Good morning. This is the conference operator. Welcome, and thank you for joining the SEB second quarter 2022 conference call. As a reminder, all participants are in listen only mode. You can register for questions at any time by pressing star and one on your touch-tone telephone. At this time, I would like to turn the conference over to Mr. Johan Torgeby, President and CEO. Please go ahead, sir.
Thank you very much, and welcome everyone to this Q2 2022 summer quarter report. As customary, you can find the presentation that together with our CFO, Masih Yazdi, we will go through today on our website. Starting on page 2, with summarizing the highlights of this quarter, we can see that we've had a very solid operating performance despite the worsening macroeconomic outlook and Russia's war in Ukraine, and we attribute this very much to the very well-diversified business model of SEB. I also wanna point out that as we've had heightened uncertainty and higher volatility, the demand for certain services and products that we have has increased quite markedly, and we'll come back to that later in the presentation. Return on equity came in at 12.3% and broadly unchanged regulatory minimum buffer of 480 basis points.
We continue to see a robust asset quality with low expected credit losses of six basis points in this quarter. Flicking to the next slide, just a few comments on macro, which has clearly been the theme of this quarter. The equity market has continued to show some weakness, although some stabilization in the last couple of weeks. Interest rates have continued to be at elevated levels, but also in interest rates, there's been signs of some stabilization lately. Credit spread, spreads have more or less continued to widen during the second quarter. This is of course mainly due to the inflation rates that are affected by the war in Ukraine and now being spread around the economy and hence monetary policy has changed dramatically during this year. On page four, we just summarize the year so far.
Financial performance have gone up 6% measured as operating income, and we have a solid underlying result of up 5% before credit losses and imposed levies. The imposed levies is the word for the resolution fund fee and the bank tax together. However, including the more normalized level of expected credit losses compared to last year, the very sharp increase in imposed levies, both higher resolution fund fee in the introduction of bank tax, we have so far this year came out with the bottom line result 2% below previous years. Now I'd like to double-click on three areas of the bank during this quarter. On page five, we are focusing on SEB's diversified business model in the context of fees and commissions.
As a universal bank, we are more or less exposed to all areas of the financial markets at all times, and this is a little bit like swings and roundabouts. The stability is very obvious on the top line. However, a lot of things are happening beneath that top line. Here, as the 9% increase year-over-year in fees and commission needs to be explained, you can clearly see that lending fees, payment fees, and card activities are the two beneficiaries, partly because of the COVID recovery, but also that lending demand has increased during the quarter, and we've seen very high activity in establishing loans. The three weaknesses are anything that is more or less directly linked to asset under management or asset under custody, or you're hurt by the volatility in the market, which reduces activity such as ECM.
You can see there that in the quarter, we were 9% down in custody mutual fund. This is the life investment management, investor world. Secondary markets and derivatives, which I will come back to, showed a 3% decline, which is a very modest decline given the very sharp volatility and changes in the market. Issuance of securities and advisory predominantly driven by weaker ECM business and IPOs down 3%. On the next page, you can see page number 6. We double-click on the business area we broadly call markets, which is fixed income, currencies and commodities, and equities. Also here, the group as a whole in the markets area show a modest increase compared to the same quarter last year. However, beneath that, a lot of things have happened.
The obvious negatives have come from the fixed income area where the inventory, the market valuation impact of increased rates and increased credit spreads have been very pronounced in this quarter, -81%. Predominantly, this is driven by market valuations on securities that you have on the books. However, currencies and commodities have clearly benefited. The volatility, the increased need for hedging, risk mitigation, reallocation of portfolios, and taking care of whatever strategy industrial companies may have around sourcing of energy and other commodities have been very, very high activity. Equities I'll come back to. To the right, we then double-click on fixed income and can see that we had more or less a flat result, 0 P&L contribution from what we call rates.
These are more or less the risk-free or very low credit risk elements of the fixed income business that we conduct. However, we had a small uptick in the fixed income credit. This is in our opinion, a very strong result in an area which has had enormous challenges during this year. Even though it's down 81%, we come in at a very stable result. On the equity side, it's important to know that we're also here a full service provider. Equity sales and trading, which is the volatile part, has also gone down in the year.
We also have a large business in equity finance, which has been very robust during the quarter, hence creating a big cushion, and therefore you haven't really seen any drop in the whole area of markets during this quarter compared to last year. We go back to our favorite slide on the credit portfolio, page number seven. What we normally show here is just the exposure. Just to remind everyone, exposure is different from lending, that is the sum of the nominal amount that we have signed up for with the client. It's the credit exposure at risk. The client in certain products thereafter decide if they actually wanna borrow the money or not, and that's the lending. We have today also included lending as it's a lot of things moving around in this market.
First on corporates, we can just note a 21% increase in the corporate credit exposure compared to last year. However, we've had a very significant depreciation of the Swedish krona, and as roughly half of our business is outside, only half of this is real volume FX adjusted. That's the 9%. We also had, if you remember, the fourth quarter this year, a significant uptick in exposure because we had several serial large events that we were involved in. Those have now more or less fallen off the balance sheet, and they're being converted into other type of capital markets transactions. Therefore, year to date, we are more or less flat when it comes to the credit exposure. However, as we have replaced all of those nominal amounts during this quarter, that's a much higher activity in the lending area than we saw Q2 last year.
We therefore need to replace and all these volumes with other business. We've also seen a clear trend that more money has been drawn, and this is of course more related to NII, looking at the lending by sector. Here, the year-to-date lending is now up 6%, and in the quarter it was a 1% increase, indicating roughly a 4% annual rate for that. We'll come back to mortgages later and commercial real estate. With those few introductory remarks, I'll hand over to Masih Yazdi to go through the financial results.
Thank you very much, Johan. I'm on page nine now and look at Q2 results, isolated. You can see that operating income is down 2% compared to the previous quarter. The main highlight here is net interest income that's up 10% compared to the previous quarter and 20% compared to the same quarter last year. The big negative is the net financial income line, which has halved compared to the previous quarter. I'll come back to that. On the expenses, you can see that it's up quite significantly during this quarter. That's predominantly due to the fact that we had low expenses in Q1 due to the falling share price.
As the share price has stayed at that, those low levels, we're now more in line with the target we've set for the full year, being at SEK 24.5 billion in expenses, on an FX adjusted basis. Expected credit losses are down from the previous quarter and at 6 basis points we believe that are on low levels. Here again you can see that compared to last year, imposed levies have increased quite significantly with the bank tax being introduced and the resolution fund fee going up. If I move to net interest income, we have seen a 16% increase so far this year compared to last year or SEK 2 billion.
Most of that is coming from volume growth, mainly on the corporate side, but we've lately also seen some improvements when it comes to deposit margins due to the rate hikes so far this year. Quarter-on-quarter, 10% increase of NII. That is coming from deposit margins improving as rates going up, but that's been partly offset by lower lending margins, mainly in mortgages. I'll come back to that on the next slide. As Johan mentioned, we've had some bridges, and some of these were paid down or syndicated out in late June. They haven't had any negative effect on NII really during the quarter, but that will come in the coming quarters. We've also seen some improvements in NII within our fixed income business.
Overall, we believe that during this quarter, about SEK 200-300 million of net interest income is short term in nature and should in the coming quarters come down again. At the same time, given the fact that we had a rate hike by the end of June that hasn't had impact on NII so far, we do still see some volume growth, and we do see prospects for improving lending margins on the corporate side as credit spreads have widened significantly. This doesn't necessarily mean that net interest income will come down in coming quarters. We have to see what happens in the markets. Just a couple of comments on mortgage margins. We're looking here on the...
On slide 11, on the left-hand side, at what's happened to our pricing on a 5-year mortgage compared to the average pricing of our peers, and we're comparing that to the spread of a 5-year covered bond. This is not our funding cost, it's just a proxy for our funding cost. In practice, we have a mixture of different funding sources when looking at our funding costs. As you can see, both the prices from the banks as well as the 5-year covered bond have gone up sharply. In the chart in the middle, you can see our price minus the 5-year covered bond and our peers' price minus the 5-year covered bond, and you can see that this has pretty much collapsed during Q2.
Our price or our margin in this sense has gone down by 50 basis points during the quarter. At the same time, the average margin for our peers has gone down by 80 basis points. There's a big difference there in terms of delta of 30 basis points. This can very much explain the fact that we've had lower mortgage lending growth so far this year compared to our peers. We're slightly surprised when it comes to price discipline on this market, and we do have the ambition in the long term to be pretty much in line with our back book market share of close to 14%. We'll make sure that in the coming few months, we'll adjust our service availability and price to make sure that happens. If I move on to slide 12, look at net fees and commission.
Johan has commented on most things here. As he said, lending fees and cards are up in this quarter, whereas assets under management fees and mainly investment banking-related fees are down. Just a couple of comments on the fairly large net outflows you can see in the quarter. Just mention here that about SEK 13 billion of the net outflows is related to the new partnership with Länsförsäkringar and Landshypotek Bank that we put on that have now been moved to their distribution. The remaining part is really coming from one institutional mandate with very low margins. If you look at the underlying business within private wealth management and family offices and our retail business, flows are actually pretty stable during the quarter, which is fairly good given the high volatility in the markets.
If I move to net financial income, here Johan has also commented on a few of the developments, but overall, we think it's an underlying solid underlying business development with strengths within commodities and FX and a very challenging environment within fixed income. The main reason for the decline here is due to valuation effects. You have a negative XVA effect of about SEK 300 million compared to the previous quarter. The main negative effect here is coming from the liquidity book within treasury, where you have an inventory of very high-quality assets such as covered bonds and supranationals. With widening credit spreads, you get a negative valuation effect. Going forward, if spreads do come down again, this should reverse. If they don't, over time, this liquidity book will reprice at higher levels and lead to a higher net interest income.
On slide 14, looking at operating leverage, so far this year looks good. We've increased the operating profit before credit losses and imposed levies by half a billion SEK per quarter. Far it seems like investing more in your business can continue to lead to positive operating leverage. Page 15 on the capital development, fairly simplified this quarter with a marginal decline of the buffer from 490 basis points to 480. We've added 40 basis points net of the 50% reserve for dividends. At the same time, the weakening krona has led to the capital buffer coming down by 50 basis points. Over time, a weakening krona is not bad for our business, as it leads to higher income.
In the short term, as the balance sheet is adjusted, very immediately, you have this negative effect on capital. On slide 16, looking at expected credit loss allowances. All the allowances, all the reserves we have in the bank relative to the exposures that we have, that is at SEK 8.6 billion during Q2, up by SEK 400 million versus the previous quarter. We have kept the overall model overlays of SEK 2 billion intact. What we've done during the quarter is to fully release the COVID-19 reserves within the two divisions, C&PC and the Baltics. We've done a reassessment of the balance sheet of the loan book based on the geopolitical interest rate and inflation risks that we see.
On a counterparty by counterparty level, we have made new model overlays that adds up to approximately the same level to fully compensate for the release of the COVID-19 overlays. You can see the distribution of the overlays as well as the underlying credit reserves based on the divisions on the right-hand side. On some key ratios then, a couple of things I would point out. The main thing here is the very strong deposit inflows. We're increasing deposits by about SEK 500 billion over two quarters, and we have a loan-to-deposit ratio in Q2 at 0.93, which is by far the lowest level this bank has ever had.
We see a big demand for depositing assets on our balance sheet. Liquidity ratios are slightly weaker compared to end of last year, but they are stronger compared to Q1. You can see the capital and the total cap ratio compared to Q1, which you can see here has improved as we issued an AT1 during the quarter. On the last slide, you have the financial targets. They are kept unchanged. Dividends capital ratio 100-300 basis points. We'll try to be there by the end of 2024, and we wanna have a return on equity that's competitive with peers with the long-term aspiration of 15%. We have continued to repurchase shares of about SEK 1 billion during Q2, and we'll continue to do that according to the current mandate until October. That was it.
I think we can open up for Q&A.
Excuse me. This is the conference operator. We will now begin the question and answer session. The first question is from Andreas Håkansson with Danske Bank. Please go ahead.
Thank you and good morning, everyone. Could we start with NII? You talked this morning about SEK 408 million of NII coming from more treasury and trading related areas. Masih Yazdi, when you say that SEK 200 million-SEK 300 million is not sustainable, is that really what we should be taking out from that SEK 408 million? That's the first question.
Yeah. Thank you, Andreas. In this kind of environment, there are a lot of things happening at the same time. It's very difficult to try to get an understanding of the NII development going forward. It's not a linear trend because you have. When it comes to treasury, for example, you have the how much treasury charges the divisions on lending and how much they pay to divisions on deposits. You have different models there, and then over time, they can move in different directions on a quarterly basis, but it should net out in the long term. What I'm saying, I'm not saying that SEK 200-300 million is unsustainable.
can just confirm that about SEK 200-300 million during the quarter is short term in nature, and it is based on bridge facilities and a higher net interest income within our fixed income business than we've had historically. It is absolutely possible that going forward, that is offset by further strength within fixed income and with new bridges coming up. Then we have the fact that rates have increased further, and we are fairly positive on lending margins on the corporate side as credit spreads have widened, and there's a lag in the system where banks over time will adjust their prices according to the new spreads in the market. It just happens much faster in the capital markets than it happens when it comes to our lending and the margins we charge from our customers. Yeah.
We think about SEK 200-300 million are short term in nature, and if it's not replaced by something else, that should come off the books there and that NII line in the coming couple of quarters.
They're not other things, as you said, potentially.
Sorry. Say it again, please.
No. Yeah. Just the SEK 200 million-SEK 300 million, if it falls out, like Masih has said, that doesn't mean that NII has to go down. That could be offset by the higher margins and the higher rates and so on, right?
Yeah. That's absolutely possible. To the extent that spreads are where they are now and stayed at that level, and the liquidity book in treasury, for example, is reinvested in higher yielding securities, that should also lead to higher NII. It just depends on what happens to credit spreads. Given how fast the market is moving, it's very difficult to predict or give any guidance on what's gonna happen. The general trend is that rates are going up, which is positive for deposit margins, and the general trend is that credit spreads are going up, which typically is good for lending margins in the longer term.
Andreas, I just wanna take the opportunity to highlight that if you use the investment grade credit spreads of 50 basis points at year-end as a proxy, currently above 100, the natural effect is, of course, that we have now doubled the NII, expected NII on any given portfolio compared to the past. The pain with having that positive statement is that you need to take the modified duration of the average portfolio times that change and take it as a negative right now. As an old fixed income guy, I actually think this is quite healthy for the fixed income market, although we're gonna have a lot of volatility and a lot of pain to go through before we normalize rates. We will have a different level, and, of course, adjustments will be made to portfolios. I'm not making a prediction.
I'm just stating the obvious, perhaps.
Yeah. Perfect. A question on mortgages. On slide 11, you show that mortgage margins are coming down. Is that really correct? Because what is it? 45%-50%, I haven't calculated on Q2 now of your mortgages actually funded with covered bonds while the rest are deposit funded, where you haven't started to pay anything. Shouldn't you say that mortgage margins are actually flat in the quarter?
I mean, it's really just comparing the rates to the five-year covered bond, which is a proxy for the margin. It's not the actual margin. I think different banks have different models. What we do typically is that we blend covered bonds with senior unsecured funding when we look at our funding costs for mortgages. Whether you mix deposits into that or if you see deposits at different products, you can have different models for it. In general, you can see in the quarter, irrespective of what duration you look at, that funding costs have gone up clearly more than the average price of each mortgage for each tenor. There is a clear margin decline for mortgages so far.
Very lately, last couple of weeks, spreads are going down on covered bonds, and banks have started to adjust their pricing downwards. Maybe this will sort of average out over time. It is slightly surprising, how little mortgage rates have gone up relative to the sort of our funding costs will go up in the long term.
Right. Finally, after mortgages as well, we saw that activity levels in the housing market slowed quite a bit in May. Could you tell us a bit about volumes in June and July? Are we seeing a real slowdown, or how does it look?
I mean, when it comes to transactions, there is a slowdown of about 25%-30% to my recollection. When we look at our mortgage book, we are issuing pretty much the same amount of mortgages this June as we did June last year, as the prices are higher now than they were a year ago. At the same time, given that our pricing has differed a bit compared to most of our peers, we see an outflow of old mortgages, so to say. Therefore, we come up with a net increase of zero, basically in June. We do issue mortgages at fairly high levels still. It is more than SEK 10 billion per month of volume growth gross, but then that is netted out with as much outflows.
There is obviously a slowdown in the transaction market, and generally, we are more dependent on transactions happening from mortgage book to grow. We are not as strong when it comes to people just moving their mortgage loan from one institution to another. Then we are more focused on the large cities, and as prices nominally are higher there and prices now are going down, that could have a larger nominal effect on our mortgage book compared to most of our peers.
Okay. Thanks very much.
The next question is from Magnus Andersson with ABG. Please go ahead.
Yes. Hi and good morning. Just continuing on NII there, if you could give us some flavor around the competitive situation on deposits. First of all, you noted that the deposit base, we saw that it has increased quite significantly, if you could say where that's coming from. Secondly, if you could say something about how high you think rates can go before you will have to change rates on transaction accounts. I note that you recently raised rates on your Placeringskonto products for 3-6 months, but I guess that's a quite small product, but you didn't do anything to your other savings account. Following that, is that Placeringskonto product, is that the 2% of your deposits in corporate and private customers? That's the first one on NII.
Yeah. I mean, as you could see in the numbers, we've seen very strong deposit inflow so far this year. It's a very sort of polarized environment right now. You have some companies needing more liquidity because of working capital needs, and because of that, we have some lending growth, but then you have some companies with a lot of excess liquidity, and especially financial institutions, and the risk appetite has gone down. You see some inflows coming in deposits. Obviously, given the current pricing, we still generate and attract a lot of deposits. In that perspective, the competition isn't that high, I would say. We don't feel pressure to increase prices at this point to generate or attract deposits. As you can see, I mean, our loan-to-deposit ratio is at its lowest level ever.
With quantitative tightening, structurally, liquidity in the system should be slightly drained, and you should see deposits structurally go down. At this point, we don't see that we need to change prices too much to attract more deposits. On the transaction accounts, we don't envisage that we will pay an interest rate anytime soon. Historically, we've only paid an interest rate on transaction accounts when the repo rate has been above 3-4%. We're far away from that. We will probably pay an interest rate on savings account, and as you said, we're paying that on the sort of the three and six-month tenor savings accounts.
Those are very small, but obviously there could be flows from the current savings accounts where the interest rate is zero to these tenor accounts, given the fact that we're paying an interest rate of 0.5% for the six-month and 0.25% for the three-month. Those kind of flows can happen, and that will have an impact on the margins. Here now, there isn't high competition for deposit, I would say, because there is still a lot of excess liquidity in the system.
Okay. Thank you very much. Then just on a more detailed note on your net commission income, that was really strong in the quarter. Just if you can say something, I think the deviation is primarily driven by very strong lending and card fees. If you could say something about the sustainability there.
Yeah. I mean, outlook on fees is clearly more negative than the outlook on net interest income. There are a couple of reasons for that. Lending fees are very high this quarter. I think it's not a sustainably high level. It should come down even though I mean, our balance sheet has grown quite a lot. If we keep the same size of the balance sheet, lending fees are structurally higher than they were a year ago, but probably not as high as they were in Q2. On asset management business, obviously, at the end of the quarter, asset prices are clearly lower than the average of the quarter. If you assume that equity prices will stay where they are now
You should see some further sort of headwinds on the asset management fees going forward. Investment banking, you should be aware that we did have a very high level activity by the end of last year and early parts of this year before volatility increased. That activity has sort of some legacy elements to it. You still continue to get some fees with sort of related activity to that activity. Over time, if volatility stays high, that should sort of taper off. Then, yeah, you could see better sort of development within markets with volatility staying high. The general thing I would say is that the outlook on fees is clearly not as positive as the outlook on net interest income.
The card fee level, nothing strange in there. It was up quite substantially 17% quarter-on-quarter.
Yeah. Well, no, it's a combination of the recovery from the pandemic, but at the same time also the fact that you have 8% inflation, which means that just to consume the same basket you consumed a year ago, you need to pay 8% more. I saw this morning that the inflation is up to 8.5%. Obviously that has a positive effect. Over time, if this leads to people having to reduce their discretionary consumption, that could have a negative effect on the card business. Because if you're paying more for your housing and electricity bill, which you typically don't pay with your card, you pay with an invoice, your consumption using your card could go down.
There are positive and negative effects there, but I think we are sort of on a new post-pandemic level now, and obviously we shouldn't go down to the sort of, the during pandemic levels again.
Okay. Thank you very much.
The next question is from Nicolas McBeath with DNB. Please go ahead.
Thanks, and good morning. First, clarification on the NII. In Q1, I think you mentioned that you had SEK 200 million in unsustainable NII coming from bridge financing, and now you increased your NII by around SEK 700 million quarter-on-quarter. Your assessment now is that there is between SEK 200 million and SEK 300 million of NII that may not be fully sustainable. Does this imply that more or less entire increase in NII in the quarter you find sustainable? Not really an incremental NII of sustainable nature in this quarter? That's my first question.
Yeah. I mean, you're right. The reason we add up to SEK 100 million to that sort of short-term nature of NII is really the fixed income NII increase we've seen in the quarter. The bridges are sort of unchanged. As I said before, some of them were paid down by the end of the quarter in Q2, but haven't really had an impact on net interest income. It is correct that the remaining part of NII should be fairly sustainable. I mean, to the extent you can say it's sustainable, it depends on interest rate levels and volumes and all that, but it's more sustainable than the SEK 200-300 million.
Okay, thanks. Then a question on the property management loan book, and if you see any increased demand for bank loans from property companies that may look to replace bond financing given the worsening in bond funding conditions, and whether you're happy to take on more property management lending volumes should you see a good business case for doing that? I know you've historically been somewhat conservative with increasing your overall exposure to this segment. Any comments regarding that would be interesting to hear, please.
Yeah. Thanks, Nicolas. I can take that. There has been some tendency for the debt capital markets to be shying away from some of these refinancings of bonds. You've also seen a significant credit spread widening. However, the average maturity for most of the active participants is fairly long. There has been very little requirement to test the volume depth of the bank or the debt DCM market at this point. It's more like observable prices on the street. There's a small tendency that discussions have gone up with these companies in order to shore up liquidity and other things. It's not this quarter or next. It's for the next couple of years if this were to be maintained as the level. It's very different.
I would say the majority of real estate companies do not have any urge for this discussion, but some might do. When it comes to risk appetite for us, we change nothing. Underwriting standards are intact, and we continue with a cautious, very conservative view on how much commercial real estate in particular we allow. As I think we've said many times in the past, we have an internal measure never to go above 10% of the non-financial loan book, non-FIG loan book in terms of real estate, and that will be maintained. To support existing clients is one of our key values. We will definitely, if transactions are good, meet our underwriting standards, be able to if we want to support companies.
Okay, thanks. Then a follow-up on that. Given your underwriting and collateral in this portfolio, how large price declines in the commercial property market do you think it would take for you to start to make meaningful loan loss provisions in this segment? Could you share any comments on what kind of internal guidelines you have with regard to loan-to-value in property management? If you have any caps that you don't do lending above when it comes to LTV?
Nicolas, we did include in the presentation an appendix slide on our real estate portfolio in general. You can see that on page 21. There you can also see the average LTV we have currently on commercial real estate, as well as residential real estate and housing co-ops. You can make your own calculations on how much prices need to drop for those averages to be above 100%. I would just say generally, the lending we do is very sort of cash flow based, so it's more interesting to look at what's happening to the cash flows of these companies. We do include on that slide a stress test we've done of the 20 largest real estate companies that we have as customers.
There you can see that we've stressed them based on a three-month Euribor going up by four hundred basis points and look at their interest coverage ratio in that scenario. As you can see, all of them will be at one or above one in terms of interest coverage ratio with the average at 2.1. One other point when it comes to the price decline, just remember that there are risk weight floors on both commercial as well as residential real estate, and there we can conclude that prices need to drop by 25% before we see any capital effect of real estate prices coming down. Now I'm only talking about commercial and residential property. On mortgages, prices need to drop by much, much more than that before there's any capital impact.
Nick, if I may just, this has been, of course, the topic of this quarter, and I think it's important that when anyone does analysis to differentiate between the equity market's outlook, the profitability of any given property company compared to the loan losses this will incur for the financial banking system. There's a huge difference in those two analysis. We have seen and observed significant drops in share prices for real estate companies and significant credit spread widening. You know, for a bank, you need a systemic proportion of these companies to have a failure to pay their obligations to their bank, and therefore, the cash flow is the first most important thing.
Even if you have a 400 basis point, we don't have any of the large companies in our book that we won't think be able to pay. That's, by the way, assuming they cannot increase any of their rents. It's just ceteris paribus, everything else being constant, you know, put in the interest rate. The other bit is that once that happen, that might not trigger a default or an expected credit loss either because it's subject to timing and financing. Thereafter, you need the LTVs to be above 100 for you to incur a loss or the market liquidity to be so poor you can't sell any household or residential or commercial real estate. There's no price for them.
that's the banking analysis, and that's a quite separate one from what is going on mostly in the media right now, and that is about the profitability of any particular real estate company. I just wanna make that point.
Perfect. Thanks. That's very clear.
The next question is from Robin Rane with Kepler Cheuvreux. Please go ahead.
Yes. Hi, good morning, and thanks for the presentation. Back to the mortgage margin there and perhaps a clarification. You say the SEB margin on mortgages is down 50 basis points. Is there any timing effect here, that funding costs have increased faster now than you've been able to increase prices? That's my first question, please.
Just to point out, our margin is not down 50 basis points. We're just comparing here the five-year price versus the five-year covered bond. That's not the same thing as the margin. It's just a proxy for that. We're just trying to illustrate what's happened during the quarter. Yeah, it is definitely a timing effect that given the sharp increase of covered bond spreads and funding costs in general, there's been different strategies seemingly among the banks to adjust prices. We can just conclude that we have adjusted prices more, not as much as funding costs have gone up, but more than our peers, and that largely explains the fact that we've had very poor mortgage lending growth recently. That's the point with that slide.
Do you think you need to adjust down prices in order to protect the back book share of back book market share, or do you think the peers will eventually catch up?
Yeah. We won't be in a rush to go back to our back book market share, but we will have an ambition to go back there over the next few months, maybe by year-end. We'll see how fast we'll do that. I think it will be a combination of other banks adjusting their prices to more sort of reflect the changes in funding costs and maybe to some degree us having to adjust our prices to be more in line with our historical price, which has been sort of mid-range among the banks. We're typically slightly lower because we have a different customer base than the average of our peers. We'll obviously look at other aspects as well.
I mean, we do wanna sort of serve our customers as well as we can in terms of availability and general service level. If you can pull those levers, it's typically better levers than just adjust the price.
Okay. Thank you. You previously talked about costs being some parts of the cost base being normalized following the pandemic. Is that something that you already are seeing, or could we expect more headwinds from costs normalizing going forward?
Yeah, I mean, the main cost decline we had during the pandemic was travel and entertainment that came down from average level about SEK 100 million per quarter to close to zero during the pandemic. In this quarter, you can see that it's up to SEK 80 million. We don't think it's gonna stay at that level. We think it's gonna be lower than that. We do see a reduction, a structural reduction versus pre-pandemic expenses. In the short term now, we've seen a lot of activity, a lot of customers that wanna meet us, both due to the volatility, but also due to the fact that we haven't met them physically for some time. We think that the level you see in the quarter is actually higher than we will have long-term in the bank.
Overall, I mean, we're running the investments we do in the bank in line with the strategy we set forward six months ago. We're doing the investments in private wealth management. We're doing the investments within investment banking and all the investments we need to do within all the compliance areas and financial crime prevention. That's running very much according to the plan, so we think we are sort of on target. In terms of development, we do see already that we're getting a positive development from the sort of front office investments we're doing in the divisions. You can see that in PWM, the client intake has been clearly higher so far this year than it was last year, and it's been clearly higher than the targets we set forward. That's just one aspect of it.
We do believe that the investments that we plan for in our strategy are bearing fruit already, but we're only two quarters into a nine-year plan. We'll have to see what happens going forward.
Okay, that's very clear. Last question. One of the reasons you previously kept the COVID overlays was that you saw a risk for a sort of pent-up bankruptcies that would perhaps increase when the government support schemes ended. Do you see a risk for that still now that you've reversed the COVID overlays? And is this covered by the new sort of geopolitical overlays, or how do you think about that, I think?
Yeah. I mean, we don't think there is any reasons to have the COVID overlays anymore, and that's why we've taken them out. We don't see the risks related to COVID anymore really. Obviously, new risks have emerged, and therefore, we've done new assessments of the exposures we have and the vulnerabilities we see in them. That is due to sort of the current concerns we have with geopolitics, rates and inflation. Based on that, we've just done new assessments, and this is a very sort of bottom-up assessment, looking at client-by-client level and see to the extent they are vulnerable to current developments. In the end, we just ended up with pretty much the same kind of total overlays as we had before related to COVID.
It's a completely new assessment based on completely new risks, so it has nothing to do with the historical overlay related to COVID.
Okay, very good. Thank you very much.
The next question is from Omar Keenan with Credit Suisse. Please go ahead.
Good morning. Thank you very much for taking the questions. I just had one follow-on from Magnus' question, please. I had a second question on capital planning. Firstly, I was wondering if you could help us a little bit with the rate sensitivity number. You've seen, you know, really good deposit growth and you know, you've probably seen how the banks behaved after some rate hikes. Could you give us an updated rate sensitivity number that is gross of any lack of mortgage margin pass through, please? My second question on capital planning.
When you're looking forward to 2023, clearly it's a more difficult market environment, and you gave us some very interesting color around, you know, what kind of asset price falls are needed to even impact LGD floors. Could you help us understand a little bit around how probabilities of default are changing the book, just so that we can sort of understand what the risk of rating migration is? Thank you.
Yeah. Thanks, Omar. On the rate sensitivity, our previous guidance is that when it comes to Swedish rates, 25 basis points higher rates means about SEK 1 billion of gross sensitivity, just looking at deposit side. Then you have to make your own assumptions on the lending side and what's gonna happen to margins on the lending side. That's the gross number, and typically it's less than that because typically lending margins, especially for mortgages, come down when rates go higher. It's very difficult in the short term to say whether you're gonna see a linear effect. As I said before, there are many things moving at the same time. You have liquidity books that will be repriced at higher levels, but that takes time. You get an initial negative effect on your valuations, then over time you get a higher NII.
There are many things moving around, and you shouldn't assume this will be very linear. Over time, the sensitivity should be around that. We also have a sensitivity to Euribor or European rates in our corporate lending business that we do in euros and in our Baltic business. We've said it before that when it comes to the Euribor sensitivity, that's moving from negative territory, 50 basis points to zero. That has a negative effect on us as we have some Euribor floors in our lending. We've seen half of that negative effect during Q2, and given where Euribor is now, the second half should come in the next quarter. We have positive sensitivity in the Baltics. I mean, we have some sensitivity and it's sort of working as we expected.
The deposit inflows is mainly coming from financial institutions and corporates, where you typically don't really have a margin on deposits. It hasn't really changed the sensitivity that we have. On the capital planning, I mean, there are so many things we take into consideration. We do our capital plan. It's the volume growth we see, it's the macro risks that we see and as you mentioned, the sort of potential risk migration. During this quarter, we've had some negative net risk migration. At the same time, the new lending we've done at mid has been at good risk weights. So overall the average risk weight is actually down during the quarter. With this kind of macro outlook, you should expect net negative risk migration, which will have a negative effect on the capital.
We've said that in the past, and it hasn't happened, but this time around it should happen. To what extent that will impact the capital buffer, it's difficult to say. Given the fact that we have so many risk weight floors now on mortgages and CRE and RRE, the impact isn't that large, given that the concerns really are within those areas where we have risk weight floors. We take into account more sort of long term effects of IRB models needing to be reapproved by the FSA as well as Basel IV being introduced in 2025. That's what we do. Here now we stand at 480 basis points, clearly above our target range, and we're still doing the dividend of 50% and the share buybacks that we've announced.
The board will take sort of new decisions every time there's a need to do so, and the next step for them is to take a new decision in October to what extent and whether we do share buybacks from October until the AGM. That's the next sort of decision points for the board.
Okay. Thank you. Thank you very much.
The next question is from Sophie Peterzén with J.P. Morgan. Please go ahead.
This is Sophie from J.P. Morgan. I was wondering. My first question would be on kind of the credit quality of the new loans. On the corporate side, you have seen 12% growth year to date, and you have seen 9% growth on the commercial real estate side. You also have seen kind of RCF lending facilities in the second quarter and first quarter. Could you just kind of give a broad overview of these corporate and commercial real estate and bridge financing lending? How much is investment grade and what share is non-investment grade? That would be my first question.
Okay, Sophie, I can answer the general themes. First, most of the lending growth you've seen is actually drawn on existing facilities. It's exactly the same for that part in credit quality as the SEB credit quality, so to speak. For the new business that has been, you know, has gross numbers growing quite large and non-real estate, that's mostly investment grade and some structured finance private equity, which of course you have collateral and something else. Very similar to the mix that we have in the bank. I would say, for argument's sake, there's no change in risk profile in the new business that we do. The last one was investment grade share. Sorry, what was that?
Yeah, the share of investment grade lending.
What's the share of investment grade lending? Well, it's the majority, but yeah, I can't. I'll check up the number if you want it exactly.
If I just make a general comment there, Sophie. I think in general when you have this kind of market where all the risks are surfacing, you should be less concerned about lending growth because everyone is so diligent in the underwriting in this kind of market. You should generally be more concerned about high lending growth in a good market, because at that point you don't see the risks as clearly as you do now.
Yeah. No. I was more thinking about, like, if I look at the SAS, for example, that filed for Chapter 11 in the U.S. last week, it looks based on their kind of perspectives, like you're the house bank for them. Similarly, I guess that some of these commercial real estate companies that we know that they have a lot of funding issues, they can't access the funding markets. I know you are kind of limited in your commercial real estate kind of growth ambitions, but 9% growth year to date is still quite a lot. I was just wondering if these exposures are the kind of weaker credit quality clients than what you have on the books. I guess it sounds like it's not the case.
No, that's not the case at all. Generally speaking, the SAS case we can't comment on, although it is public that we are the financial advisor. I can say that everything has been taken into account in the six basis points of future expected credit losses. Would we have anything, we would have disclosed it of that nature. There's nothing to comment on over and beyond that.
Okay. My second question would be on the IRB overhaul. The Swedish FSA seems quite kind of, I don't know, worried. But they are kind of guiding that the IRB overhaul could potentially have a relatively big impact on the Swedish banks. So I was just wondering how do you think about this IRB overhaul impact for SEB and will it come in the fourth quarter or first quarter next year? If you could give a little bit more details here.
Yeah, I'll try to do that, Sophie. Yeah, that process is ongoing. It will probably take a year or so before we get a final decision on what that's gonna mean for us. We're working on our sort of application as we speak. Generally, if you look at the current models that we have and relate that to the historical defaults that we've had, we believe that they are conservative. If you compare our risk weights that we in general have to European banks' risk weights relative to the historical defaults, I'm pretty sure that that analysis will show you that we have been much more conservative than basically all European banks.
That's our input in this discussion with the FSA when we do this overhaul, and we'll obviously try to convince them that it is important to look at the data, when you do these models. The data shows that we've had very low losses relative to the capital we reserve against those losses. In the end, I mean, it's their decision is up to them. We'll do our modeling. We'll try to validate it, that as well as we can and document it. In the end, it's gonna be a discussion with them, at what calibration level these new models are approved at.
Okay. Also I guess it's fair to say, Sweden hasn't had a credit event, in the past 30 years, so clearly that has also impacted the models.
Well, if you look at the data, the data shows that Swedish GDP per capita has grown as much as European GDP per capita in the last 5 or 10 years. It's been a very similar economic development. What I think people miss in this is that banks up here have pretty good underwriting standards, and I relate that a lot to the financial crisis we had in the early 1990s, that a lot of things changed. We had a much bigger crisis here, and I think the banks in general here, not just SEB, but all banks here, learned a lot from that. Past experiences are important when it comes to underwriting standards. Another point I would look at, if you look at our net interest income, the net interest margin, it is clearly lower than European banks on average.
Either we do have better asset quality, or we are extremely poor at pricing risk, and you have to make your own mind up around that.
Related to that, I guess, your models don't go back to early 1990s when you model the probability of default and loss given default. I guess your models will only cover maybe the past 10-20 years max. You haven't had a credit default or you haven't had any loss experience in your models.
The requirement is that the model should be based on five years of history. We use much more than five years, and we do have elements of the nineties crisis in our models.
Okay. Thank you. The final question, could you just confirm that you still have around SEK 7.6 billion of total assets in Russia and Ukraine, and that you have no provisions against this exposure?
Can you repeat that, please?
Yeah. In your annual report, if I look, SEB had combined total assets in Russia and Ukraine of SEK 7.6 billion. You had around SEK 1 billion of book value in Russia and Ukraine. Could you just confirm that these total assets are still unchanged and that you have no provisions against these loans or total assets?
Yeah, I can confirm that. Well, in terms of our exposure, I mean, it's a lot of deposits that we have at Central Bank in Russia. In terms of the lending, we have a big majority, more than 90% is there's a parent guarantee from a Nordic or German company on that exposure. We feel comfortable with those parents of those subsidiaries we lend money to in Russia.
It's the legal entity the exposure is in Russia or Ukraine, right?
Yes, guaranteed by the parent. It's not the legal entity's credit quality that comes in the equation. It's the parent if the guarantee holds or not.
Okay, thank you.
Sophie, I just got the number here from a very adept colleague. Around 65% of the volumes that we have underwritten this quarter was investment grade, and therefore that means 35% wasn't, and that's 5 percentage points higher than the average. The balance sheet is currently 60% investment grade, 40% is below triple B minus.
Thank you.
The next question is from Namita Samtani with Barclays. Please go ahead.
Hi. I've got two questions, please. Firstly, I understand your M&A policy, but I wondered if your appetite for M&A has increased in the past few months, given valuations of certain FinTechs and even other financial players have significantly dropped. Or looking at it from another angle, given a notable proportion of employees have been let go from some of these FinTechs, do you have appetite to increase hiring in the tech or the data space? And just to follow up on that question, what's the preference between balance sheet growth, buybacks and M&A? And secondly, just a question on the German business. How do you intend to protect this given the macro vulnerabilities in Germany right now? Thanks.
Yeah. Thank you. Nothing has changed on the call, it's acquisitive appetite, M&A appetite given the market turbulence lately. That is then to say that we have in our business plan and our strategy is predominantly organic. No assumptions in the bank are really based on anything but an organic expansion in this strategy that we released six months ago. We did open up for partnerships, and within partnerships there are of course sometimes interesting corporations that entail that you acquire or you share part of the equity with companies. We've done this very successfully, mostly in fintech and, you know, the green-greentech, clean tech as you have seen in the past. Nothing has really changed. What has changed is you have to stand out these days.
Things are moving around in the market. There's definitely gonna be problems and opportunities being created. There is an increased focus in monitoring what's out there, both on the West Coast of the U.S. as there's a lot of fintech center around there. There is definitely heightened activity level. As you have seen, the valuations in the technology space and the startup space is very volatile and have been moving around a lot. Hiring tech. We are super interested in hiring tech people that are now being laid off. There is now, as far as I know, 63,000 people that have been laid off this year within startup and technology companies around the globe.
This is definitely an area where we have often talked about the very tough competition for talent and there where the new economy, the startup, the fintechs of course have attracted a lot of good talent. That is now of course coming to us. We have already hired in the strategy that we have some during the last months. Was there another? Was those two? Oh, Germany. Sorry. Germany, we are doing everything we can on call it the academic level. So we're stress testing the bank given the extreme uncertainty around how particularly the gas supply will develop.
We've also used the Deutsche Bundesbank's scenario, so they've done a lot of work on how this could affect the German economy if the worst comes, and we put that through and do all the preparations. I feel fairly comfortable right now that we can handle those issues given the strong capitalization, the strong liquidity, and the very strong asset base that we have in Germany in particular, where you have a very focused Large Corporates focus business for SEB.
That's helpful. Thank you.
The next question is from Rickard Strand with Nordea. Please go ahead.
Hi. Good morning. A follow-up question on your Swedish mortgage growth. So you mentioned in Q1 that you had some issues with your customer service center. Just want to hear if those issues are resolved now. Also a follow on to that one, if we see the market growth slowing down substantially in the coming quarters. You also mentioned that SEB naturally has some headwind there if we have a scenario where transactions slow down. In such a scenario, do you still feel that you would prioritize coming back to growing in line with the market? Or would you rather than prioritize margins instead in such a scenario?
Yeah. Thanks, Rickard. When it comes to customer service, no, it's not fully solved. It's never fully solved because we wanna improve all the time. I think it has improved since Q1, and we see further improvements going forward. If you look at the data, it seems like the main reason we're not taking our fair share is the price. Obviously we try to sort of pull the service level lever as much as we can because that's a better way of serving your customer than just reducing price. That's continued sort of improvements all the time. In terms of the transaction level and whether that sort of could lead us not taking our fair share, I mean, you're right.
I mean, if there are structural reasons why we in the short term cannot take our fair share, we'll take that into account. The main thing for us is that we don't want to lose good customers of the bank, and we'll do whatever we can both in terms of service level and price to make sure that they don't leave us. That's the main point.
Thanks. A second question on costs. I know you haven't given any guidance on cost levels, absolute levels for the coming years, but you've hinted of a cost income of around 45%. Just sort of how should we think about if interest rates give a positive contribution or rate hikes give a positive contribution to NII? Should we still consider 45% to be a level you'll be around? Would you reconsider that given the sort of uncertainty of the long-term implications and how sustainable the rates are and also the uncertainty about sort of loan loss impact, et cetera? Just curious to hear your reasoning around that.
Yeah. Firstly on the point 45, that's nothing that sort of dictates how much we invest a certain year. That's more of a long-term implicit level we think we need to be at.
To reach the 15% return on equity. That's just how we use it. It's an implicit target, it's not an explicit target. Secondly, you should just be aware that this year we've moved the resolution fund fee out of the NII number, and it's below the cost income line. Everything else equal, we should actually have a lower cost income level than 0.45 to reach the 15%. We'll revisit this by year-end to make the necessary adjustments to that. I mean, by the end of this year, we'll look at the investments we think we need to do for next year. Based on that, we'll make a decision on the cost target for next year.
Those investments will be based on what we need to do in 2023 to reach the 2030 targets we put forward in our strategy. We calibrate that based on the development so far, the appetite we have, and obviously the profitability of the bank here and now. If rates go up and that leads to a better income line than we have expected, then obviously that sort of creates room to do more investments in the short-term, but we don't wanna make the decisions based on that. We wanna make decisions on what makes sense for the bank to do. Yeah, that's how we look at it. I mean, there is one big uncertainty when it comes to next year that we haven't faced in many years, and that's salary inflation.
We've been very used to about 2.5, 3% salary inflation for a long period of time. Now this is a big uncertainty for next year, given the high inflation numbers. We'll have to wait and see where that lands when it comes to the centralized negotiations. Obviously, that will also impact how much extra investments we can do in addition to the salary inflation that we might get next year. That's a sort of added uncertainty this year.
Thank you very much.
The next question is from Jens Hallén with Carnegie. Please go ahead.
Thank you. Yeah, two risk questions. First on the model overlay reallocations, can you say something about the sectors where you apply them to? Put my second question straight away is on commercial real estate. Thanks for the useful stress that you put into presentation. I just wonder, when you do the stresses, do you also then do a stress when the wholesale market is closed for these companies? You know, if it's closed, they have lots of short-term funding. Could that then potentially be a liquidity stress for the commercial real estate companies, breaking covenants and then in the end, your exposures? How much do you look at the whole debt structure for these companies when you do these stresses? Those are my two questions.
Okay, thanks, Jens. On the model overlay, I wouldn't look at sectors. It's more counterparty by counterparty. But obviously, to the extent that a company has a lot of expenditures related to energy, for example, that's gonna have a negative impact on their cash flows. It's more based on individual names in different sectors rather than sort of certain sectors being impacted. On the CRE, I mean, what we do take into account, as you saw there on that slide, we assume rates to go up by 400 basis points. But then a lot of these companies have hedges on, which means that their funding cost doesn't go up to the same degree as the short-term rates go up. So we take that into account.
In terms of sort of a liquidity crunch, these companies not being able to refinance themselves, it doesn't really affect in the short-term because they don't have to refinance themselves, a lot of them in the short-term. Also there's a potential possibility for them to get bank financing instead. The general answer is that, no. I mean, in this type of a stress test, you look at their funding costs going up and assume that they can fund themselves. It's absolutely impossible to fund yourself at any spread levels, then that's a different scenario.
Yeah. I'd like to add two things, Jens. First on the model overlay. Every counterparty is taken in the normal expected credit losses. Overlays are over and beyond. You do it bottom up when uncertainty is particularly high, because it's almost like an expert judgment. Yes, you can say that this is the probability of default from a company who's heavily dependent on energy prices. You know that your point estimate in this particular instance is more uncertain than normal. You use an expert judgment, some wisdom, and some sound thinking that we need to put a little bit aside because the world is moving. That's why it is very much so. Of course, exposure to Russia is one of the factors going in.
Then what you're alluding to on the real estate side is the liquidity analysis rather than the credit quality analysis. That's not necessarily in there. There is some part of credit and liquidity analysis that marries, and that's the availability of funds, et cetera. Right now, I think your point is a very important one. Right now, this is not a credit quality issue. It's a very high uncertainty around liquidity. Can I refinance a debt at a reasonable price tomorrow, rather than necessarily the quality of the asset might not have changed from yesterday, but the market's appetite to refinance me might have changed. Those are very separate analytical tools.
The PD doesn't change because the probability of you not meeting your obligations is kinda the same from the company operational side, but it's significantly reduced because you don't have liquidity to pay your bills.
Okay. Makes sense. Thank you very much.
The next question is from Martin Leitgeb with Goldman Sachs. Please go ahead.
Good morning. Thank you. Thank you for taking my question. I really only have two follow-ups on commercial real estate. Thank you very much for all the color given in the call already. The first one is just, I was wondering if there's any portion of your commercial real estate book you're particularly focused on. I mean, historically, when we have seen large moves in commercial real estate, it's some form of speculative development and stuff like that, which creates credit issues going forward. Is there anything you could comment in there in terms of your overall book, and the disclosure on slide 20 is very helpful on, you know, what portions of your overall book you're particularly focused on. Secondly, I was just wondering.
You made a comment earlier with regard to lease indexation, and I was just wondering, is that very common in Sweden, or basically most of the commercial leases in your loan book index? Could this be essentially a meaningful offset to obviously higher swap rates? Thank you.
Yeah. Thank you. If you can, in this day and age, you probably understand that the subsegments of the real estate exposure which you are particularly focusing on comes from three areas. First, the category that has a pass-through contractual strength or not. If you have inflation, do you have a real estate exposure where you have pre-agreed with the tenant how to increase it or not? If you don't, you are more exposed, of course, to see how negotiations will go in the future, and that goes both for increased costs and increased inflation in general terms. The other one, subsegment is the. Not everyone has the same cash flow. It's the relatively weaker cash flow metric. We show on our slide, we have today averaging 4.6 an interest cover ratio.
That means that operating profit available to service your interest rate is 4.6 times higher. That subsegment, which is in the weaker end, that's where you particularly need to focus right now to stay close. That all is natural then to say the third is leverage. It will be very intertwined. Right now it's more the ones who have relied heavily on high indebtedness. They are of course more exposed than the ones who are looking lower on both cash flow metrics and LTV metrics. We have shared with you there the averages of our portfolio at 46% for the commercial residential side and at 27% for the co-op side on the residential side.
I don't dare to answer the percentage or proportion of what is indexed or not, but I hear from many clients that there is a lot of the retail lease contracts that are indexed in some shape or form. I don't know, Mats, if you wanna give some more color on that mix.
Yeah. I mean, I'll just a couple of general comments. In commercial listed companies in general will index their rents to inflation levels, and that'll typically happens in October every year. In the very short term, given that on the funding side, they have a lot of hedges, and they don't need to do a lot of funding. In next twelve months, you'll see a lot of real estate companies actually improving their cash flows because their income will go up more than their interest expenses. That's pretty interesting, and obviously it would be good if they keep some of these cash flows for potential funding costs going up later on.
If I would talk about concerns in general, I would say that we are clearly less concerned about the large real estate companies that we have exposure to because they are scrutinized quite a lot. It will be more concerns about really small real estate companies with maybe SEK 50 million of loans that they've invested in the last few years, where you have sort of difficulties fully getting grips of the entire book because we're talking about many more exposures where you don't have this sort of process of going through several committees in the bank when the credit's approved. In general, I would be more concerned about the smaller ones rather than the large ones.
This was very helpful. Thank you very much.
The next question is from Maria Semikhatova with Citibank. Please go ahead.
Yes. Hello. Thank you for the presentation. Couple of questions. First, clarifying on net interest income. If I look in your fact book, funding cost on customer deposits increased from 3 basis points to 22 basis points over the quarter. I just wanted to clarify what parts of your deposit portfolio have been repriced up in second quarter. Following up on NII, if it's possible to isolate the impact from rate moves quarter over quarter. Then your interest rate sensitivity implies roughly SEK 250 million from a 25 basis point hike on deposit margins. We saw that the increase in NII was over SEK 400 million from deposit volumes and margins.
I know there are different things going on there, but is it fair to assume that so far the repricing is trending above your expectation or your guidance on interest rate impact? Then, separately on cost of risk outlook, you reiterated the outlook for the full year that you expect cost of risk to be below to be at low levels this year. We are now at seven basis points in the first half. Is there anything you could add, let's say, on the outlook for the second half compared to the first half?
Yeah. Try to go through those questions. On the deposit margin going up from 3-22 basis points, most of our deposit is from corporates, where you have market pricing basically. With rates going up, you're gonna pay more for those deposits. You should just be aware that this is a mixture of all the deposits we have. It doesn't mean that we've changed the deposit rates by that much on the retail side because of being very heavy on the corporate side. This sort of average deposit price goes up as much as you can see. It's mainly corporates, basically. On the interest rate sensitivity, again, there are a lot of moving parts. We have a sensitivity to the repo rate, but we also have a sensitivity to STIBOR going up.
Given that the three-month STIBOR expects further repo rate hikes, it means that STIBOR has gone up more, and there is some sensitivity to that. To the extent that we have had higher sensitivity in Q2 relative to the 25 basis points, it also includes the fact that the STIBOR is up more than 25 basis points. Then that's the SEK 400 million you mentioned. That's the really sort of the deposit margin development in the divisions related to how much treasury charges or pays the divisions on lending and deposits. There are sort of lags between how much they charge and how much they pay on the lending side and deposit side. Those lags will play out over time. In a short period of time, we're talking about 60 business days, there are lags there.
You can sort of fully trust that that is in line with whatever we've guided for on the interest rate sensitivity. We guide for a sort of more normalized level that happens over a period of quarters rather than one single quarter. Cost of risk second half of the year. I mean, the only thing we can say, we believe it's gonna stay low. We don't see anything here and now deteriorating in terms of asset quality. We think we are well reserved, both in terms of the total allowances we have related to the stage three loans. You can see that that's 55%, if I don't recall that incorrectly. We have these overlays of SEK 2 billion that we have for a potential rainy day. We think it's gonna stay low this year.
Going into next year, it depends on obviously what happens to macro. We've seen a long period now with negative revisions on the outlook on GDP growth in many countries. Obviously if that continues, that's gonna sort of deteriorate the outlook, but it could also rebound and look differently. We have to wait and see what happens. What we have visibility on is the remaining of this year, and we think it's gonna stay at low levels.
Thank you very much. Just on the FX move impact on NII, if it's possible to isolate how much it contributed to the increase?
Was that the mortgage impact?
Impact from exchange rate moves.
Exchange rate moves Q on Q is very limited. It's about SEK 50 million in total on income and pretty much unchanged on the cost side. Year to date versus last year, it's SEK 500 million positive on income. It's more than 50% of that comes on fees, so less than 50% on net interest income, and it's about SEK 200 million on costs.
Okay, thank you very much.
The next question is from Riccardo Rovere with Mediobanca. Please go ahead, sir.
Thanks. Thanks for taking my questions. I have a couple for Johan and maybe a couple for Masih too. Starting with Johan. In 2020, at the time of COVID crisis, we saw corporate loan demand going through the roof in the first part of the year. I remember well that slide of the new commitments. Then we saw a decline or let's say a stabilization or a stagnation in the following quarters. My question here, do you see corporations in those days behaving more or less in the same way of the first part 2020? Or do you think this time is different? This is my first question. The second question I have comes to your green strategy, ambition and so on.
When you presented your strategy months ago, there was something that was considered to be dark brown and now is seen as a bouquet of red roses. Does it change anything? Does it open up brand new opportunities for you? Or we should take that kind of strategy as it was and changes nothing. This is the second question. I have a couple for Masih. The first one is on overlays. Is it possible to have an idea whether in the SEK 2 billion that you have set aside for energy related, war related, Russian invasion, whatever, is there any part of that that maybe includes as, at least as a scenario, probability weighted of a complete cut off of gas from Russia to the Nord Stream in Germany and then that will probably go through the whole continent?
Is that something that you have taken into account when you have set aside those SEK 2 billion, which by coincidence are more or less the same number of COVID overlays? The other question I wanted just a clarification more than anything else. When it comes to the part of NII related to fixed income, bridge financing, the SEK 200-300 million that you've been mentioning before and capital of SEK 100 million that you mentioned in Q1, just for me to understand, this is not a one-off or at least not a one-off.
By nature, maybe the number is a one-off. This number will continue to be there. It could be higher, lower, it could go up and down quarter by quarter, but it could actually be zero. But it's not a lump sum that disappears. It is just something that is very difficult to, let's say, also for you to have an understanding how this could go on. Is that fair assessment of what you said? Thank you.
Thank you, Riccardo. Excellent questions. We could sit here now for some while. Your observations from 2020, I'll just remind everyone we did SEK 139 billion extra credit exposure granting in eight weeks because there was some sense of panic. This is, again, large corporate. We can compare that to now, where you have actually seen that the outright level we do today is on par or higher than we were then. We have been able to kind of maintain that. We call this whole concept of temporary or short term. It's very much a concept of what time perspective do you have. Do you want it to be replicated next quarter? Yes, we are very keen in telling you guys this cannot necessarily be replicated in the next day.
If you think three, five, ten years like I do, these are super stable businesses. We will have bridge financings. We will have these levels that we've now incurred in the long run replicated. I have no clue if it's gonna be lower or weaker next quarter. This time it's very different. This is how I would reason, Riccardo. Pandemics are by nature a transitory feature. They come and then they go away. It's a health crisis that you need to deal with that has economic consequences. It doesn't necessarily change the economic fundamentals of the world. It might change your perception on how to travel, where to travel, and how you view you know the risk of diseases and pandemics and epidemics, et cetera.
There's been very little panic in the financial markets from a corporate banking perspective this time around. A war in Ukraine, it's a more slow-moving animal, and it has definitely more permanent potential consequences for the planet, for the world, for the geopolitical situation, as you see with energy for the globe, and therefore monetary and fiscal policy. It affects politics, it affects everything, but it's a more slow-moving, and it's certainly not a passing phenomena. A war might be a passing phenomena, but the consequences could be permanent for humanity. Therefore, we do see some very small tendencies to a similar pattern, but not this panic all at the same time. As I pointed to in my presentation, the difference between loan lending this quarter compared to credit exposure is unusually high.
That, therefore, must mean that people are using commitments that have previously been undrawn to cover for the consequences of this economic reality we face today. Hence, working capital goes up. I spoke a little bit about this as a positive potential in Q1. Now it came. It's certainly part of why lending is growing in this quarter, because people are using previous commitments maybe to cater for higher input prices. The classical thing, it now costs 10, 20, 30% more to get the material and the services you need to produce your good before you can sell it. There's a time lag. Working capital goes up and you need to draw your lines, you need to contact your banks. This is of course much more uncertain where this permanently leads.
I think that we continue to see that this is a potential driver in the future that slowly but surely, particularly given your German situation, where, you know, rationing of electricity might be a reality later this year in Germany. Of course, there will be a lot of working capital needs. Enormous, I would say. All these companies need to pay their salaries and their bills, but they might not be able to operate as freely as they have because they need to shut down for periods of time or even evenings, or what do I know. On the green presentation or the dark brown that you now call roses, it is very interesting. We have decided for now not to change anything.
On the brown, the green and the future, the three indices that we track, we are all more or less on track, as we said when we presented them last fall. The big question is, of course, how to treat natural gas in brown. Just as a reminder, we treat 100% of the gas as a fossil exposure. We make no difference between oil and gas. If it is a fossil-based energy material, we include it. Of course, now everyone wants to say that you shouldn't treat them similarly. But to be prudent for now, we do treat them both as brown, and then we'll see if this needs to. I mean, we are hoping for a taxonomy. We are hoping for a definition of green exposure in banking and brown exposure to be agreed by everybody.
We will change these metrics so they become comparable or at least add a metric so it becomes comparable. From our viewpoint and our part of the world, we still think that gas is not as good as non-fossil based energy generation. Masih Yazdi?
Yeah. On the two billion overlays, no, that does not include a stop of gas to Germany. That will be a clearly more adverse impact on macro. The two billion is based on the current macro outlook, but obviously that would be good to have if things get worse. On NII, you're absolutely right. These are not one-offs. These are short-term in nature. Because people in general see NII as very stable, we just wanna mention that there are parts here that are short-term in nature, could easily be replaced by other things that are short-term in nature. But we don't know at this point, and especially the fixed income part. That's why I say SEK 200-300 million. That one could easily stay on the books. We don't know.
It is, typically short-term in nature.
Thanks. Thanks a lot, Masih Yazdi. Just a quick, very quick follow-up, still on overlays. Is it fair to assume that now those SEK 2 billion will be part of the furniture for quite a while?
Can you repeat that, please?
SEK 2 billion. It's fair to assume that they will be there for a while.
Yeah, exactly. That you will not be allowed to release or to use it, you know, given what's happening. It was supposed to go away. They went away, but they've been replaced, and now the SEK 2 billion will stay again, at least this year, for sure. Maybe 2023 too, I would imagine. Is that fair to say?
I think it's fair to say that the triggers for the SEK 2 billion being removed are a bit more or less tangible than the triggers for the COVID-19 to be removed. That's the way I would say. I think, generally speaking, in principle, these are temporary, because you can't have sort of evergreens in terms of overlays, especially when in the discussions with the auditors, it's important to have clear triggers for when these type of expert judgments are on the books and then remove them from the books. Yeah, you're right. It's difficult, more difficult to find triggers for this than the COVID-19 overlay.
Okay. Thanks. Thank you.
The next question is from Nick Davey with BNP Paribas. Please go ahead.
Morning, everyone. Yeah, Nick Davey from BNP Paribas Exane. Three questions, please. The first, briefly a follow-up on the point about the German gas switch off. You say it's not covered in your SEK 2 billion. Could you give us any insight from your stress tests with the Bundesbank as to how bad that could be? Second question, listening to you talk on capital, you're saying there are possible enormous working capital needs from companies. You're talking about PD migration. Do you think we should all de-emphasize buybacks in our thinking for the next few years? Third question on repricing. We focused a lot on mortgages and your famous slide 11. I guess if you did it for corporates, that spread would be quite negative. So would you be more optimistic from here about repricing on mortgages or corporates? Thank you.
Okay. I'll start. Thank you for the question. The Deutsche Bundesbank. I mean, what Masih said is absolutely correct. We need to do every quarter an assessment with everything we know, and we do that bottom up. If we find that the bottom up is scarily, we're worried that it's not adequate because other factors can be taken into such as increased uncertainty, we can have an expert judgment and say that all these companies are particularly difficult, so we add something. They're temporary in nature. When it comes to stress testing, that's the whole plan of SEB's capital, which is included in the way that we do adverse and severe adverse, the Lehman case, and this is part of the ongoing work in the bank. In that sense, it is 100% catered for.
We would have done this update and said, "We have adequate capital now to stomach it." If it does happen, we know that it's then 100% probability that the economy will be affected. Today, it's not 100% probability. Therefore, that will of course change next quarter when we know more. Nick, the working capital need is of course a potential outcome that if you do get some shortages on keeping your sales up because you have to shut down from time to time, you need to carry more inventory, et cetera. What was your question on PD migration? If we
It's more a point generally about capital trend. It's really the broad observation. You're telling us that as the situation deteriorates, your PDs might go up, your risk-rated assets might go up. The volume picture is quite strong.
Oh, I understand.
Really, my question. Yeah.
Yeah. I don't worry about that, but Mats here will now tell you why.
Yeah, I mean, in general, I would say that any dividend or buyback for any company is really a sign of weakness, to be absolutely honest. It's better to be able to employ all the capital you generate in the business you do. We have a higher return than our cost of capital, and therefore. The optimal situation would be that we don't pay a dividend and do no buybacks because we can reemploy all the capital and continue to grow our business. If there is a higher working capital need, and risk is going up, which typically means that margins are going up, then it will be better for us to just employ that capital and service our customers. It will be better for them, and it will be better for shareholders as well.
Sure, I mean, if that happens, then that's good. It's gonna create more value than do the share buybacks.
Okay. Mortgage versus corporate repricing?
I can start on that. We spent a lot of time on this call talking about the retail side of Sweden, and I just wanna say that if you do look at the NII, which has improved significantly in this quarter, please look at the slide Masih Yazdi had. It's all in LC&FI. What we haven't talked about is the 50% of the bank that is outside Sweden and the largest division in the bank and the dynamic between M&A and ECM on the books, under the trading, et cetera. I think that there's a clear positive opportunity for the first time in a very long time to reprice corporate lending. Just a fraction of what has happened in the corporate bond market would be a very positive endeavor.
We also as banks have experienced a higher cost of funding in the public debt market. Even if we can't do what the bond market do on the loans, we definitely need to cater for increasing the price just because of the fact that it's also been more costly to source the funds. I think those margins are going to be much more down to what is corporate banking in Europe having to do in order to cater for higher cost of funding for the European Bank, as well as seeing that the probability of default as it is priced in the public bond market is clearly indicating higher credit spreads. On mortgages, I would almost say it's the opposite.
Mortgages is one of the safest asset classes you can have, albeit we are at a peak-ish level right now on valuation of property, and one can ask, is the vintage 2020, 2021, 2022 the peak vintage of mortgages. This is a very domestic, highly competitive situation where all banks, to different extents, will enjoy or not enjoy a return to positive interest rate environment. That has very much to do with how much deposit you have and what dynamic it has on it. This is a minor question in my mind. The big one is where I'll signify, but that's certainly the case for the Swedish domestic mortgage bond market and the Swedish deposit taking for retail.
There, I think it is much more like I have said in the past, much more prudent to assume there will be a new equilibrium in one or two years' time between margins on mortgages with margins on deposits, which is in between the interest rate sensitivity assumption, which is that you don't change any margins anywhere else but enjoy the benefit from deposits. We have also introduced a positive yield on the savings accounts in Sweden to 50 basis points for six months tenure and 25 basis points. There is something happening on both markets, the deposit market and the mortgage markets. I guess the answer, the short one to your question is it differs a lot, and it's positive for corporates and negative for mortgages.
Thank you. Sorry, just to pick up on the corporate point, because that's sort of what I was probing at your response. You've been at the forefront of repricing upwards on the mortgage side. Do you think you're there on the corporate side as well? Because what we can see in the data so far is it's been quite a muted response compared to what you've seen in the bond market. Is there anything holding you back other than time?
Yes. We have no pricing power on the corporate side because we are globally exposed to competition. I cannot have any meaningful impact by, you know, by ourselves in any market when it comes to the large corporate multi-currency RCFs. They are priced by 10 banks together, and it's a much more sticky type of thing, where the lowest price. The bank who's willing to go the lowest, the cheapest often is the price dictator, and then you get an option to participate or not. On the domestic side, in mortgages, it's much more down to the competition here to dictate what it is. We cannot, we don't have a price list for corporates like we have for mortgages, so there's no such resemblance. This is more a macro trend.
There is a little bit of bilateral pricing power in the corporate space. That's typically also the domestic SME and mid-corp, where you can do similar things, but not when it comes to the large exposures we have. It's a global phenomenon.
Okay. The ten other banks who are all exposed to the same funding conditions that you are and all watching the same bond market conditions that you are, you say the other nine are still dragging their feet and being a bit irrational.
Correct. We, you know, I've been doing this for 25 years. The difference between a five-year unsecured exposure on a corporate credit, the 25-year graph between the bond market and the loan market. Loans are always cheaper, more or less. Not always, but absolutely 95% of the times. Now the difference is the largest one I've seen in a very, very long time. That means that we are dragging up. Banks are much more slowly moving. It also is true on the opposite, by the way. When spreads tighten in the bond market, banks don't lower the price immediately either. We work with these RCFs. They're typically five years long, and that's kind of our cycle in the corporate bond, the corporate banking market, while the bond market is today. It's a one day long.
They reassess the credit spread every day.
Thanks. That's really interesting.
Gentlemen, there are no more questions registered at this time. Mr. Torgeby, back to you for any closing remarks.
No, thank you very much for this. I think it's a particularly topical time. I wish everyone a good summer. I do need to say one thing that no one asked about, and that was the fees and commissions on LC&FI. I just wanna point out that the volume growth in assets under custody was a major thing for us compared to one year ago, why this has performed relatively stable. We've gone from SEK 13 trillion-SEK 19 trillion in assets under custody, and I think it's an area we rarely talk about, but I just wanna make that point as we have really changed in the last few years, five years, from also being a custody bank. That's an important focus area in the strategy going forward in combination with AUM and AUC.
Thank you everyone for today. I wish you all a good summer and hope to see you this fall. Bye-bye.
Ladies and gentlemen, thank you for joining. The conference is now over. You may disconnect your telephones. Thank you.