Ladies and gentlemen, welcome to Handelsbanken Q1 2017 external conference call. Today I'm pleased to present Rolf Marquardt. For the first part of this call, all participants will be in a listen only mode. Afterwards there will be a question and answer session. Rolf, please go ahead.
Good morning, everyone. Welcome to this conference call for the first quarter 2017. Joining me today, I have Mikael Hallåker, Head of Investor Relations, Lars Höglund, Head of Debt Investor Relations, and Annika Engler, Head of Group Accounting. The slides used for my presentation are as always available at handelsbanken.com. Let's start with slide number two. The business activity in the bank was strong in the first quarter. Lending grew in all our home markets in local currencies. The bank has continued to generate capital. The annual average growth rate in equity per share including dividends was again a steady 15% when adding the first quarter. The Common Equity Tier 1 capital at the end of the quarter was estimated to be 50 basis points above the target range.
As we said already after Q4, we see a good potential for growth for the bank, not least in the home markets outside Sweden. If the capital level remains above the target range, the board intends to distribute the excess to shareholders either through using share buybacks, extra dividend, or a combination of the two. On slide number five, you can see the P&L for the first quarter compared with the first quarter 2016. Operating profit increased by 8%. Net Interest Income grew by 4%. Business volumes continued to increase in the quarter. This more than compensated for the doubled fee to the resolution fund. Net Fee and Commission Income increased by 8%, driven primarily by fund management and payment fees. There is an increase in all home markets, which is a result of a high activity in our branch network. Staff costs fell by 20%.
However, there are some elements that need to be adjusted for. In Q1 2016 the bank did set up a reserve of SEK 700 million as you know. This quarter in Norway, the pension plan has been changed into a defined contribution plan, which means a one-off positive impact of SEK 239 million. Finally, as communicated earlier, the bank has resumed allocation to Oktogonen. During Q1, this amount was SEK 243 million. Adjusting for these items, the staff costs decreased by 2%. Other expenses increased by 11%, mainly driven by higher IT development costs. We see a lot of opportunities on the back of the digitalization. Therefore we intend to increase the ambition further. We estimate that IT development costs will increase by approximately SEK 200 million this year. Loan losses were virtually unchanged at four basis points.
As you know from this year, interest expense from subordinated debt are no longer tax deductible. As a consequence, we assess the full year impact of this to be SEK 280 million in increased tax expense. On page 21 you can see the quarterly development of net interest income. From this year, lending and deposit margins are defined as the difference between the customer rate and the internal rate charged from or given to branches. The main reason behind the SEK 218 million drop in net interest income in the quarter is the doubling of the resolution fund fee applicable from this year for Swedish banks. State fees in total increased by SEK 207 million. There has been some decline on lending margins, primarily in the household segment in some home markets again in Q1, but nothing dramatic. The exception is Norway, where margins have improved during the quarter.
Negative currency effects and fewer days in the quarter all in all reduced NII by another SEK 100 million. The benchmark effect, which over time is zero and which gave a positive contribution in Q4, was SEK 45 million lower this quarter. Looking at the business, there has been good activity in the quarter where higher lending volumes added SEK 75 million in our home markets. Lending margins dropped somewhat, which reduced NII by SEK 29 million. Mortgage margins in Sweden was 106 basis points rounded, which means a decline by slightly less than one basis point quarter-on-quarter. Back to slide number six, where we show the net interest income for the group since 2009.
Here on the green bar, you can see the impact of state fees on net interest income and that the underlying trend in NII is increasing. We have adjusted NII for currency effects here and highlighted state fees over time. As you can see, during the first quarter, considering these adjustments, the underlying NII was the highest ever. On slide number seven, you can see net interest income for the last five quarters. We have adjusted the numbers for currency effects and again highlighted state fees. As you can see, in fixed currencies, the underlying net interest income has increased by 7% or close to SEK 500 million compared to the first quarter last year. In the same period, state fees have increased almost SEK 200 million on a quarterly basis. The underlying improvement in net interest income is a reflection of the bank's organic growth strategy.
The activity in our branches is high, and we have seen new customers and higher business volumes also in the corporate segment in Sweden during the first quarter. Slide number eight shows the lending growth in local currency since 2012 in our various home markets. Sweden has shown a very stable growth, even though it has been slightly higher lately. In the U.K., growth has also been very stable but naturally much higher. During these years, our branch opening pace has varied quite a lot. During the last year, we only opened a small number of branches in the new home markets. The growth in business volumes have been unaffected, though. The branches in the U.K. have continued to grow their business and customer base in a stable way.
In Finland, growth has slowed during the last couple of years, but we must keep in mind that the economy in Finland has been very weak. Despite this, we have been able to grow the business. Norway made a jump in 2016. Our branches always have a list of prospect customers that they want to do business with, and towards the end of 2015 several of these opportunities did materialize. Finally, Netherlands where growth has been very strong, and this continues. As we have said already after the fourth quarter, we see good growth potential for the bank, not least in the home markets outside of Sweden. Slide number nine shows the development in our Swedish mutual fund business. You have seen this slide before, and it's very encouraging to see that the positive development continues.
During the first quarter, the bank's mutual funds business in Sweden had a net inflow of SEK 6 billion, which represents 23% of the total net inflows in the Swedish market. Our share of the total stock is still only around 11%. The trend has been positive for a number of years, and since 2010, the accumulated net inflows in our Swedish mutual funds has been SEK 137 billion, which compares very well with the other large banks. During Q1, asset management in our home markets also had a good growth, adding SEK 2.3 billion of net inflows. Several of our home markets had all-time high volumes under management. Now to slide number 11, please. In Q1 2016, as you know, we took a provision for primarily early retirements in Sweden. Since then, the number of employees in Sweden is down by 449 people.
At the same time, we have continued to grow outside of Sweden with some more branches and more employees in existing branches. Interestingly, for the first time now we have more employees in our home markets outside Sweden than in Handelsbanken in Sweden. The bank also continues as before to invest in IT development, which explains staff increase in other units. All in all, the number of staff is now 236 fewer than at the end of 2015. The adjustment work initiated in 2016 continues according to plan, and the target remains. All else equal, costs should be lowered by SEK 600 million-SEK 700 million from 2018. On slide number 12, we summarize the main focus areas for IT spending. We have a high ambition to be local and digital. These are four main areas where we focus our efforts.
Within the savings business, we are in the final stage of installing a new securities platform where investments have been made for a number of years. This, in combination with a massive improvement in the support for advisory services, will provide an even better offering in the savings area. Digital meeting places are gradually adjusted to new modern frameworks that can be used in our various home markets. This enables the customer to get the same experience regardless of meeting place. We can also use video for customer meetings to a larger extent than before. Technologies within robotics and artificial intelligence will enable more efficient processes within the bank. Finally, of course, PSD2 will enable the bank to provide a whole range of new digital opportunities for our customers. On slide number 13, you can see our development in the U.K. during the quarter, which continues to be strong.
Operating profit in local currency improved by 7% compared to Q1 2016. There was a good business development and growth was achieved entirely in the existing branch network. No new branches were opened in this quarter. In local currency, net interest income increased by 6%, while fees and commissions increased by 30%. Assets under management in Heartwood grew by £200 million in the quarter and were £3.1 billion at the end of Q1, the highest level ever. At the same time, household deposits increased by 60% compared to one year ago. All of this illustrates that our branches have been successful in gaining a larger share of the customer's total business. One important reason, of course, is the fact that the bank has the most satisfied customers of U.K. banks, and the gap to peers is meaningful.
The loan loss level fell to two basis points for the quarter. On the back of Brexit, there is a scenario where we may need to turn the U.K. branch into subsidiary. We still don't know if that will be the case, but of course, we are making all the necessary preparations to be able to do that. Slide number 14 shows Netherlands, where the development has also been very good. Operating profit increased by 73% in local currency compared to Q1 2016. During the first quarter, we opened branch number 26. Business volumes grew strongly. Lending was up 38% and deposits 84%. On the corporate side, most of the growth is within the SME segment. Also in Netherlands, the bank has the most satisfied customers and among corporate customers, in particular, the gap to peers is substantial.
Optimix that we acquired last year has EUR 2 billion under management and contributes highly to the increase in fee and commission income. Cost-income ratio fell by 4.2 percentage points, and return on equity was 12% in the quarter. The loan loss ratio was two basis points. As you can imagine, we have high expectations on our Dutch business also going forward. Slide number 15 shows the capital and liquidity position. During the first quarter, the Swedish FSA approved our new PD models for corporate lending. Using these new models the bank had a Common Equity Tier 1 ratio of 23.8% at the end of Q1. This represents an increase of 1.1 percentage points compared to Q1 2016, in spite of the high risk weights for corporate lending that the new models generate. Total capital ratio was 29.7%, up from 28.8% a year ago.
The bank assesses that the Common Equity Tier 1 requirement from the Swedish FSA was 20.3% at the end of Q1, taking the new models into account. The target of being one to three percentage points above the requirement for Common Equity Tier 1 remains. The actual Common Equity Tier 1 ratio was therefore 50 basis points above the target range as set by the board. As we have said, we see good growth potential for the bank, and this can be expected to consume some capital. At the same time, the bank is continuously generating capital as we have seen. If the capital position remains above the target range, the board intends to distribute the excess capital to shareholders. This can be done by activating the share buyback program and/or paying an extra dividend.
As you can also see on this slide, liquidity continues to be very strong for the bank. LCR was at 148% and the NSFR was well above the expected upcoming minimum level. To summarize on slide 16. The first quarter was another stable one where operating profit increased by 8% from one year ago. Equity per share including dividends again grew with an annualized rate of 15%. The business activity was high and the bank had lending growth in all home markets. Net interest income grew by 4% year-on-year in spite of higher Resolution Fees, thanks to increased business volumes. Fee and commission income also grew in all core markets, and the strong development in asset management continued. The cost-income ratio improved to 44.8%.
The digital development provides many opportunities for the bank, we have decided to ramp up the ambition to be local and digital even further. Meaning that IT development spending will increase by SEK 200 million in 2017. Loan losses were four basis points in the quarter. The Common Equity Tier 1 ratio was 23.8%, being 50 basis points above the target range. We see good growth opportunities in the bank. However, should the capital position remain above the target range, the board intends to distribute the excess capital to shareholders by share buybacks, extra dividend or a combination of those, take the capital back into the target range. With that, I conclude my presentation and open up for questions. Thank you.
Thank you. Ladies and gentlemen, if you do wish to ask an audio question, please press zero one on your telephone keypad. If you wish to withdraw your question, you may do so by pressing zero two to cancel. That is zero one to register for a question. There will be a brief pause while questions are being registered. Our first question comes from the line of Aude Saramos from Goldman Sachs. Please go ahead. Your line is now open.
Hi. Good morning. This is Aude Saramos from Goldman Sachs. I have two questions. The first one is on capital. When I look at the impact from the model changes this quarter, it's well below the estimated impact you provided during the last quarter. I was just wondering if you could elaborate on the differences and confirm if this is the final number approved, so there is nothing more this year that should change in the capital and capital requirement, or just minor changes. Related to that, when you state that you will use the flexibility of a special dividend of a buyback if the quarter one remains above the target, could you elaborate a little bit in term of timing and what target we are talking about? Thanks.
Hi. Thank you. First of all, regarding the corporate risk weights, we have not changed. What we have communicated before is not the change from what we see today. The estimation we have done is about the same. The total impact of the new PD models is a reduction of a core equity Tier 1 ratio of 1.8 in total. That should be within the estimation we have given already last quarter. Regarding the flexibility regarding buybacks, the reason why we have communicated clearly here is that, first of all, we want to be clear about the fact that the target that we have to be 1 to 3 percentage points above the SREP requirement is something that we stick to.
That remains, and we think that is well suited for first of all the growth we want to be able to have and that we see. Also to take care of some of the volatilities that we experience in the capital now and then, depending on external factors that we can't affect. I also want to be very clear on the fact that we want to grow. Now we find ourselves being above the target range. As we have communicated before, first of all, we want to be compliant, of course, but secondly, we want to be able to grow to the extent that we undertake all the opportunities we have in the market when we get on board new clients. What is then left is something we will distribute back to shareholders.
That is something we can do through using the share buyback program or paying extra dividends. We will use those tools to calibrate ourselves back into the target range. We see still very good growth opportunities, and during Q1 we have also seen a slight pickup in lending to corporate clients. That is something that normally is slightly more capital consuming than lending to, for instance, property management companies. Now we are above the target range. That is to some extent also explained by the change in the asset values in pension assets. That is a major explanation to the change compared to Q4. Now we will follow the development and then in the long run, we will calibrate ourselves back into the target range. That is the message.
We don't communicate any specific point in time when that is going to happen.
Okay. Thank you. Related to the growth opportunity that you're saying, specifically you mentioned on the corporate client side. Could you give me a bit more detail in terms of geographies? If you see some in Sweden, in which sector you would see them, and talk a bit about the competition as well.
Yes. Regarding growth, we are growing in all home markets, but we have seen lately a change related to Sweden. We have some positive signs here in the corporate market. Regarding competition and margin development. On the corporate side, margins have been quite stable during Q1, so no major changes. We see, of course, fierce competition, but no major changes. That goes for most of our home markets. The margin pressure we have seen is mainly on the private side, and particularly so in the U.K.
Okay. Thank you very much.
Our next question comes from the line of Matti Ahokas from Danske Bank. Please go ahead. Your line is now open.
Yes. Good morning. Two questions from my side as well, please. Also on the excess capital distribution, you write in the report that if the current situation remains, is this dependent on the outcome of further regulatory issues, or is it purely the current state in terms of the buffer to the 300 basis points? On slide number 21, you have the SEK 47 million negative margin impact in Sweden. Could you break that down into corporate and mortgages, please? Thanks.
I will take the first question. I will pass the second one on to Mikael Hallåker. Regarding regulatory issues and the potential impact of that on the estimation regarding the capital situation. That is not the main reason why we communicate the way we do. What will happen regarding changed regulations is still very unclear to us, and it will remain so for the rest of the year, we expect, or at least a couple of months, especially in the Basel process. We also feel that we have a really good starting point when we have to adjust to that, depending on the outcome. That is not the main reason, that is not the basis for the conclusions we have made. That is rather based on the market opportunities we do have and growth opportunities we do see.
Regarding the margin question, I will pass it on to Mikael.
Mikael, hi Matti. Looking at the Swedish lending margins, on the mortgage side, we report a drop from 107 to 106 basis points. Really, to be honest, decimals half a point when you look at the decimals. A small part of that is on the mortgage side. The rest is on the corporate side. Let me add, we also have changed in this quarter to start measuring lending margins at the rate paid by customers less our internal prices that we charge the branches. It turns out that there was a positive excess in NII in the treasury department that would indicate maybe that our internal prices have been a little bit too high, and that there's been some excess treasury that's really a margin. The internal prices have really been a little bit higher than what we've actually paid the market.
I would say that maybe we have exaggerated too much, but most of it would be corporate.
Great. If I just may have a quick follow-up on, I also see that you've increased the allocated capital to the business units quite a lot. Is this related to the PD models approvals, or is it something else, and what's the reason behind it?
The allocation, first of all, we do allocate all the capital we have to the different business units. We have started to change the allocation based on the PD models, but that has been done in the first step, and particularly to the U.K. It will be finalized in next quarter.
All right. Thanks a lot.
Our next question comes from the line of Anton Kryachok from UBS. Please go ahead. Your line is now open.
Good morning, thank you so much for the presentation. Just two questions please. One on NII and one on capital. Just on net interest income, continuing on the theme of mortgage margins. I understand that you don't set prices centrally, but when you talk to your branch managers in Sweden, how do they view margin development in Q1, when we had basically for the first time in many years STIBOR rising on average quarter-over-quarter rather than falling? Are they looking to pass that funding cost increase fully on to the consumers, or are they looking at it in aggregation with the improved deposit spreads that they're seeing? That's my first question, please. The second question please, on capital. It seems that you are emphasizing the buyback rather than the special dividend that you've relied on in recent years.
Can you please remind us what is currently within your mandate for a buyback in the AGM, if there is one? Also, do buybacks need to be approved at the end of the year, or can those be launched earlier if required? Thank you so much.
Thank you, Anton. Regarding net interest income, how the branch managers view the fact that market rates have moved somewhat in the short term. I like to say that, first of all, that is not reflected. The external movements in short-term rates are not necessarily passed on in the internal rates applied. The internal rates we do apply, and that is what the branch managers do face, is something that is dependent on the mix we have and the funding mix we need to have to fund mortgages, and that is much more long-term debt behind that. That number and the internal rates haven't been affected. Also as a consequence, branch managers haven't been affected by that. What we see when we look at the trend on mortgage margins, it has been fairly stable.
It's down one basis point during the quarter, but in reality, it's more half a basis point, so it's really a small change. Regarding capital and share buybacks and us preferring that is not the case. The intention is just that we want to be. What we tell is that if we have excess capital and we continue to see the situation we have today, if that will remain, we will calibrate ourselves down into the range. When we do that, we have two tools that we could use, and that is share buybacks and it's dividends. We don't have a particular preference, I want to underscore. That was not the intention to send that signal.
The circumstances regarding share buyback program is that, first of all, if we would want to use that, we have to apply with the Swedish FSA to do so, to get a permission. If we would do that, and when we have filed a full application, the Swedish FSA will have 60 days to give an answer. When they have approved it from that particular day, we would need to deduct the whole amount from capital at day one, no matter if we would have bought anything back or so. We haven't filed any application, and we have no immediate intentions to do so. We just want to underscore that this is one of the tools. We have no preference that we want to communicate.
Regarding the size of the potential share buyback program approved by the annual meeting was 120 million shares at the maximum.
Thank you. This is very clear and very helpful. If I may just circle back to your answer to the first question on the margin. I remember that a couple of quarters ago, you used to show a slide which indicated lost net interest income from lower interest rates in Swedish operations on deposits and equity. I guess my question on the mortgage margin is linked to that. Do you think that in a rising interest rate environment, you will be able to get back that lost income that we have seen on that chart? Do you think that your branch managers, when you pass on the funding cost, they will think in aggregate about the mortgage margin and deposit margin? Thank you.
Hi, Anton Kryachok. It's Mike here. I think obvious on the deposit side, it will all depend on, we are currently paying basically zero on deposits, and I guess most banks are. When rates start to go up, I'm sure all banks would like to stay at zero as long as possible. It's really going to be the competition that determines how much market rates will able to go up before you start seeing somebody start raising the deposit rates.
There's no doubt that as long as deposit rates are not hiked at the same pace as market rates go up, there's no doubt that we're going to start regaining some of those lost deposit margins.
Got it. Thank you so much. Very helpful.
Our next question comes from the line of Geoff Dawes from Soc Gen. Please go ahead. Your line is now open.
Hi. Good morning, everyone. Geoff Dawes here from Soc Gen. A couple of questions from myself. One quick one on Danish credit quality. You had obviously a very big loan loss impairment last quarter, and then practically a zero value this quarter. What was the cause of that? Was that some reversals from the losses you took last quarter, or is it just the ebb and flow of loan losses as they come through the P&L? Can you just give us a bit more color on that? Because it's obviously quite a big swing from well above expectations to well below. The second question is on the U.K. You said there's a scenario where you'll need to subsidiarize in the U.K. Does it have any implications on your funding model there?
Obviously, you run a very big surplus of loans over deposits, would you need to issue locally or would you still just take the balance from the group under a subsidiary model? Finally, on the branch opening program, you did state it slowed down a little bit. I know we've spoken about this in the past. Is there any specific reason for that? Do you expect it to pick up as the year goes on now that you've got capital to commit to that? Those would be the three questions. Thank you.
Hi, Jeff. Thank you. About the Danish credit loss, that was one major exposure that we had had on the books for a long time, and that had been a long-time problem loan. Now we have dealt with that through the loss we took in Q4. Apart from that, the credit quality in Denmark is really stable. What you see now is more normal figures that we could expect from Denmark. It's a low credit problem level. We have stable credit quality in Denmark, I would say. On the U.K. and Brexit and what that might mean to us. It is too early days to tell what the impact will be because we don't know for certain. We have discussions ongoing, both with Swedish and U.K. regulators about the potential impact and how we are going to face that.
Today, we run the operations through a branch, that is something we find very efficient. We'd like to continue to do it that way. If that will be possible in the future or not, it's still unclear to us, we have those discussions ongoing. If we will have to, we are of course making the preparations necessary to be able to set up a subsidiary and to file an application to do that if need be. We simply don't know at this stage. I think also the legal circumstances around that and so on are still unknown, we are making preparations. What the potential impact will be on funding and funding requirements, that is as a consequence also too early to tell.
Finally, on the branch opening program, and the fact that we haven't opened as many branches in the U.K. last year compared to what we did a few years back. We have come to a point where we feel that we have a really good presence in the different local markets, and we have a quite good footprint in the U.K. We do cover a very large part of the market geographically. The focus has, for the time being, shifted more towards, as you say, digging where we stand, and added on new employees and new business to the existing branches. That does not exclude us from opening up new branches in the future, but we haven't felt a need to do that so far. We have the footprint we need to continue to grow.
If you look at the development when it comes to loan growth and deposits growth and also fee and commission income growth and so on, we are still growing quite steadily in the same pace from quarter to quarter, more or less. That is a sign of us not being dependent on the exact number of branches we do have. Although we have a strong branch focus, it shouldn't overemphasize the number of branches as a good proxy for the potential development we have going forward. That also goes for Netherlands, where we have added now one new branch office. The new branch openings haven't been that many, although that is the case, we continue to grow in that market as well.
Great. Just to quickly follow up on the second question. Within the scenarios you're looking at, is there the possibility that you might need to fund entirely in the U.K.?
That is too early to tell actually, because that depends on the outcome and there are different potential outcomes, and since we don't know, it's too early to assess. If you look at the formal requirements, the most demanding form is if you have a ring-fenced activity. We are looking at our total balance sheet and so on. We are quite far away from being in that corner so far at least. That is where you would find the most requiring amounts regarding local funding. Once again, I think it's actually too early to actually know exactly at this point.
Okay. Thank you for your answers. Thank you.
Our next question comes from the line of Brajesh Kumar from Societe Generale. Please go ahead. Your line is now open.
Hi, good morning all. Brajesh from Soc Gen Credit Research . Just one question for me please on 2017 funding plan. Have you guys given any thought around issuing a non-preferred senior? What about sub-debt issuance? Can we expect some this year, or are you guys happy with the current AT1 and Tier 2 levels? Thank you.
First of all, on the plans for issuance of MREL instruments. No, we don't have any immediate plans to do that during 2017. We still are in a wait-and-see mode when it comes to getting greater clarity in the legal circumstances in Sweden in particular. We'd like that to change or at least to know what will come in that end before we start issuing. We also think that we have a really good position since we have a lot of maturing senior unsecured debt that we could start replacing when we know the rules of the game. We think we still have time to wait a bit until we move. Regarding sub-debt issuance, we have no immediate plans to make any decisions.
Okay, thank you.
Our next question comes from the line of Riccardo Rovere from Mediobanca. Please go ahead. Your line is now open.
Yes, good morning to everybody. Just two, three clarifications from my side. On the excess capital, and correct me if I'm wrong, my understanding is that you want to go first for growth opportunities. If there is anything left, you will go for a capital distribution. You have no preference between extra dividend or buyback. What is not clear to me in this equation is where you put the regulatory issues, something like IFRS 9, and in the special case, if you are in the position now to say whether you have a guidance where the impact could be and Basel IV. My understanding is that you are sick of waiting for clarity on this topic. Am I getting it right in, let's say, condensing all the message they've been giving so far? Still, this is my first question.
The second question is, when you talk about excess capital, you say you have a managerial range between 100 and 300 basis points, but the range is pretty wide. My understanding is that we should be using 300 rather than 100, but I want to be 100% sure that I get it correctly. Last thing I wanted to ask you is a follow-up exactly on the first question, whether the corporate risk weights on PD models or something like that, the impact is over because the corporate risk weight on IRB advances still 27%. Just want to be 100% sure of that. Lastly, four basis point risk cost. If rates remain where they are, do you think this is a sustainable level? Thanks.
Okay. First question. Yeah, if you did get us right when it comes to the communication on capitalization. Yes, you have understood it completely the way we want to communicate it. Are we sick and tired of waiting for the outcome of Basel IV and so on? Well, no, we are waiting, and we will see where it will end. It's really hard when it comes to Basel IV and potential output floors to know what that exactly will mean. What I refer to then is still the uncertainty, not around maybe the calculation as such, but which buffers that would still count when you use that measure and which ones that will not count. That is really important to understand the impact. That is something that will be quite far away in the future or several years from now.
We will have time to adjust to that. That has not impacted our way of thinking around today's capitalization, I must say. We feel that we have a really strong position. We are very well capitalized. We have a good capital generation capacity, and we have also the possibility to manage that situation if that was to become a binding requirement. Regarding IFRS 9, we haven't communicated the impact in our case. We are working on that, of course, and building development models and adjusting models and so on. We will come back later with guidance on that, what it will mean to us. What I can say about that is that considering our credit quality and how stable that tends to be over time, that is something that also impacts the outcome of IFRS 9.
You shouldn't expect any major disruptions in our case. We have a good starting point considering our credit quality. Regarding the target range of us being then 1 to 3 percentage points above the SREP requirement and that being a wide range. Yeah. Well, compared to some other banks, it's wider. The thinking behind this is that we want to have this buffer because we have a growth strategy, and credit growth is capital consuming. We want to be able to catch the opportunities we get when we get them, and without any restrictions. That's why we want to have a buffer. Yes, that's correct. If I am to prioritize capital, the first thing is, of course, to make sure that we are compliant. Secondly, we want to grow the business.
If we then have excess capital and more capital than we need, considering our growth, considering capital requirements, and considering also potential volatility in the capital requirements related to issues that we can't control, then we will distribute that back to shareholders and calibrate ourselves back into the target range. Should we think about this as a 3% target or a 1% target or somewhere in between? Well, we have this buffer for us to be able to deal with some volatility and also growth opportunities we have. We should be in that range. That also means that we should be in that range. If we see growth opportunities, it's of course good not to be too close to the limits, but the range is the buffer we want to have. Then corporate risk weights, is the game over for now?
Yeah, I would say so. You never know, and it's really hard to know exactly what will happen in the regulatory arena and how regulators will actually act in the future. I can't forecast that. From things we know today, and the work of, and requirements that were raised a year ago by the Swedish FSA, that has been dealt with now through the approval of the PD models we just introduced. Finally, the question regarding the loan loss level of four basis points. Is that a sustainable level? I would say yes, it is. If you look at the credit losses and the loan loss levels we have had over the last years, the underlying credit quality has been very strong all the way through. We have an underlying low loan loss level.
We have had on top of that a few major cases that actually explains a very big part of the total loan losses we have seen. I would say so.
Very clear. Thanks. Thanks a lot.
As a reminder, if you do have a question for the speakers, please press 01 on your telephone keypad. Our next question comes from Jacob Kruse from Autonomous. Please go ahead. Your line is now open.
Hi. Thank you. Just two questions. Firstly, on the mortgages, could you comment at all on the back and front book dynamics in Sweden, where your front book stands relative to your back book? Also on the whole issue of fixed rate versus floating rate mortgages, how the margin look there, and what outlook you see there. My second question was just on your digital plus local strategy. Does that basically mean that you keep your entire branch network more or less unchanged, and then you also have a competitive digital platform relative to the other banks? If so, do you see that as creating a problem in staying competitive on cost, or can you merge these two strategies together without having to pay up twice? Thank you.
Okay. Regarding mortgages and the front book and back book, if we look at that, we are actually seeing very similar margins both on the front book and the back book. Regarding the question of fixed rates and variable rates, I'll pass that on to Mikael Hallåker.
Yeah, we are closer to 60% variable or three-month rates now are 40% on the fixed side. This is also something that tends to change very rapidly when rates start to move. Currently it's slightly more on the variable than on the fixed.
Is there a margin difference between the products?
Okay. On the topic of the branch network and keeping that. The branch is the bank. The branch as the way of being close to the customer will continue to be the case. That's the ambition, and we haven't changed that. We want to be local and be close to the client. That's really the core of our business model, to be local and build strong relationships. That will remain the case. If you look at the number of branch offices and meeting places we have in Sweden, that has been reduced by 10 branch offices during the quarter. That is something, it has not been a target from our side, to be honest. The fact is that we realized that when we concluded the Q1 report. It has not been important to us.
What is important to us is that we are cost efficient and run a good business. That is something we can do also keeping the branches. The branches as such are not the big cost base in the bank. The cost base in the bank is mainly headcount and IT system. We'll stick to that. We want to be local and digital in good combination. The message we want to send around this is that us being focused on running the operations through branch offices doesn't mean that we neglect IT and digitalization. On the contrary, that is something that will add on and does already today add to our offer to clients. That is something we feel that we have to develop, and we want to improve what we have today.
We have a good offer, but we need to, of course, adjust that and improve it and take the different business opportunities that the digitalization also gives to us.
Okay. I guess my question is just, are you not then running both a distributed distribution network? I appreciate that the rent of the branch is not a big cost, but clearly you also have people in the branches and they have systems, et cetera. Are you also then running a centralized distribution in the digital form? Wouldn't that put you at a cost disadvantage to somebody who decides to go much more firmly down one of those two strategies?
No, we don't think so. If we look at the development so far, what we can conclude is that we are an efficient bank. The cost-income ratio we run at is low compared to many other banks. We also see opportunities in improving that. So far that has not been the case. If you want to serve clients well, no matter if you do that from a central point or you do that being present locally, you need people to do that, and you need IT systems to do that. That's the reason behind it. We want to have the people local because we have the experience that that is good for business and building relationships and also getting business and make a good return out of that, because if you're close to the client, you can do more business and get a service.
That is our starting point, and that is also our experience that we are able to do that in an efficient way and a cost-efficient way.
Okay. Thank you.
I'd like to add one thing, and that is, the business model we have is flexible. We do all the time adjust the way we work, the way we approach clients and so on to move with the tides.
Okay. Thank you very much.
Thank you.
Our next question comes from the line of Jan Walter from Credit Suisse. Please go ahead. Your line is now open.
Yes. Hi, Jan Walter here, Credit Suisse. A couple of questions on my side. I joined late, so apologies if they have been asked already. First on the liability margin and STIBOR three-month is up around five basis points in the quarter. When we look at the breakdown in the presentation around the NII, why don't we get a positive impact from higher liability margins just in principle? If you could elaborate on that. That's my first question. The second one is on, I think you mentioned the cost savings of SEK 600 million-SEK 700 million kicking in in 2018 from the program. Can you say anything how much of that could flow to the bottom line?
I am aware that salary inflation as well as IT investments will eat up some of the savings, still, any color there whether or not that could hit the bottom line or to what extent? Those are the two first questions, please.
Okay. I pass the first question over to Mikael.
Hi, Jan. Well, looking at it, we state in the report that we are actually changing a little bit the way that we calculate the margins in this quarter, moving away from STIBOR as the benchmark rate, and we calculate margin as the customer rate less the rate our internal prices that we charge or credit the charge for loans and credit for deposits over to the branches. That hasn't changed. That has an impact on this because obviously we are living in a positive rate environment with zero on deposits and we're still charging on the asset side where STIBOR is so far outside that range. That's why we made the change.
It's true in the sense that, of course, as long as we keep zero on deposit rates and the part of the loan book that is funded by deposits obviously have an increase in margin when STIBOR goes up. It's partly that we change from this quarter the way we calculate margins.
Okay, thank you. Just follow up there quickly on that answer, Mikael. Did the bank materially change deposit rates in the quarter? For example, if we look at the retail deposits in Sweden?
The answer is no.
If we exclude corporates.
We didn't materially change any rates, no.
Okay, thank you.
Regarding the cost savings program, well, that is running according to plan. What we have communicated before is that we will all else equal reduce the cost by SEK 600 million-SEK 700 million per year on an annual basis from 2018. Although we don't communicate how far we have come in that, we are still estimating that that will be the case. It's running according to plan. I think you can see that although we don't disclose the exact figures, you can also get a notion of how far we have come through looking at the staff numbers we do communicate. We are 449 people less in the Swedish branch operations and Swedish regional banks. We also have made some reductions in some other countries, the older home markets outside Sweden, not big ones, but some.
Also in head office. On the other hand, we have recruited new people and added on people in the IT development side to be able to increase the development pace. That is feeding through the numbers today. On the other hand, of course, we are then growing outside Sweden and particularly in the U.K. and Netherlands, and we also invest in IT. That would, of course, move in the other direction. I don't know if that is clear enough.
No, that's very helpful, thanks. Just a final question on data here. Have all the applications been approved now with Swedish Financial Supervisory Authority regarding the model adjustments for higher corporate risk weights? Is any application still pending?
No. We got the approval at the end of Q1, and that covers all the corporate risk weight models.
Okay. We shouldn't see any type of RWA inflation coming from that side, really, even though you have in the SREP ratio you communicate in the report the effects from the higher corporate risk weight order is included in that one that you state in the report 20.3%, I think.
Yeah. That is the complete history around the corporate risk weights. We never know what will happen in the future when it comes to regulatory discussions. From everything we know now, that has been dealt with when it comes to the PD models.
Sure. Okay. No, many thanks for that.
Okay. Yeah.
Our final question comes from the line of Yafei Tian from Citi. Please go ahead. Your line is now open.
Thank you. I just have a quick question on the Resolution Fee contribution starting from 2018 onwards. Given the increase in the contribution rate, how much higher contribution fee year-on-year do you expect to see in 2018 numbers? If you have to move U.K. to a different structure, I assume you don't have to make the contribution for the assets that are in the U.K. How much savings can you get from moving U.K. to a subsidiary? A quick follow-up question, a specific number question on the operating cost in Sweden banking. This quarter it's relatively higher, and in your comments you mentioned around SEK 100 million higher in cost from internal purchase services. Is this something that would be considered as ongoing, or is it just specific to this quarter? Thank you.
Okay. Regarding the Swedish Resolution Fund fee for 2018. Now you need to keep in mind that the increase is just a proposal. It's early stage. That might happen. If it happens and it will be increased then to 12.5 basis points. That would mean on an annual basis that the total cost would be SEK 2.5 billion per year. It's estimated to be SEK 1.8 billion, it's a SEK 700 million increase if that happens. That hasn't been finalized, so we don't know if that will be the case, but we certainly see the risk for that. If we have to put up a subsidiary in the U.K., we don't know that is the case, but potentially it would be. Yes, we don't have to pay the Resolution Fund fee for the U.K. book to the Swedish Resolution Fund.
That would of course reduce the amount. I don't know if we have communicated that. It's clearly we have said that increasing cost obviously for a subsidiary will partly be funded by lower Resolution Fund fee. That will help some because, of course, running a subsidiary will be more costly than running a branch. The number is in the range of SEK 200 million that we would save. On the other hand, we would have some costs, of course, in transforming the branch into subsidiary. Finally operating cost increase in Sweden, is that ongoing? That is related to development products we are running both for business development purposes, but also to a very large extent to compliance-related products. Okay?
Okay. Thank you.
Thank you. Thank you very much.