that and say that it's 12% in a full year.
You're going too far, so to say, with the analysis. It's showing that there is life and activity levels and it's likely to come down a little bit in the third quarter, of course. That would be my guess.
Great. Thank you.
Your next question comes from the line of Johan Ekblom from Bank of America. Please ask your question.
Thank you. Just a couple of questions. Just coming back to the net interest income. I guess you're flagging two negative effects. One being the impact of the flatter yield curve, which I guess is what we're seeing in the corporate center. Secondly, the deposit impact from the recent rate cuts. Am I right in assuming that if the yield curve stays where it is, the result in the corporate center should stay at this rather negative level, or is there anything else going on there? Just secondly, given the adjustment we've seen to mortgage pricing so far, do you feel that the volume growth and whatever pickup you've had there is enough to offset that? When you talk about stable NII, that's stable in SEK terms. That's the first question. Secondly, just on fee income.
It's pretty clear that there's a positive underlying trend, but also you've pointed out several times that you've been involved in a number of transactions, et cetera. How should we think about the underlying growth rate in fee income? I'm assuming it's something less than the 12%, 13% we've seen. Finally, you have two big capital gains coming in the second half, which totals about SEK 1 per share after tax. How should we think about this? Are you in a position where this could be allocated, or you're thinking about how this could be returned to shareholders? Will that just be part of the overall capital discussion towards the end of the year?
Right. If I start on the NII question, I think you said two negative things, yield curve and deposit impact. I think I agree with those, but the third factor, which is positive, is the fact that we have maturities of some of the old funding that we took earlier that's maturing. We had a little bit of that now in Q2, not very material, but there's a little bit more coming through in Q3. I think I added those things together. I also added in, over time, increasing margins in the mortgage book, even though that is going to be playing out over a number of quarters, I think. I added to it the fact that the Merchant Bank should be able to hold its margins. I think all that in combination meant that NII should be flattish for the next couple of quarters.
On the second question for fee income, Annika?
On fee income, I think again that when you look at SEB, it's important to say that we will never be a NII bank. We are so dependent on our large corporate institutions doing activity. I think what we've tried to show over the last years is that you can actually be a stable activity-based bank, but of course, it goes up and down. I would rather say that if you follow the Q2 back a few years, you can see that we always have good fee income in Q2. In particular, that is because the securities finance business is pretty lumpy, but that's what most of the activity is. Also some other businesses. I think we're quite proud of that. That shows in Q2 every year. I would say it has grown a little bit this year.
I think that also shows the traction that we are working even harder with clients and we're gaining more business. This is one of our core businesses that we are investing in, that we believe in. Continuously, I hope that we will continuously deliver good.
If I may only add to that, remember that we, since 2010, have probably on average increased the number of clients across all the segments by some 20% or so. It took a while before we could see that the activity level started to have an impact on that. We now have a broader client base, and when we get a little bit more activity on these different segments from the different parts, then of course that in summary turns out to be a relatively good growth number as such. It's more to do with having a larger number of clients doing a little bit more, but not doing a lot more on the book right now. Therefore, we believe it to be sustainable.
Of course, we're not going to see exactly the same transaction come back the next day, but we're going to have a number of transactions that are swings and roundabouts, that in general creates that sort of growth. That's what we're trying to talk about, the sustainability by having the franchise and why it's turning into a little bit of the NII tick and go as well. That's how we look at it as such. To your third questions on the capital gains and how you're going to deal with the nice bottom line from that point of view.
I think that's just a question we're going to have to come back to. I think you talked about distribution to shareholders, and I think it's, as Annika said, the financial targets and whatever we do around that is going to have to be clarified around Q4, hopefully. As you know, there are a couple of things that the regulator needs to straighten out still when it comes to capital monies around the countercyclical buffer and how that is finally going to work and which level it's going to be at. The other one is the Pillar 2 components, where methodology has to be harmonized among the banks. Once we know that sort of thing, we can factor in whatever we're going to do on things like capital gains and other things.
Thank you.
Okay, your next question comes from the line of Christoffer Rosquist from Barclays. Please ask your question.
Yes. Hi, it's Christoffer from Barclays. Just two questions. The first one on trading and the second one on the cost of liquidity buffer. On the trading income or financial income in the markets division, I think you described in the report that the decline quarter-on-quarter was due to two factors. Among those, the flattening of the yield curve, and second, less volatility. I appreciate that volatility is by definition difficult to forecast. But when it comes to the yield curve, would this current level that we saw in this quarter be what we should expect going forward if there is no change to interest rate levels or even a continued deterioration if the development in Q2 in rates continues in the third quarter?
The second question I had is that you also write that just as you distributed the cost of capital reserves, you also distributed the cost of the liquidity buffer. Just wondered what assumption you've made there regarding your corporate deposits. If you've used sort of your own internal assumption regarding the stickiness of corporate deposits or if you used the Swedish authorities' current sort of assumption that they are less sticky than you suggest. Thank you.
Right, Christoffer, on the liquidity buffers, if I start there, what we do is actually a mix. We try to obviously take some lead from both the LCR and the NSFR in how we do our allocation to the divisions. But we also look at behavioral maturities rather than contractual maturities and sort of work on that basis as well. It's really a mix. I think it's important to keep doing that until we know what the NSFR measure is going to finally look like. It's already changed quite a bit, and as you'll recall, last year-end, it changed materially, and it meant that we got about 10 percentage points better NSFR once that new definition came in. And we still have to wait until the end of this year before we know the final calibration of that.
I think until we know for sure how that all works, we're going to work with a mix of internal and external assumptions, so to speak. When it comes to the trading income, I think you pointed to the flattening of the yield curve and the volatility, or rather lack of it. I think the other thing you need to keep in mind, which is depressing the trading line a little bit, is the fact that the spreads have tightened for SEB's own debt. And it's tightened actually more than on the asset side, which means it's a little bit of a headwind on that. That's another component which you need to factor in there.
Okay. Thank you.
Your next question comes from the line of Alvaro Serrano from Morgan Stanley. Please ask your question.
Hi. Thanks for taking my questions. It's more of clarifications, more one question, but three quick ones for you. Jan Erik, you mentioned that overall you would expect Q3 and Q4 to be relatively flat. Should I assume then the SEK 135 million in the other division, the drag is the run rate we expect going forward, or should they be less negative? Second, obviously loan growth was very strong in Q2. Might not be recurrent, all of it at least. Going forward, when you see the prospects of improving corporate demand as you've highlighted, do you think you can still accumulate capital based on the demand and the pipeline you're seeing over the next few quarters? Put another way, is your appetite still towards increasing dividends, be a special dividend if necessary, or towards investing more in the business?
Lastly, in terms of mortgage pricing, obviously the rate cut of 50 basis points has been put through. Most banks, I think, my understanding, has reduced their offerings only 25 basis points, including yourselves. Can you confirm then, do you expect that to be, should we interpret that as a spread increase of 25 basis points what we should model going forward? Thank you.
Alvaro, I think on the NII question again, I think I was trying to say that in total for the whole bank, I was saying that NII is probably something that we will defend on this level for Q3 and Q4, and I didn't want to go further out in time or to break it down into the separate divisions more than that, really. I'm just trying to give a little bit of a guidance on the back of the fairly large rate cut that we saw. Again, I was arguing that we can compensate for some of that through increased volume, holding the margins in the Merchant Banking, increasing margins over time, even though it will take time in the retail bank, and a little bit cheaper funding cost in the center at the treasury.
I think on the loan growth, and the rate we saw in Q2, I think looking forward if the macro conditions don't deteriorate and the confidence levels in the market remain where they are today, I think the corporate demand is probably going to continue to be positive, whereas I think there are reasons to believe that retail expansion is going to slow down a little bit and perhaps not have the same pace as it's had before. I think all the different banks, certainly through the Swedish Bankers' Association, are discussing different measures to curb that development a bit, and so does the regulator and the politicians. I think from one source or another, or a combination of measures will mean that that growth pace is probably going to slow down a little bit.
Whether there will be capital to distribute or not at some point is going to be something we will have to return to when we come to our financial targets, as Annika said earlier, around Q4 results.
I think that's when we will know the two things that I pointed to Pillar 2 and countercyclical buffers. I think it'll just be pure speculation before we know that. I think are we building capital at a pace where we can sustain the organic growth that we do? Yes, we feel very comfortable around that, of course.
Mortgage pricing.
On the mortgage pricing given the repo rate cuts.
Yeah, maybe I could comment that because I think the challenge is here that we do it differently, all banks. I think SEB, we're now into our sixth year of transparency, where we show our clients our finance costs, and that's an average of a five-year bond for our bank customer margin. We don't really look at the rate, but what we try to do is, of course, we follow our peers a bit, and we try to be in the middle somewhere what we show. Actually, we have a much more transparent and exact way of pricing our mortgages. Of course, mortgages are coming down. Margins are fairly stable, highly competitive still. All banks are very active here. Again, we are waiting.
The Finansinspektionen have said that they will, during the autumn, come out with clarifications regarding how all banks should show more openly the mortgage margins. I think we need to wait before we can actually compare and see how this exactly looks, because it's quite difficult today. We have our own way of doing it, and it seems like it has been very well appreciated by clients, so we don't really want to change it now. We are waiting for the Finansinspektionen to see.
If you look at the reaction from the different banks and what your competitors are doing, what you think they're doing, is it fair to assume that it seems like margins are now increasing or set to increase?
I think that slowly but steadily, the margins are increasing.
Okay. Thank you.
Your next question comes from the line of Nick Davey from UBS. Please ask your question.
Yes. Good afternoon, everyone. Three questions please, most of them follow-ups. The first one's on this question of divisional net interest income, sorry to harp on this one. I know you've given us very helpful guidance at a group level, but I just want to better understand, if I may, the flow of this net interest income in Corporate Center, because I remember you saying last quarter you changed the FTP, I just want to understand that you basically had a SEK 400 million swing in the net interest income in Corporate Center. If I understand it well, you're saying some of that's then being passed internally to the Merchant Banking for the shift in your view of corporate deposits. I just want to make sure I've understood that correctly.
Just to think out, you're talking about the reinvestment yield risk, which all banks face from lower for longer rates. I want to understand then, I guess that risk then is borne by the divisional net interest income lines, if I understand that well. That liquidity is now sort of boosting divisional NII, if there is some reinvestment risk, this Merchant Banking NII, which has come up, may come down again, we just shouldn't get too worried about corporate lending margins on their own if we see that playing through. That was the first question. Second one, sorry to come back on these discussions of what is a temporary and what is a recurring fee and commission income. I just wondered if you could comment on the German business.
I know you've got a slide in there, looking at revenues in Q2 2014, SEK 1.1 billion. You've had a run rate for the last three quarters of SEK 600 million to SEK 700 million. Could you help us understand, is there any sort of step shift in Germany structurally? Is this high revenue base reflective of a couple of big transactions this quarter in Germany, which may reoccur in another quarter somewhere else. To understand that P&L in isolation, that would be great. Third question and final question on capital, to square the circle here, we've had some discussions already in the call of special dividends and these kinds of things. I know there's a lot of uncertainty out there. I know you're waiting for H2.
I'm trying to understand, if I read the most recent Finansinspektionen release, it's pointing you towards a target Core Tier 1 somewhere near 17%. Do you have any strong beliefs that that's way off the right number? Anything in there that you're particularly pushing back on or would you be okay with us to plug that into our models? Thank you.
Hi, Nick. Let me try to run through on the NII side. First of all, I think the change on the other and eliminations, which is where we have our treasury NII. Between Q1 and Q4, when it went down by some SEK 230 million, had to do to a large extent that we changed the internal funds transfer pricing, where we're paying more for deposits in the divisions. That was a transfer from treasury to the Merchant Banking and retail because we wanted to make sure they were pricing deposits according to what Jan Erik said earlier, the behavioral part of the deposits. We also pre-funded maturities coming up later in the year, and that had an impact on the NII on that side. This quarter, we have continued to raise around SEK 30 billion of long-term debt in the treasury part.
We haven't had many maturities because they came late in the quarter in June, then we had a relatively expensive sterling transaction maturing here in July, for example. We were running with a double cost then we took in some more funding. Furthermore, we issued a Tier 2 paper in May that also created a cost for us, of course, on the treasury side that may over time get dedicated back to the divisions because they need to carry the cost of capital and so on. There were many things in this particular start of the year that brought the NII for the treasury part down. As Jan Erik said, we think now in the third quarter, it's more likely to jump up back up again towards a higher level since we have maturities that will then help us, of course.
We will also get, given the repo rate cut, it's not only negative because it's not only deposit rates that will impact the retail part, but it also gives us a little bit cheaper cost of funding, of course, for the business. The problem with treasury is where they put the funds when there is very little yield to the reinvestment risk of that and what type of risk you want to have on the book when rates are so low. For example, duration risk doesn't really give you anything, is it worth to sit on that? Credit spreads are very narrow and tight. Do you want to sit on any credit risk on the paper side and so on? You end up putting a large part of the cash into basically very secure covered bonds and into central banks.
Treasury would benefit now from this quarter on, given that we have cheaper funding costs, we have also the maturities of some of their more expensive debt and so on. That is likely to help us. The divisional part is going to go down a little bit likely in retail due to the fact that the amount of deposits we have, of course, is getting more and more into the zero range as we can't lower the savings rates on these deposits more than to zero. Therefore, we have the floor risk on that.
Regarding Germany, if you go back and look at the second quarter, there's always been a little bit of a high end to it in Germany because of the securities financing business, and we are getting a larger part of the market in there because we also are able to create relatively cheaper cost of funding and we are broadening our customer base. The same sort of trend showed up in Q2 last year, and it actually showed up in Q2 in 2012 as well. The magnitude is a little bit larger in this quarter than it was in the earlier Q2s because we have an increased number of customers that we're doing this business with.
It's not something that will be, let's call it sustainable into Q3, of course, but it's something that's sustainable with the business model and that will come back in Q2 of next year again. On the rolling 12-month basis, it's actually very sustainable, and it's increasing.
Okay, thanks.
On the capital question, I think the uncertainty is there, and if 17% the correct number or not, well, I think you need to work with some sort of bandwidth here and to accept that the regulatory paper that came out on 8th of May, I think it was actually said we would be just south of 16%. The two uncertainties again are the countercyclical buffer where the National Debt Office, the Swedish regulator, and the Swedish Central Bank meet and discuss, and the ministry. They sit down and discuss macroprudential tools, and they need to sit down and talk about these things as well. After that last meeting, the National Debt Office thought the countercyclical buffer should be set at 0%. The regulator felt it should be higher, and the Central Bank felt it should be at 2%.
There you have three different answers from three different bodies. That's where they are right now. Whether it's zero or two or something in the middle makes a big difference for what the end result is going to be. The other one is Pillar 2, where they have to work out the methodology for things like market risk in the banking book. How is that going to be done in a uniform way in the banks? How are the different banks going to calculate the pension risk in a uniform way? I think there's uncertainty around those things as well. I think for you to assume anything just south of 16% all the way up to perhaps 18% depends on what you think on those. 17 happens to sit right in the middle of those.
I think that sort of bandwidth, I think, Nick, is what you can get from what we know today.
Very clear. Thank you.
Your next question comes from the line of Omar Keenan from Deutsche Bank. Please ask your question.
Hi, good afternoon. Thanks very much for taking the questions. Firstly, a question on your targets. The quarterly run rate is now exceeding the SEK 20 billion operating profit target. They do look rather dated now. It is probably a little bit early, especially ahead of elections in September and new measures potentially on capital. Can we expect an update on targets perhaps in January with the full-year results? Would it be safe to assume that the long-term 15% ROE ambition is not going to change, even if that implies higher operating profits on a larger capital base? I just had a second question on fee income. In the second half, typically the first quarter is seasonally weaker in the Merchant Banking, but the counterbalance is that in Q4 you have your performance fees from wealth management.
You have given us some very helpful guidance on NI progression in the second half. Can we expect that second half fee income will at least be in line with the first half? Are you able to give that kind of guidance? Thank you.
First of all, targets, hopefully, if we get all this information out during autumn when we release the Q4 figures. I guess our ambition is by that time, late January or early February, that we will also be able to announce new financial targets, of course. At the press conference today, I did not let go of our long-term ambition to reach the 15%. I guess the simple answer to that is as far as some of our best peers have 15%, and that is what the best banks have. We have to go for the same. Our long-term ambition is not to let go of that. Of course, it has to be within reason, regarding the capital situation and everything. The long-term ambition is still there.
We need to see exactly as Jan Erik said, how these three different parts are trying to get along with what will be the new rules for us. I think we are also a bit worried about being too gold-plated compared to rest of Europe. There is a lot of discussions going on to Sweden at the moment. I do not think it is a problem very much today. I think we must worry about maybe five to 10 years out on the curve if you are too harsh on Swedish banks. When it comes to Q3 is always weaker because activity is down. Again, being a much more of an activity-based bank, activity usually goes down a bit in Q3. I guess Q1 and Q3 are always weaker quarters than Q2 and Q4.
Again, performance fees, you never know if you have performed or not. It's quite difficult to say in advance if we have or not, of course we are optimistic that we have a good team and hopefully that we're doing our best. It's very difficult to say today that we will deliver exactly what we hope that we will deliver.
To add to that's why we so much come back to this picture that you know of average quarterly income and so on, that we're sort of working on the averages because a particular quarter may be a little bit here and there, lumpy with one way or the other. On average, we are through having more clients, creating better leverage on the investments we have made, and that's what's there. Whether that's going to yield you better numbers or equal numbers, et cetera, into H2, it's difficult for us to predict. We believe we have a bigger base to stand on, and we're continuing to attract new clients.
Okay. That's great. Thanks very much. Maybe if I could just follow up with one question on regulation, I just push my luck. In the past two, three months, we've had a lot of news flow in Europe, but also locally on risk weights and leverage. In your discussions with the Swedish regulators, is there something new other than the countercyclical buffer, the finalization of the individual Pillar 2 requirements, and potential action housing measures that we should be aware of? Is there a increased focus on potentially raising or say gold plating leverage ratio regulation in the Nordics or doing something on corporate risk weights, or is there nothing new there?
Fundamentally nothing new, Omar. I think as we've commented many times before, the Swedish regulator and central bank and politicians are sort of fundamental believers in a risk-weighted balance sheet, they don't look to Leverage concepts as something which is as a primary constraint. They don't want that, at the same time, they recognize the skepticism in other geographies, they realize that they can't, for perception reasons or real reasons, take your pick, neglect the notions of a leverage ratio completely. They're looking at it as a standardized underpinning as it were. They are, I think, listening to debate around the corporate risk weight as well, that's not something that is going to happen in the near future. I think that's going to be pushed forward in time, if ever.
Slight change in tone, perhaps, in that they recognize what's going on in Europe more than before, but their own conviction of the merits of a risk-weighted balance sheet is still there.
Perfect. Okay. Thank you very much.
Your next question comes from the line of Edward Firth from Macquarie. Please ask the question.
Yes, good afternoon. It's Ed Firth here from Macquarie. I just have two quick questions. The first one was, back to fees and commissions. But if I look in your note on page 21, secondary market and derivatives revenue was up more than double. Is that the securities finance business that you're talking about? Because it looks to be pretty much more than double any quarter in the last two years. It just seemed to be a huge leap, for what you're describing in more of a sort of incremental business. Just sort of comment about that and how we might expect that going forward. And then, I guess the second question was a slightly broader question, looking out over two or three years. It seems that Sweden's skirting on the edge of deflation and may well go into a deflationary environment.
I just wanted to ask you how that affects the way you look at your business and how that affects, as you look into a new strategy, which areas of the business may or may not be more or less attractive in that environment, and whether that is the way you're looking at the business going forward.
Hi, it's Ulf. I think on the net fee and commission side. Yes, absolutely. The secondary market and derivatives jumped up. Equally, if you look at the fee and commission expense in the same table, you can see that that jumps up as well by SEK 400 million or so. The two of them are very much connected because it has to do to a large extent with the securities finance business. Then, of course, if you do transaction on one side, you get income, and then in order to offset that, you pay someone else part of that income. You'd be acting as a broker in a way, or intermediary in between the two. Therefore, the expense side goes up as well.
For that reason, we added this at the very bottom of that table, thereof net securities commission, which basically puts the two sides together.
Okay
That is of 12%. The very sharp jump of the secondary market and derivatives is to almost, but not fully, large part offset by the jump that you see on the expense side, and therefore the net of them is only 12% up or so. We have made comments that we're talking about that securities lending probably produce something in the neighborhood of maybe SEK 100 or so more than they did this quarter.
Okay
in the Q2 of last year. It's not really any big number, and that's not the main factor. The main factor has to do with, as we said before, many different sources of fee income in many different places within the whole group. If you look into the divisional as well as the geographical split, you can see that that's a factor that happens in many different places. I would just like to come back to what Annika said in terms of the geographical split, that we see big increases, 20%, 30%-40% in our countries outside of Sweden.
That we now have four out of five countries or regions actually producing more than SEK 1 billion in operating result for the first six months. It's not really that particular business. It is much more of a broad-based increase of the fee and commission side across the whole bank, actually.
Correct.
Annika.
The recurring activity. I think it's important to say that securities finance is a core business for us, and we can see many competitors that have not been very successful in that area. It demands a lot of IT support and solutions and really being at the top end of doing that. I think also it shows that we are a major player in this also on a European level. I think it will continue. Deflation, no. That's not really our target yet. I think now with the last big cut from the central bank, that's not what we are anticipating. We will go into business planning during autumn, and we will, of course, simulate different scenarios. That's not really on our radar screen that we would change.
I think going back to, again, we have the client base we have, and we have the cross-selling. For us, it's more kind of really being close to the clients and doing the best we possibly can. Then we need to simulate a bit, we have not been into deflation yet.
Okay, great. Thanks.
Your next question comes from the line of Riccardo Rovere for Mediobanca. Please ask your question.
Good afternoon to everybody. Just three questions from my side. First of all, just to get back one second on loan growth, which is clearly outpacing the economic growth in the Euro area and in Sweden too. Can you provide us a breakdown of what you are financing? How much is, especially in corporate, how much is working capital? How much is investment, CapEx? How much is in M&A? Just to have a feeling of what is driving such very good performance that you are showing quarter after quarter. The second question I have is on the leverage ratio, which is down 10 or maybe 20 basis points in the semester. In light of the macro-prudential actions that are put in place in Sweden, is something that you look at, is there any way which you can improve the leverage ratio in the next few quarters?
Last thing, just to have your feeling, is there anything in this set of numbers that you would consider as clearly one-off or maybe not sustainable? Thank you.
Hi, Riccardo. I think in terms of the loan growth, when Magnus Carlsson, the Head of Merchant Banking division was asked about that this morning, he said that it is not working capital, it is not CapEx. It is to a large degree driven by transactions where our clients are using their strong balance sheets in order to make acquisitions and other sorts of transactions in order to improve their franchise. It's more that than a general trend of them needing more money in order to grow their business organically. They're more talking about making acquisitions into other areas and so on. That's the kind of growth we are seeing.
Okay. Shall I interpret what you say, Ulf, as a kind of M&A euphoria? Maybe the euphoria is going to go away one day?
No, I wouldn't say euphoria. I think we have made comments in earlier calls, rather, that the Swedish corporates are really in a very strong position because they have had a lot of cash on their balance sheet. They have had relatively good crisis or post-crisis scenario. They have been growing in many areas, they have a banking system that also can fund them relatively competitively, therefore they historically have been very active in making acquisitions and growing their franchise in other parts of the world. For five years, nothing has really happened, now we're seeing a little bit of effect from that some companies started to do transactions and make acquisitions into other regions, that's part of what you normally would see in Sweden. I would say more bringing back to the normal level that we have seen earlier.
We're not talking about any euphoria because the difference is to the very lame period we have had in the last five years, rather than it being un-normal compared to what we are used to having before the crisis happened, so to say. It's more going back to normal.
Okay. You would consider this sustainable, let's put it this way. This is my understanding from your wording, correct?
Yes. As I said before, it won't be the same company making the acquisitions in the next month, so to say, but as part of the overall number of clients, it's likely.
Okay. All right. On the leverage ratio?
It's confidence building. One should remember, when a few of the companies have started to do that, you can see that other companies may get more confident about making similar transactions into other areas and so on.
Riccardo, on the leverage ratio, I think as we commented on a previous question, the fundamental belief in the regulatory in Sweden is on risk weights rather than leverage. I think the fact that we've reduced a little bit from 4.2 to 4 in this quarter is no big deal in my mind. We are well above the 3% that Basel talks about. If and when we need to adjust leverage, we can do so. I think the balance sheet can be addressed in many different ways. As you know, we have fairly large trading operation which is customer flow driven, but we do have possibilities to steer how much of that we keep on the balance sheet. There are other lines that we can work on as well. I think it's not something that's going to take effect overnight and come and bite us.
It's something that we can manage.
Okay. Just to finish on this. Is it correct to say that the leverage ratio at the current stage is not driving your management decisions?
Well, no, it's not a primary constraint in our minds or in the regulator's mind. At the same time, one needs to keep an eye on it, and it's something that we can't disconnect ourselves from completely. It's another ratio that needs to be managed, in my mind. It's not the primary one.
Okay.
Just to be clear, Riccardo, I think this is a detail, when we calculate and publish our leverage ratio, we do so on an average. That average is 4.0 at the end of June. The actual end of June, 30th of June, so to speak, if you look at that balance sheet on that day, it's actually 4.3. That's the detail, there you are.
Okay. Interesting. Finally, when I was asking about if you see anything that is clearly not sustainable or one-off in these set of numbers, did you spot anything?
No, I don't think there is. We've had the long debate around securities finance business and that impact and whether you want to call that a one-off or not. It is in the year a one-off because it takes place in Q2.
It recurs every year, so to speak, in Q2. Other than that, I don't think there's anything in particular.
Very clear. Thank you very much.
Okay, your next question comes from the line of Arjesh Bhawa from Societe Generale. Please ask your question.
Hi. Just a quick question. Just wanted to know if there's some potential CoCo issuance in the near medium term in the pipeline and the plan, if you could throw some light on that and maybe the legal clarity or the tax implications surrounding that if you plan to issue CoCos and something on the trigger. That would be helpful if you could give some color on that.
Well, I wish I could. I think the only clarity we've gotten this far from the regulator was enough to make us issue a Tier 2.
Okay.
Was that three, four weeks ago. CoCos additional Tier 1 issuance or tax implications are still to be clarified. We'll have to come back to you on that. I don't really want to comment on that today because it's too unclear.
Okay, got it. Thanks a lot.
I think maybe, sorry, just to add to that, you have to factor in also that in September we've got elections and I think on pretty much all those topics there are variations of the theme from different parties and we'll just have to see what the outcome is of that. Whatever the sitting government says today, it may be very different after September. We just have to wait and see what happens on that.
Okay. Thanks a lot. Yeah. Thank you.
Your next question comes from the line of Adrian Tsay from RBC. Please ask your question.
Good afternoon. This is Adrian Tsay from RBC. I have two questions please. On the wealth management division, the net new money showed a very strong quarter across both institutional and private accounts. Is this indicative of SEB taking market share or are there any other developing factors there? The second question is on the timeline. I'm trying to understand the timeline of repricing of liabilities. What proportion of your covered bonds are either on variable rate or that you swap into variable rate immediately after issuance? Thank you.
Hi Adrian. If we look at the inflows within the wealth management division as such, I think there are three different stories going on at the same time. The first one is the private banking where we've been able to attract around $20 billion, $25 billion of net new money every year and that has been a seven, eight year story right now, which means that we're getting to these healthy numbers where growth is 20%, 24% or something. Very nice growth. That's continuing and it's been the case for a long time, showing that we have very good franchise there. The second story has been around our distribution of SEB produced funds itself, where we have had a situation where maybe our funds weren't fully up to par and the distribution of external funds was a little bit easier.
We had external funds distributed to our clients through our retail network, by making the fund offering we have ourselves more efficient, simple to understand, and better performing, we're able to attract inflows into our own funds, whereas we earlier had outflows, we had inflows into external funds. We've been able to turn that around. We have inflows into our SEB funds, which then of course also creates good numbers in terms of the growth. We're talking about relatively small volumes, but still it's there. Also you can see from the fact book that the institutional client side within wealth management for a relatively long period of time has had relatively modest outflows, I would say, and not inflows overall.
We have come through a situation where we have reworked that and we this year have seen a material pickup in terms of the institutional flows we are getting. They are up actually by SEK 26 billion in this quarter. One of them has to do with a bigger mandate with one of the insurance companies in Sweden that is public. They attracted another SEK 10 billion or so as well by just getting more and more clients. Performance is key to being very good in terms of attracting new flows on the institutional client side. That's why it's important to us to be able to show these numbers. SEK 40 billion is a relatively strong number. It has to do with the acquisition of a mandate, but that's only maybe one third of that and the rest has to do with good inflows.
There you have the three factors behind it. In terms of repricing of covered bonds, we issue normally two to five to maybe seven-year covered bonds in general, and then we manage the interest rate risk by swapping them to the duration we want to have in order to match our book and so on. We very rarely have floating rate covered bonds being issued. They tend to be on a fixed basis, and then we swap them to the duration we think we want to have in order to match the duration on the asset side.
I would say that the repricing is happening more according to three-month, six-month STIBOR and EURIBOR, et cetera, rather than being repriced in terms of using the swap curve rather than being used to reprice the underlying bond in itself, because that tends to be stuck there at the fixed rate that we entered into from the beginning.
Okay. Clear. Thank you.
Your next question comes from the line of Jacob Kruse from Autonomous. Please ask your question.
Hi. Thank you. Annika, I think you were in the press earlier today or yesterday talking about amortization requirements being potentially welcoming them being even harder. Is that following any kind of discussions with regulators? Is that just a view you're taking as a banker in terms of how mortgages should be run in Sweden? Thank you.
Thank you. There is a debate in Sweden, our finance minister has been quite vocal about that if banks don't do anything about this, there might come a regulation regarding this. It's a lot of discussions. In the Swedish Bankers' Association, we are today discussing how to proceed. A couple of years ago, we decided in the Swedish Bankers' Association to have forced amortization down to loan-to-value to 70%, which actually today works. 90% of all new loans today is amortizing. The challenge has been that the old loans are not still amortizing as well. I think coming back to more of a savings and amortizing culture, the culture in Sweden has been rather poor when it comes to that.
I've been quite vocal in saying that in SEB, we've used 50 years as a kind of guiding principle of trying to get our clients to amortizing 50 years. I think you could actually shorten that to 40 years today because the lowest interest rates cut, it can almost equivalent to 40 years if you have the same rate. People could actually use the situation of paying back to themselves and also getting less leveraged. I think we're all trying to find ways forward or make sure that the households are not too leveraged, and this is one way of addressing it. I think also we worry about if we will not agree or suggesting something along all banks, that there might be legislation regarding this, which would be more unfortunate.
If you look, for example, to the Netherlands, it was very unfortunate when they were too aggressive on this. It's a delicate balance in how you do it. We have started, and I think we'll continue. I actually do think it's a good idea, and I think probably one could do a little bit more to shorten the total horizon, maybe down to 40 years or something. That's what I had a discussion about in a Swedish paper.
Thank you.
You're welcome.
There are no further questions at this time. If you would like to continue, please.
Thank you very much, thank you all for those questions. Since we're getting into the summer period, we will try to be on the lines and be able to respond to your questions, at least during this week. Then it may be a little bit more ad hoc next week since then we're getting, hopefully, some rest, all of us. With that, thank you for participating, and hope to see you and hear from you. Bye.
That concludes our conference for today. Thank you for participating.