Good morning, ladies and gentlemen, and welcome to the Quarter Three Report for Svenska Handelsbanken. With us today, we have the CEO, Pär Boman , who will present the report and give his comment to it as well. For those that are following this on the telephone, there will be a question and answer session directly after the presentation. For those that are following us on the internet, there is a possibility to ask some questions as well. By that, I leave over to the CEO, Mr. Pär Boman.
Hello everyone. Welcome everyone to this conference call for the third quarter. It's Pär Boman talking. I'm standing in today for our CFO, Mr. Ulf Riese, who usually hosts this presentation. Unfortunately, Ulf has been hit by a slipped disk and is unable to be here today. He sends his regards. As you know, back injuries are always tricky, but we expect him to be back shortly. With me today, I have Mikael Hallåker, Head of Investor Relations, and Jörgen Ålander, Group Head of Accounting. My presentation today will refer to the slides which are available at handelsbanken.com. I want to start my presentation with a graph on slide number two, which shows the group's value creation over the last five years. The darker part of the bars represents equity per share, and the gray part represents accumulated dividends over the period.
As you can see, we continue to report a very stable average growth of 15%, also after the third quarter 2011. Looking at Q3 alone, the bank actually reported an all-time high operating profit with adjustments for non-recurring items from earlier quarters. We truly believe that this stable performance is a result of the bank's low tolerance for risk and focus on credit quality combined with low costs and controlled for gains. Looking at our financial performance on slide four, you can see that the bank has developed favorably over the last year. The operating profit in Q3 was up 21% compared to the third quarter 2010, up 14% for the nine-month period, and 5% up on the second quarter. Higher net interest income and lower loan losses were the main drivers behind the performance. The return on equity rose by one percentage point compared to January-September 2010.
The return on equity in the third quarter amounted to 14.1%, up 1.4 percentage points from Q3 2010, and 0.1 point higher than the previous quarter. I would like to point out that this has been in a market with ever low growth and despite a quite significant increase in equity capital. The Tier 1 capital ratio in Basel II was unchanged from the second quarter at 17.4%, but increased by 1.7 percentage points year over year, mainly due to accumulated earnings and improved credit quality. Also, the cost efficiency has improved. The cost-to-income ratio dropped 2.3 points compared to Q3 last year, and it was 1.5 points lower than in the second quarter. For the nine-month period, the cost-to-income ratio fell by 0.8 percentage points. As we have stated earlier, we see continuing potential to improve the cost efficiency further in our Swedish branch office operations.
Moving to the P&L, as you can see on slide four, and the P&L account for the nine-month period 2011, on slide five, you can see that operating profit grew by 14% year over year, adjusted for changes in exchange rates of SEK 119 million increase of 50%. Net interest income was up 10% compared to the cost of lending period 2010. Adjusted for exchange rates effects of SEK 338 million and non-recurring items of those SEK 150 million, as I just said, with a cost of lending negative impact on net financial items, the net interest income was up 11%. This number includes an increase in different government and deposit guarantee fees of SEK 333 million. Adjusted also for this, underlying net interest income rose by 13%.
Net commissions were down 2%, mainly due to brokerage commissions being down 19%, which in turn is explained by lower client activity and lower turnover in the market. The negative impact was partly offset by fund management fees and payment fees being up 10% and 5%, respectively. Net gains and losses on financial items decreased by SEK 148 million, mainly due to lower activity levels among our customers. As we do not do any prop trading and as we gradually have reduced our risk limits over the last couple of years, customer activity is the main driver of the bank's net gains and losses on financial items. Costs were up 4%, mainly due to the annual increase in wages and 4% increase in the average number of staff.
If we turn to the quarterly P&L account on slide number six, the quarterly one, you will see that the operating profit was up 5% compared to the second quarter, mainly driven by higher net interest income and lower loan losses. Net interest income grew by SEK 353 million, or 7% QoQ, adjusted for the SEK 150 million in non-recurring interest income I mentioned earlier, for positive exchange rates effects of SEK 32 million, and for SEK 50 million in higher state and deposit guarantee fees, the increase was SEK 286 million, or 5%. Increased lending margins in Sweden due to the bank's favorable funding situation contributed SEK 141 million and higher lending and deposit volumes in Sweden added SEK 55 million. The increase in branch office operations outside Sweden was SEK 159 million, or 10%, adjusted for the exchange rate effects.
Net commission income was down 2% between the quarters. Higher lending and insurance commissions did not fully offset the impact from lowered equity markets related fees. Costs were down 1%, mainly due to the other administrative expenses being seasonally lower in the third quarter. Loan losses remained low and amounted to - SEK 157 million, translating into a loan loss ratio of 4 basis points. The credit quality remains sound. Now I would like to turn to the bank's financial positions on slide number seven. The Tier 1 capital ratio was unchanged at 17.4% in the quarter compared to 15.7% one year ago. The profit in the period and the positive churn in asset quality offset the negative effects of higher lending volumes. The total capital adequacy ratio decreased to 19% compared to 20.7% one year ago.
The decrease year over year is fully explained by the fact that the bank has called close to SEK 16 billion of subordinated loans according to plan. The liquidity reserve increased to more than SEK 700 billion. U.S. dollar deposits with the Federal Reserve increased by SEK 93 billion in the third quarter alone. International investors turned more cautious in the way of increased financial turbulence seen in markets and placed more deposits with 100%. The liquidity reserve catered for the bank's funding needs for well over two years, even in a theoretical scenario where 10% of the total group deposits leave. The liquidity reserve catered for the bank's funding needs for well over two years, even in a theoretical scenario where 10% of total group deposits leave the bank theoretically.
On slide eight, you can see the bond funding done by the bank in the first nine months of 2011. In total, we issued a total amount of SEK 167 billion in bond funding in the first nine months of the year, which already now is almost 50% more than the entire maturing volume for 2011. 35% of the issuance was done in the senior unsecured market and 65% from the covered bond assets. Through this issuance in Q3, the bank had kept pre-funding all maturing bonds one year ahead. In early October this year, the bank issued a 10-year senior unsecured bond in the euro market. This was the first benchmark size 10-year senior unsecured issue since February by any bank in the euro market.
The order book amounted to EUR 3 billion, but since we had no immediate use for the money, we chose to scale down the issue from EUR 1.25 billion. On slide nine, we show the quarterly development in the group's net profit after taxes since the beginning of 2008. We have managed to keep the quarterly return on equity about 12% throughout the financial crisis. The earnings trend has been relatively stable, even if we did see some disappointing weakness since 2009 when credit losses increased. However, since mid-2010, we had reported a gradual and stable improvement in both earnings and profitability. As I said earlier, Q3 2011 was the best quarter ever if we adjust for extraordinary incomes in some earlier quarters.
For Handelsbanken, the decentralized organization combined with our strong credit culture and strict credit policy, together with the constant efforts to reduce market risk, are keys to reduce the cost of risk and to create stability in our earnings growth and long-term shareholder value creation. This stability is also important in order to get a strong position in the funding market. A strong position secures competitive funding costs, which without doubt will be increasingly important for the profitability of the banks moving forward. Now I will turn to the risk-adjusted net interest income on slide 10. This is actually one of the most important metrics that we use in Handelsbanken and a key factor explaining the stability in earnings I just talked about. Internally, we always risk-adjust the net interest income by also deducting the cost of risk, namely loan losses.
Even if they appear in different places in the profit and loss accounts, there are two sides of the same system. Even if it's often quite easy to increase net interest income, it's a lot more difficult to do it without also increasing the credit losses. It's therefore important to always analyze these two items together when trying to assess a long-term earnings generation capacity in banks. In Handelsbanken, we have seen a very stable and positive trend in risk-adjusted net interest income during the last five years of financial turnover. Also in 2009, when the credit losses increased, also in Handelsbanken, we were able to keep the level flat as the increased loss level were offset by wider lending spread. This is quite different from what you have seen in most others.
In the last five years, the average annual growth in risk-adjusted net interest income has been over 10%. Most of you will recognize the graph on slide 11 showing the split of revenues in the bank. In the last couple of years, we have continuously worked with reducing the earnings volatility in the bank. The focus has been on reducing the market risk, which tends to be the main driver of volatility in the revenues of the bank. Apart from removing volatility, the aim is to improve the capital efficiency through allocating the bank's equities for long-term stable cash flows. As you can see from the graph, the main visible result of our efforts is an increase in total share of net interest income and commission income and a decline in share of trading.
From making up an average 85% of revenues in the period 2005- 2007, net interest income stands for 96% of revenues Q3 2011. The trading income share has declined from 12% in the early period 2005- 2007 to 3%- 4% of revenues today. We are certainly happy for the customer-driven, low-risk trading income, but will continue to avoid position taking. From a shareholder perspective, we believe that this strategy is the most beneficial in the long run. As you all know, a large part of the revenues in bank January reports as trading income will soon require significantly more capital in Basel III than work. On slide 12, we show the development in the bank cost-to-income ratio over the last six quarters.
Over the period, the ratio has dropped by 3.1 points from 48.1% to 45.8%, and the improvement is due to a combination of revenue growth and cost control. Being more cost-efficient than our peers is one of the most important means to reach our company. The goal of having higher return on equity than the average of the competitors in our home market. Over time, operating costs can, of course, not grow faster than revenues if this goal is to be reached. The branch office operations in Sweden is working with a higher market share in the major market. In such a situation, cost efficiency is crucial to reach a satisfactory profitability. Through improved IT and support systems, together with more customer-friendly work processes, we believe we over time can bring the cost-to-income ratio in Sweden down to 30% from the current level of 35%.
In the branch office operations outside Sweden, and particularly in the U.K., the situation is different. In the U.K., for example, the bank has not yet penetrated the market and our market share is low. Consequently, focus is currently more on growth than on administrative efficiency. However, we cannot see anything indicating that we should not be able to run the U.K. business as efficiently as we do in Sweden, subject to reaching sufficient sales in our operation. Now I'm turning to slide 13 and the performance in the Swedish branch office operation. For the period of January- September, the operating profit increased by 27% to SEK 9.9 billion compared to the corresponding period 2010, mainly due to high net interest income and lower credit losses.
Net interest income rose by 23%, mainly due to higher short-term interest rates resulting in declining deposit margins, but growing lending and deposit volumes also contributed positively. The fee to the Swedish Stabilisation Fund, which impacts net interest income, increased by 78% or SEK 280 million year on year, and the benchmark FX subsidy was SEK 71 million lower than in the first nine months of 2010. Adjusted for this, the underlying net interest income increased by 26%. The cost-to-income ratio declined to 35.1% compared to 39.3% in the corresponding period 2010. The bank continues to invest to improve efficiency in the branch offices, and there is a clear potential for further improvement. The credit quality remains strong, and the Swedish operation reported loan losses of SEK 18 million in the nine-month period. In Sweden, the bank continues to gain market shares in the savings market.
Since the beginning of the year, we have seen a net inflow to the bank's mutual funds of SEK 10.7 billion. The other mutual fund companies in the Swedish market showed a combined net outflow of SEK 13.9 billion. In the last five years, we have invested significantly to improve our position in the savings market, and for the last three years, we are now seeing that these investments are paying off. Now, let's turn to slide number 16 and the branch office operations outside Sweden in the first nine months of 2011. Year -over -year, the operating profit increased by 6% to SEK 2.3 billion. Adjusted for exchange rate changes, the increase was 10%. Adjusted for exchange rate effects and higher deposit guarantee fees, net interest income increased by 1%. In Great Britain, Finland, and Denmark, net interest income increased by 13%- 17%.
Worse pressure on lending margins caused net interest income in the Norwegian business to go down by 11%. Compared to the second quarter 2011, the operating profit in Q3 increased by 33% to SEK 956 million on the back of higher net interest income and lower loan losses. The combined operating profit in the four home markets outside Sweden reached a new all-time high in the quarter. Loan losses were lower both year on year and quarter on quarter, and the loan loss ratio amounted to 8 basis points in Q3 and 17 basis point s for the full period. Moving on to the U.K. business on slide number 17, you can see that we are now up to 111 branch offices, including appointed Branch Managers, and we are currently opening a new branch every 10th business day. One new branch every 10th business day.
The local currency net interest income, as well as profits before loan losses, grew by 27% in the first nine months of the year. The average lending volume grew by 23%, with lending to households being up 47% and corporate lending by 17%. Average deposit volume rose by 25%. Quarter -on -quarter, the operating profit increased by 10% in local currency. Turning to the following slide, number 18, you can see how the average pre-provision profit in the U.K. branch has developed as it grows older. Break-even is reached after approximately two years. After that, the cost-revenue gap tends to widen quite quickly, and the pay tends to pick up when the branch is some five years old. We cannot see any signs today indicating that the historical trend should not change going forward.
With more than 75% of the branches being younger than four years old, most of them are not yet providing any significant profit. However, we have a lot of branches that are now moving into profitability, and we believe that there is a significant future earnings generation capacity in the organization we have built to date. Our next milestone is to reach 150 branches. At that level, we will be fully competitive with the large clearing banks in the corporate system. Our large U.K. peers may have 1,500 up to 2,000 branches, but they only have at most 100-1 50 that are able to grant credits and fully service corporate customers. Needless to say, we remain very optimistic when it comes to the potential in our U.K. operations. To conclude, we believe the bank showed a solid performance in the nine months of 2011.
Earnings per share was up 14%. Return on equity increased to 13.8% for the nine-month period and 14.1% in the third quarter. Net interest income grew 7% in the second quarter and was up 10% for a year. Credit quality remains sound, and loan losses declined year over year, as well as sequentially from the second quarter. The Tier 1 capital ratio according to Basel II remained at 17.4%. The liquidity reserve increased to SEK 700 billion, and the bank has stayed pre-funded one year ahead. In Sweden, the operating profit was up 27% compared to the first nine months of 2010, and the four home markets outside Sweden showed a combined operating profit at record levels in the third quarter. That concludes my presentation, and I would now like to invite you all for questions. Thank you.
Ladies and gentlemen, if you have a question, please press zero one on your telephone keypad and you will enter a queue. We have a question from Mr. Nick Davey from UBS. Please go ahead, sir.
Yes, good morning everyone. Nick Davey from UBS. I've got three quick questions, if I may. The first is on risk rates in Sweden and specifically on the mortgage segment. One of your peers yesterday was willing to say that they felt now the base case was that risk rates on Swedish mortgages would move up probably to a floor level, perhaps at around the 10% level at the end of next year. Could you comment on this, please? Is this more or less in keeping with your own expectations? Do you have a view on this kind of a shift in risk rates, which I guess goes against everything that you stand for on pricing credit risk effectively if they bring in a blanket or a floor level of risk in mortgages? Could you talk a bit about that topic, please?
The second then, and I guess link is on mortgage margins in Sweden. Clearly, you've seen a second quarter in a row of expanding mortgage margins. Could you please talk us through this dynamic? How much do you think of the book has repriced up to new levels? To what extent do you think this could be a supportive dynamic into next year? Thirdly, and finally, a question on funding. I think you referenced there, Mr. Boman, in your presentation about issuing 10-year senior unsecured in the beginning of the fourth quarter and then not really having much that you could do with it. I suppose the question is, will you continue to run one year pre-funded? Should we expect continued very long dated issuance in what are clearly very tricky markets for most European banks? What kind of earnings impact should we factor in? Thank you.
Thank you. When we talk about risk weights and how we measure and changes that will come, we all know that most of the banks, including ourselves, have been calibrating the whole system into a Basel II world. As you know, if you have no credit losses, the risk weights will move down to zero some way ahead. In the old system, Basel I, the risk weight on houses was 50%. If you have mortgages secured by [bostadsrättsbevisning], a very typical Swedish collateral for.
At the tenant-owned associations we have in Sweden.
Yeah. The risk rate was 100% in Basel I. If you look to our Tier 1 capital ratio in a Tier 1 world, we have 7.5%. If we go back to the old system, I don't think we will do that. If you hypothetically think that you should go back to Basel I with a risk rate of 50% of houses and 100% for the others, the Tier 1 capital ratio would be 7.5%, and we will be more capitalized than we normally were in Basel I. From that perspective, all capital is in place. Even if you go the whole step back to Basel I, today we're working under transition rules where the risk rate on houses is 40% and the others are on 80%. You can see that we are compliant with that system today.
The impact, if we go to something else than we have in Basel II, and we will do that, and I think it will be something maybe between what we see in Basel III and the transition rules, something between that will be some kind of floor or rule or whatever it will be. The only impact that this will have is that we will have to allocate a part of the buffer, capital buffer we have generally in the banks will be allocated directly to that part of our assets. The capital is in place, so it's more or less a question about allocation. If we allocate more capital for dedicated product, that will indicate that the price level will increase. If we put more capital and if we take away capital, the price level will go down. The profitability of the whole group will not change.
I think a proof on that is the fact that we had Tier 1 capital ratio in Basel I, which is 7.5%, which is far above the range we worked with from the beginning of the 1990s up to 2004. I don't think it will have any large impact at all if we change risk rates from 6%- 10% or 15%. It will have some impact on how we set the price on that specific product. It will not change the profitability of the whole group. People, we are far above the old target in Basel I. When we talk about margins generally, what you can see in Q3 is that we have not continued in Q3 to increase the pre-funding of maturing bonds. We are 12 months ahead today, and it was also the case in the end of Q2.
When we had pre-funded ourselves and moved from 6- 12 months, it had put a pressure on net interest income gradually. Now we do not have any more pressure, but the cost is SEK 60 million in the third quarter. That will help to build margins. We have increased volumes in the U.K., and we operate in the U.K. with margins which are in this area, in those products on a higher level than we have in every topic group. That is the driver. The key question is if the market will start to look more at the old system, Basel II or something like that, or if it will believe that Basel III will be in place quite soon. If the market believes we will have Basel III quite soon, there will not be any dramatic changes, I think.
If the market believes that the new system will be close to Basel II, or we have to live with the transition rules for many years, I think the market will start to allocate some capital buffers, which already are in the system, but they will be more dedicated to mortgages and to the Swedish bostadsrätter.
Do not negotiate.
Yeah, that will lead to a higher price level. It's also important to have in mind that in the old system after 2004, we had differentiated prices on houses and those apartments. We had differentiated the prices because the requirement was separate from CPA. This is the key question. Depending on what you believe about the pain titles for introducing Basel III or living with the transition rules, you will come to different conclusions.
Thank you. That's a very clear answer.
Yeah. On the funding side, I think it's important continuously to keep on issuing senior unsecured bonds because we both need it in a long-term perspective, but we also need the price information from the market to know what is the funding cost of the bank if you are on the 10-year point in the curve. Now we get the information about that, and that's valuable when we set our own internal prices. There are a lot of reasons to do it. On the other hand, we have huge buffers and reserves. It's not necessary to do more than we need to keep the price information updated.
Okay. Thank you.
Next question comes to [Mr. Masi]. What's upgrade suite? Please go ahead, sir.
Yes, good morning. Three questions, if I may. The first one is on deposits. If I look at your balance sheet, there's an increase in deposits of SEK 75 billion quarter -on -quarter. However, if I add up the different business segments, the sum of the increase is much lower than this. Could you please explain the difference between the development in the balance sheet and the different business segments, please? The second question is on lending margins. As you say, this has increased your NII by SEK 141 million in the quarter. Could you split that into how much you've seen that increase in mortgages and corporates, please? Also, you might have answered this question at the beginning of the telephone conference, but the one-up of SEK 150 million, SEK 15 million in NII, can you please explain what you've included in this number, please? Thanks.
The deposit is more or less driven by corporates, and there are also some parts of financial institutions, but mostly corporate deposits. When you talk about margins, as you know, close to 50% of the whole book, all assets are in subsidy pay. The funding, the performance we have had on the funding side and the capability to reach, compared to the market generally, cheap funding, that will help to build the net interest income in that book. We also have had an influence in the bank book, if I say so. Thirdly, I will not change, it's not a change in accounting, but it's that kind of volatility we sometimes have between NII and the net interest income. Maybe you will have some information about this.
This is Mikael . As you know, there are a number of areas where you always have some moves between net interest income and the trading line. It could be when you trade your own debt. It could be when spreads widen in hedge positions and other things. We normally try to keep this very low. It was a little bit bigger in this quarter than it usually is, which is why we wanted to point it out. It inflates a little bit net interest income for the quarter with SEK 150 million, but it's nothing strange in the numbers, so to say.
The important thing for us was to communicate it, so you don't overestimate the development in net interest income.
Okay. Thank you very much. Thanks.
Next question comes to Mr. [Chris Ekstrom] from Bank of America. Please go ahead, sir.
Thank you. Two questions, if I may. First, just very quickly, have you given or can you provide any guidance on the impact of Basel 2.5 in terms of risk-weighted assets? Then secondly, just looking at the asset quality side, there's two sub-questions. Firstly, you mentioned in the text that the large reduction in NPLs is because of a few larger exposures no longer being classified as non-performing. At the same time, you have the biggest write-off this quarter, SEK 1.7 billion that I can recall at least. I'm guessing the reason they're no longer considered non-performing is because they're written off. I just want to make sure I've understood that correctly. If you can give any comments as to what that is regarding too.
Then just the second part of that question is, if we look at the provisions taken in this period of SEK 480 million, you know that's the highest level we've seen since early 2010. Should we be reading anything into this trend?
If I start with the risk weights in Basel II, I will say that nobody knows exactly what the next system will have in terms of risk weights. It cannot be on the left side of the line, if I say so, you have the Basel I. As you know, the risk weights in Basel I, they are 100%, 50%, 20%, and 0%. On the other part of the line, if I say so, you have the Basel II, with very low risk weights generally. The new system will, I think, be something between those two systems. As you can see, if we go back to the old system, Basel I, we have 7.5%. If it will be in Basel II, we have 17.4 % in that system to calculate. I think we will end up something between those two systems.
As I understand, Basel III will be closer to Basel II than to Basel I, if I say so. It will also be something between the transition rules and Basel III. I don't know where the floor will be. As you can see, we have capital to be compliant with all those systems. That will not change the profitability of the group, even if we will change the price to the market in different products.
I was more thinking about the CRD III changes. I mean, they're coming into effect in 65 days. I would assume that you have some estimate of the risk-weighted asset impact it'll have.
Okay. You want to spike the lead? You can give me a call after, we can quote it. We can talk about the details. I guess you're asking for the impact of Basel II and a half on risk.
Yeah, no, I'll give you a call later. That's fine.
I can do that. On the second question then, on the impaired loans, it's actually a combination. Yes, there are a small number of larger exposures that we don't consider to be impaired anymore. We also, like you said, had some well-provisioned old losses that have been in there that we really chose to write off in this quarter. They were well provided for in the loan losses there. I guess your last question was, there were new provisions in the quarter. Was that correct, Johan?
Yeah, I mean, it's SEK 480 million, which I guess, to find a similar number, we have to go back to the first half of 2010. We're heading into more uncertain times on the macro side. I mean, should we expect that trend to continue from, I guess, at a low at the end of Q4, SEK 130 million, and it's now back up to close to SEK 500 million?
I will say that I cannot see any trends. As you know, the credit losses all in all is on a very low level. At that level, you will always have volatility between quarters depending on single exposures.
I think you can also note that we write in the capital segment of the report that we had a positive credit risk migration in this quarter as well.
Excellent. Thank you very much.
Next question comes to Mr. Ronny Rehn from KBW. Please go ahead, sir.
Good morning. A few questions for me as well. On the funding markets, I just want to get your thoughts. What do you think is going to happen if the markets do not reopen within the next two or three months? Do you see subbanks in Europe kind of running out of eligible collateral for the central bank or other forms of liquidity? Thank you. In terms of costs, you have had some competitors that are kind of looking to cut costs next year. How does that make you think about your own cost base? Is it kind of creating a bit more ambition to do even better? Lastly, on the trading side, out of the different product areas, which one sort of was doing best and which one was doing worst this quarter? Thank you.
The first question, I think that the first, a short answer is that the first bank starting using ECB as a provider of funding and liquidity was in August 2007. Since that day, it has been banks all the time using ECB. At the summer, it was close to, I think, 400 banks using ECB. If the situations continue in the worst direction, that will increase. If it goes in the right direction, that number will decrease. We don't have any plans at all at any cost-cutting programs. I really, really hope that we will be more employed in the bank five years ahead, continuously what we are today. We have no plans at all to fire people. We will continue to open up the branches. We have no plans at all to close some branches. Probably.
No, I don't think so. I think, apart from we talked about that accounting volatility that impacted net interest income, it's mainly the pure client-driven FX trading and fixed income business that makes up the revenues.
I think trading is the same one. Lots of income makes it now less than 5%. It takes that time.
I just wanted to say FX and fixed income trading did actually go quite well in the quarter.
Yeah.
Thank you.
It was a normal season, but you know it's a small business. Like I said earlier, we don't do any prop trading. What we do is what you know the clients want us to do, and that was an ongoing business. I wouldn't say it was particularly good, but it was normal for the third quarter.
Okay. Thank you.
Next question comes to Mr. [Henry Christiansson] from Citi. Please go ahead, sir.
Good morning. Henry Christiansson from Citi. I have two questions. One on risk ratings. Your risk rating continued to improve. The average risk rating for corporates is now 34.2%. Just looking back six quarters, your average risk rating was at 42%, some 8 percentage points higher. In a scenario where we see global slowdown, much as what markets now forecast, should we expect a gradual drift upwards towards these recent historic levels rather than structural or model changes to the portfolio or how you manage risk rates that I've overlooked? Second question is on your international operations. Your U.K. operations continue to show solid growth rate and have a strong quarter. Could you give an update where you are with your other test markets?
I was thinking Germany and Netherlands in particular, and whether you're using your current relative strength to be opportunistic and accelerate for expansion, not only in the U.K. but also in other successful test markets where competition to some extent is a bit wrinkly? Thanks.
I cannot see all in all the change in the quality of the assets. Of course, if we will have a strong downturn, the risk rates will go up. If it goes another way, it will continue down. You also must have in mind that we work all the time with the portfolio and work out exposures where we can see that we have a higher risk than average, but we also take in new exposures and new customers and new clients with a significantly lower risk rate. The change you can see between the quarters doesn't signal anything else than it does, but it doesn't say anything about the future. I cannot see that it indicates a trend. If you go to what we're doing in different markets, yes, that's right. We are open. We have opening up test branches in both Netherlands and Germany.
If you go back a couple of years, we also did it in Poland. Poland is not interesting for us. We cannot find a risk which is generally acceptable for us. We have no ambitions at all in Poland to build up a branch network. If you go over to Germany, the situation is quite harder in Germany compared to the U.K . regarding the competitive landscape. There are also some drawbacks, which in this environment is very, very hard to find to go to profitability. I'm talking about mortgages because they typically have such a long maturity. They are up for 30 years, and nobody could hedge risks today which are 30 years long, not in a large volume. In small volumes, you can do it, but not in a large volume. We have Netherlands.
Netherlands seems in many ways quite similar to the U.K. if we're talking about the competitive landscape. The culture generally in Netherlands seems to be quite similar to what we had in Denmark and Norway. We continue to work in Netherlands, and we have now 10 branches. You can see it is at a step something between a test period and a decision where we will make Netherlands a new home market. We are not there yet. It's important to say that. The business we have in Netherlands is very, very, very small, and it has no impact at all on the growth level. My best guess is that in the future, someday, hopefully, we could define Netherlands as a new home market. There are lots of things that must be in place before we are ready to sit down and value it.
It seems the country which is most similar. We have no ambition in other countries at all at the moment. The U.K. is 100% focused on the U.K. As I said, we are looking into Netherlands but on a very, very small level.
Okay. Thank you.
Next question comes from Ms. Claire Kane from Royal Bank of Canada. Please go ahead, madam.
Hi there. I just have a couple of follow-up questions. On the Swedish mortgage market, can you just give us an idea of the pace of repricing of the loan book that you're doing on the market as a whole and for yourselves, and how much you think that will continue, and whether or not you have a kind of indication of where the mortgage spreads could reach, and if you think that your expansion might be faster than peers? Also, if you're seeing any signs of a slowdown in demand or if you think it's more of a supply issue that the growth rates are coming down in the system in general. A quick comment on your views on where your capital levels are. I know you say that given on Basel I, you'd have an acceptable level of capital.
I just guess, at what stage do you think the situation would be much clearer? Is there any kind of implication for your dividend payout? If you are much more on a Basel II basis, do you see a kind of return of the excess capital to shareholders in the future? Thanks.
I think if we start talking about the mortgage market in Sweden, the repricing of mortgages mostly are doing to a better price than we had in the stock. Yes, that's right. On the other hand, more and more of the stock is on longer and longer maturity. The repricing impact on the total stock is going down depending on the fact that less and less customers reprice. They have already decided to do loans with one, two, three, or five years maturity. We have no ambition at all to be a larger provider of loans generally in Sweden. We have generally a market share which is 25% in Sweden. I would say more or less of all products. We have 25% in mortgages. We have a little bit more generally on the corporate side. We have a little bit more than 20% across corporate side.
We are a significant player in the Swedish market. We have no ambition at all to have a 30% or 35% or something like that. We had a 33% in 2004 or 2005. At that moment, we took the decision to shrink a little bit to get a general risk level, which is more in line with what we want to see. The last question you had was about the capital level. I think that we and other banks had to take some kind of internal decision in the autumn, in the early winter, should we continue to work with the Basel II guidance generally, or should we add something else which is more like the transition rules or Basel I? We are in that evaluation process.
At the moment, we think we have to wait and see more detailed how the solution in the southern part of Europe will be managed. We all can read the capital directive number four from the 21st of July. If we think that that will be Basel III, that will give us a good guidance. You also have to know when will it be implemented. If you summarize all those things, I don't think there are reasons at the moment to plan for shifting out capital to shareholders. As you can see, if you look into the reports, we are over-capitalized if you compare to what we were in Basel I, and we are using it in Basel II. I don't think it's the right time to discuss to reduce the capital in the banks.
Yeah, it's Mikael . You also asked about the slowdown in mortgages, if I understood it correctly, and whether it was supply or demand. I would say on the household side, there's no doubt that the demand has come down gradually during 2011. It's a declining demand from households.
Okay. Great. Thank you.
Next question comes to Mr. Chintan Joshi from Nomura. Please go ahead, sir.
Hi. Good morning. I've got one question and two follow-ups. Firstly, could you tell me, you've discussed that you've got Swedish mortgage margins at 77 basis points currently. I just wanted to understand how you calculate this, what you use as the cost of funding. Different banks report this differently. I just want to nail down how you get to your 77 basis points. The other two follow-up questions. Firstly, on the follow-up, you said that kind of in the Basel II transitionary world, risk rates are 40%, and in the Basel III world, risk rates are about 5%. The answer lies somewhere in between, which I would think means 20% - 25% risk rates. I'm just wondering if that is what you are thinking or not.
The second follow-up question was, perhaps I didn't get this properly from a previous question, was the SEK 141 million margin increase, how much of that is driven by mortgages? I probably didn't get the other question as well, which was the front book versus back book, how much is repriced? You've got about 50% of your book in variable. I would think that's repriced within three to six months fairly quickly. Really, the repricing that is outstanding is on the other 50%, which is fixed. I just want your comments on that, please. Thank you.
Thank you. Other questions. If you look into the report, you can see that we had a profitability on shareholders' equity, which is 14.1%. That's the total package of margins, of volumes, on funding strategies, of customer service. It ends up to 14.1%. Of course, as a banker, you also appreciate if you could increase the net interest income, and you can do it in different ways. What we have done in this quarter is a lot on the funding side and get a lot of revenues on the funding side. When you have it as a package, and as you know, our starting point is always the customer. The customer uses a lot of products.
It doesn't make sense to focus just on margins on mortgages because what we have focused at the moment is to get customers to have mortgages in Handelsbanken also to move over their savings through the banks and what they have in mutual funds and in the equity savings and in other institutions. At the moment, that's much more important for a long-term increase in profitability rather than focusing on the margin on a specific product.
I'm fair enough, but I just wanted to understand your calculation.
Okay. That's Mikael . When we calculate the mortgage margin, we try to do what we call an assure calculation, which is the difference between what the clients pay to us and what we actually pay in the market. We do make some small adjustments. For example, the benchmark effects, as you know, can go up and down a little bit. There could be some other short-term volatile elements that we remove. Overall, it's not against any benchmark rate. It's against what clients pay us and how much we pay in the market.
How much you pay in the market would be kind of a blended cost with deposits, covered bonds, senior unsecured, all combined, or would it be more covered bonds and senior unsecured?
The deposit side is in the bank. It's not in the mortgage company. That would be the mortgage bonds and the funding of the mortgage business, which is wholesale funding.
Got it. Okay. Thank you. The follow-up questions, please.
All right, gentlemen. As you know, we don't have Ulf Riese with us here today, and I have to continue for other meetings. I can take one more question, and then the IR department is available for questions.
Sorry, could I just follow up on that question?
Could you ask me what I participate in? You're welcome.
Just on the risk weights, what do you thought about the risk weights? You said 5% in Basel III world, 40% in Basel II transition world. That kind of gets us into the 20%- 25% range. Is that how you are thinking currently?
We have no specific idea about it. When I walk to work every day at the moment, we are living with transition rules. In that world, corporates have 100% risk weights and mortgages 50%. We all know that we will live in another system, and we hope it will be quite soon. Please, next question.
Thanks. Thank you.
Next question comes to Mr. Jacob Kruse from Autonomous Research. Please go ahead, sir.
Hi, Jacob from Autonomous. Just two questions. Firstly, you had a very negative outlook, I guess, in Q2 with regards to the global macro and generally. I just wanted to see if you could give us your views currently. Secondly, when it comes to the U.K., the funding position there, do you get any pressure from U.K. regulators with respect to the very high loan-to-deposit ratio and the amount of wholesale funding, even if it's group funding that goes in there for that business, or any demands that you have to reinforce it or anything like that? Thank you.
No, we have no pressure at all. In all our dialogue with the FSA, they really, in many ways, welcome us to the U.K. and the way we do it. We have no pressure in that typical area at all. If it will be the case, we could easily move over cash resources we have in other central banks around the world and put it into the Bank of England if that would be the case from a liquidity side. We have no questions or pressure at all in that typical fiscal area. I think we always have to have in mind that in a global world, we are a quite small bank in a small part of the world working in a small currency, Swedish kronas, with all the reasons to be cautious and have research and buffers and so on.
We are prepared for the worst and hope for the best. That's the strategy at the moment. Thank you, gentlemen.
Thank you.
Thank you.