Welcome to this Telephone Conference and Webcast for Handelsbanken's First Quarter Results. I leave the word to Handelsbanken's CFO, Ulf Riese.
Welcome, everyone, to this Conference Call for the First Quarter 2011. With me today, I also have Mr. Jörgen Olander, Group Head of Accounting, and Mr. Mikael Hallåker, Head of Investor Relations. My comments will, as usual, refer to the slides available at handelsbanken.com. To first give the overall picture of the development of the bank, I would like to start with the graph on slide number two, where we show the value creation in the bank quarter- by -quarter for the last five years. The graph shows the equity per share generation in the bank, including the dividends that have been paid out. As can be seen, we have now added yet another stable quarter in the five-year sequence in a rather hostile environment.
From the second quarter, 2006, to Q1, 2011, the bank has generated an average annual growth in equity per share, including dividends, of 15%. From our perspective, the bank's low tolerance for risk, focus on credit quality, combined with our growth model, are the key factors behind the stable performance over the years. On slide number three, I would like to go through some general comments regarding the first quarter this year. The uncertainty about the Final Basel III rules is certainly one of the main topics in the bank sector today. When looking at the first quarter, Handelsbanken is building capital, and the Tier 1 ratio goes up regardless of which regulatory framework we use for the calculation. In Basel II terms, the Tier 1 ratio amounted to 17.2%.
Before having any firm view on the new rules and their implications, we think it is both important and prudent to wait until the regulator has clarified the final rules and until the funding market has had a chance to react to these rules. After this has happened, we will revisit the question of what the adequate capitalization going forward should be. The instability in the European financial markets is still very much present and could easily deteriorate as the continued sovereign debt crisis in Europe unfolds. As you know, we have no exposure to the countries in question, but the situation does have a large impact on the general conditions in the European financial markets.
In light of this, we brought the liquidity reserve up to over SEK 600 billion, mainly as a result of allowing more institutional deposits entering our balance sheet and then placing those funds in central banks. We continue to pre-fund maturing bonds, and we do it through issuing a balanced mix of senior unsecured funding and covered bonds, despite the fact that the five-year senior bond is some 50 basis points more expensive than a similar covered bond. The issues of senior unsecured debt are important, I think, for several reasons. Firstly, we expect it to become a gradually more important funding source as deposits, and especially corporate deposits, are becoming more volatile and less suitable for funding longer-term assets. Secondly, senior unsecured issuance is important not to overly subordinate unsecured investors relative to covered bond holders.
Thirdly, keeping unused capacity in the covered bond pool strengthens the bank's liquidity position. Up until now, we have already refinanced and pre-funded all upcoming bond maturities until April 2012. Other things worth noticing on the first quarter are that the Swedish branch office operations generated all-time high in operating results and that the growth in the U.K. has accelerated. The quarter was, however, affected by a number of special items, which I think is worth mentioning before going deeper into the profit and loss statement. This, you can see on slide number 4, where we have an analysis of the change in net interest income year-over-year and quarter-on-quarter. The reported net interest income increased 4% compared to the first quarter 2010.
Here, the tariff of the fee of the Swedish Stabilisation Fund has doubled from the start of 2011, and this was the main reason for state fees increasing by SEK 83 million. The benchmark effect in Stadshypotek decreased by SEK 107 million, and exchange rate effects reduced net interest income by SEK 158 million. In addition, the pre-funding of maturing bonds impacted net interest income by some SEK 120 million. Adjusted for these items, the underlying net interest income increased by 12%. If we then go to look quarter-on-quarter, net interest income was down 2%, but making the same adjustments as for the year-over-year analysis I mentioned and adding the fact that Q1 is two days shorter than Q4, the underlying net interest income increased by 3% in the quarter, mainly driven by higher deposit margins in the Swedish operation.
Going on to the summary of the first quarter on slide number 5, you can see that the operating profit grew by 4% year-over-year and was up 3% from the fourth quarter. Net interest income was down 2% from Q4, but adjusted for items affecting comparability, as I just mentioned, income increased by 3%. Loan loss ratio more than halved compared to Q1 2010 and amounted to 6 basis points in the quarter. Return on equity amounted to 13.2%, down 20 basis points from the fourth quarter, mainly due to the increase in equity generated by the profit in the quarter. Tier 1 ratio amounted to 17.2% compared to 16.5% in Q4. Here, the explanation is higher Tier 1 capital and lower risk-weighted assets thanks to increased credit quality together with the stronger Swedish krona.
Looking at the rest of the profit and loss account compared to Q1 2010, you can see on slide number 6 that net commissions were down 2%. Lower commissions from structured products, lending, and insurance were partly offset by fund management fees being up by 23%. Net gains and losses on financial items decreased by SEK 139 million due to a higher deferred capital contribution to Handelsbanken Liv and to a lower equity-related result. Costs were up 3%, mainly due to the annual increase in wages and to a 4% increase in the average number of staff. The overall impact was partly mitigated by a positive effect from exchange rate changes. Loan losses were halved to - SEK 244 million, and the loan loss ratio amounted to 6 basis points.
If we then turn to the comparison quarter-on-quarter on slide number 7, you can see that the operating profit increased by 3% compared to the fourth quarter. Apart from the changes in net interest income discussed earlier, lower net commission income was the reason for total income falling 2% in the quarter. This decline was mainly a result of lower commissions related to the issuance of structured products and to seasonally lower income from the card business. Commission income from equity sales in the secondary market was unchanged between the quarters. Costs amounted to SEK 233 million, or 6% lower than in the fourth quarter, mainly due to seasonal effects. Exchange rate changes had a positive impact of SEK 53 million. Loan losses declined by 17% and amounted to -SEK 244 million, and the credit quality remains sound.
Turning now to slide number nine, you can see the iTraxx Senior Financials five-year index compared to Handelsbanken's five-year senior CDS spread. As you probably know, the iTraxx index shows the average CDS spread for the 25 largest and most liquid European bond issuers in the banking and insurance sectors. In my view, this is a very relevant indicator of the degree of financial disorder in Europe. As can be seen in the chart, the iTraxx index remains volatile at historically all-time high levels, indicating significant uncertainty in the funding markets. On the contrary, you can see our CDS spread stabilizing at very low levels in comparison to the market. Since some time, we now, in fact, have the lowest CDS spread of any comparable European bank.
When you look at the market as a whole, it is still difficult, I think, to assess how the sovereign debt crisis in Europe will evolve. Furthermore, increased uncertainty about the U.S. situation increases the complexity. Currently, we see substantial risks for further deterioration of the conditions in the funding markets as a whole. To this picture, one should also add the substantial need for European banks to renew and prolong their funding as a result of the coming year's new liquidity rules. With all this in mind, we think it's a wise investment to continue to be conservative in our funding activity, which I will come back to shortly. If we then go to slide number 8, you can see that we have continued to strengthen the financial position of the bank in light of the turmoil in the European financial markets.
Tier 1 ratio amounted to 17.2% and was up from 14.6% in Q1 2010 and from 16.5% in the previous quarter. The increase in Q1 was chiefly explained by the profit and by improved credit quality, together with the strengthening of the Swedish krona. The total capital adequacy ratio increased to 20.4% compared to 19.6% one year ago. The increase here was driven by a combination of the profit in the period and by lower risk-weighted assets. Looking sequentially from Q4, the capital ratio went down by 0.5 percentage points since we called a subordinated loan of $800 million, which had a negative impact of 1% on the ratio. As I mentioned before, we also chose to increase the liquidity reserve, which now exceeds SEK 600 billion. Operationally, this is an easy exercise, just allowing more institutional deposits to enter the bank's balance sheet and then placing the money with central banks.
Since we are attractive as a deposit taker, this could be done without any negative effect on the result. On slide 10, you can see the bond funding done by the bank in Q1. In total, we issued SEK 68 billion in bond funding in the first quarter, and slightly more than half was done in the senior unsecured market. Through the issuance in 2010 and so far in 2011, we have already pre-funded all bonds maturing until April 2012. As I said initially, we believe it's important to have a balance between senior unsecured and covered bonds. Already issued senior bonds are certainly more stable than corporate deposits, and issuing senior bonds means controlling the level of subordination in the balance sheet. On top of that, it strengthens the bank's liquidity position by keeping unused capacity in the current bond pool.
For these reasons, I think it's fair to think of senior unsecured funding as likely to be the only long-term funding source for banks to finance cyclical corporate loan growth going forward. I think it's important to remember that the covered bonds can only be used by banks to fund mortgages. In addition, requirements of over-collateralization in the covered bond pool means that not even all the mortgages in a bank can be totally funded by covered bonds. Looking at the asset side, the demand for corporate loans and thereby the loan growth tends to vary substantially over the business cycle. Household deposits in the market are fairly stable over time and thus not able to meet the funding needs of banks in a business cycle upturn.
Structurally, household deposits can also nowadays move way more rapidly since internet banking means that the client can change bank even in the middle of the night. Historically, it was normal for most other banks to fund strong corporate loan growth in the short end of the yield curve. However, with the new liquidity rules, senior unsecured funding of longer duration is likely to be the main, if not the only, reliable source of funding available, as cyclical loan growth tends to outpace deposit growth quite significantly. If we then move to slide 13, I would like to make some comments on the Swedish branch office operations. year-over-year, the operating profit here increased by 26% to just over SEK 3 billion, being an all-time high, and mainly due to higher net interest income and lower loan losses.
Reported net interest income rose by 17%, mainly due to higher short-term interest rates, making it possible to recover part of the deposit margins previously lost when the interest rates went down. The double fee to the Swedish Stabilisation Fund reduced net interest income by SEK 53 million year-over-year, and the benchmark effect in Stadshypotek was SEK 107 million lower than Q1 2010. Adjusted for this, net interest income was up 22%. The credit quality remains strong, and the Swedish operation reported net loss recoveries of SEK 29 million in the quarter. If we look quarter-on-quarter, the operating profit increased by 2%, net interest income grew by 7%, but the positive impact was partly offset by net gains and losses on financial items, being SEK 96 million lower than in the fourth quarter 2010 due to lower FX activity.
Costs were down 2% due to administrative costs being seasonally lower in Q1. You should remember also that the annual wage negotiations for 2011 had a full impact on staff costs from the 1st of January. One of the main opportunities in Sweden lies in the savings markets, where the bank's market share is significantly lower than within other product areas. Over the last couple of years, we have made significant efforts to improve in this area, both by reorganizing and by improvements in the quality of our products. In 2009, we started to see some positive results, and the bank took 26% of net new savings in Sweden in 2010. The first quarter this year showed continued progress, with the bank taking 25% of net inflows to mutual funds.
This is two and a half times higher than the bank's market share of the total outstanding mutual fund volume in Sweden. Now, let's turn to slide 15 and the branch office operations outside Sweden. year-over-year, the operating profit declined by 7%, or SEK 50 million, in total explained by exchange rate effects amounting to minus SEK 52 million. Net interest income was down 12% compared to last year, and here, 10 percentage points are explained by the stronger Swedish krona and the new doubled tariff for the Swedish Stabilisation Fund fee, as well as higher fees for the deposit guarantees. The remaining part of the decrease is mainly explained by increased pressure on lending margins in the Norwegian branch office operation and by the deliberate reduction of lending volumes in Handelsbanken International in 2010.
Compared to the fourth quarter 2010, operating profit fell by 6% or by SEK 42 million. FX effects and higher state fees explain half of the change, and the rest is mainly explained by the lower lending margins in Norway. Loan losses were lower both year-over-year and quarter-on-quarter. Going on to the U.K. business on slide number 16, you can see that the expansion of the branch network continues and that we have opened seven new branches in the first quarter. If we look at in the last 12 months, we added 24 new branches, and at the end of the quarter, we had reached 90 branches that had opened for customers. On top of this, we have recruited another seven branch managers in the process of opening branches at new locations.
With the current pace, we will pass 100 branches in the first half of this year. We are certainly happy about the progress in our U.K. business, even if the operating profit, as you can see, dropped by SEK 29 million in the first quarter. Net interest income was down 3%, but adjusted for FX effects and higher state fees, the underlying net interest income increased by 3% in the quarter. We continue to be very optimistic about opportunities in the U.K. market and expect the business to grow substantially in the coming years. To conclude, in the first quarter, the operating profit was up 4% year-over-year and 3% sequentially from the fourth quarter, despite the fact that some special effects like exchange rate changes, double fee for the Swedish Stabilisation Fund, and benchmark effects in Stadsuppotet had a negative impact on earnings.
In light of the continued uncertainties around how the situation in the European financial markets will develop and around what impact new regulation will have, we have deliberately invested in further strengthening our balance sheet. We have continued to build capital and further pre-funded the balance sheet, as well as increased the liquidity reserves. We remain very optimistic about opportunities in the U.K. market, and we will most probably open branch office number 100 in the second quarter. Finally, we are starting to see positive effects from our focus in the Swedish savings markets, where we took 25% of the net inflow to mutual funds in the first quarter 2011. 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 0 1 on your telephone keypad and you will enter a queue. The first question comes from Mr. Nick Davey from UBS. Please go ahead, sir.
Yeah, good morning everyone. Nick Davey from UBS. Three quick questions if I can. The first on liquidity, which I know is a topic you spent a bit of time on in your presentation. If I look at the balance sheet, the amount held in cash and balances with central banks seems to have trebled Q on Q. Can you just confirm for me firstly if there's any change in how you account for that figure? If there isn't, please a little bit of a background as to why you've trebled that figure on the quarter. Is this something the regulators are focusing on particularly increasingly in 2011? Is this a management decision? A little bit more color there would be appreciated. The second question is on corporate deposits, which as you say have gone up about 17% Q on Q. The big driver seems to be other corporate deposits.
Can you just talk us through the movement there? Thirdly, on risk weights. Again, they've come down on the quarter specifically in the corporate book. Can you talk us through a little bit maybe the regulatory, any regulatory view on risk weights or any regulatory discussion that's going on with risk weights? Any scope you see for further potential reductions in your corporate risk weighting as you move more of the book onto advanced IRB? Just a little bit more color, please, around the corporate risk weight. Thank you.
Thank you very much. On liquidity, it's true, as you say, that we have increased the deposit that we place with central banks. You can also see this in the breakdown on page 38, note 13. It's not any regulatory issues at all. This is purely a management decision. As I mentioned, it's operationally very easily done because we just allow more institutional deposits to come into the balance sheet and then we place it with the central bank. As has been said, we see a deteriorating situation in the European financial markets. Because of that reason, we took out the liquidity reserves. We think placing it with central banks is a good part of the liquidity reserve to do that since we don't know how long this situation will prevail in Southern Europe and the sovereign debt crisis, etc. On corporate deposits, your question was what's happening there.
Let me stress that corporate deposits are really not something that we use in our funding. We look at it as overnight funding, and corporate deposits are to its nature somewhat volatile. It's also part of it. We have done reclassification from financial institutions into lending and also on the deposit side to corporates. There is such an effect, and you can see that from both if you look in the fact book and if you look in the notes. When you take the part that comes from the business side, it's also true that we have taken on more corporate clients, and with that has come corporate deposits. You talked about risk weights. Also here, we of course got the note in the report, and you can see that the corporate risk weights, as you say, have gone down.
It's both a matter of the quality of the new clients that we have taken in and riskier assets going out of the balance sheet. It's also the yearly validation process where we have, because of the quality, got lower risk weights when you look at the outcome of the models. You asked also about advanced method. As you can see, we are moving into advanced method. It's a gradual process where you get more and more of the assets certified by the authorities and so on. I don't want to give any exact time frame for this. It's all dependent on the workload in the Swedish Financial Supervisory Authority and how quickly they will decide on this. I think you should look upon this as having a slight positive effect, but not very dramatic. You shouldn't really, in my view, put any large attention to it.
My best guess is that we will have a slight positive effect in the numbers going forward, but it's not dramatic.
Thank you. If I could quickly just come back to the liquidity question, if I may. I think you indicated the table you've got on page 39 of your Q1 report, which slips out a bit more granularity around the liquidity reserve, which I think is new disclosure. Can I just take you back then to the choice of keeping all of this cash with, I guess, in either cash or with the central banks and not redeploying it or holding covered bonds or domestic government debt? I mean, can you just talk us through a little bit about your thinking, I guess, as to how this liquidity reserve is split and the yield or lack thereof that you're getting from this liquidity reserve? Thanks.
Yeah, so it's, as you say, a mix of different returns because of which central bank we are talking about and which kind of bond, if you look at the liquidity portfolio that you are investing in. The way we look upon it is both, of course, taking into account the duration of both the deposit or the bond that you hold. We then have, of course, internal goals for the duration here. We don't look at all really on the return as such, on the liquidity reserve. It's not a goal in itself. Having said that, when we have a goal on what we want to achieve, of course, we optimize within the different parts. When it comes to central banks, of course, that's a very, very both liquid and very, very flexible form in every sort of respect in handling the liquidity reserves.
As I mentioned, because we have such a good and attractive name in the deposit market, the institutional inflow that we get in deposits means that we get it at such a good rate. As a matter of fact, the increase of SEK 100 billion that we have done in the quarter has not had a negative effect, as a matter of fact, on the result.
Okay, thank you.
The next question comes from Mr. Johan Ekblom from Bank of America. Please go ahead, sir.
Thank you. Just a few questions, if I may. First, if we can come back to the net interest income development in Norway, I guess you pointed out that part of it is FX and part of it is related to tighter lending spreads. Are there any particular products where you're seeing pressure, or is it across the board? Would you expect this to continue, or should we see some reversion back to where we were prior to this quarter? Secondly, in terms of your funding plans, you've done clearly more funding or pre-funded more now than you had a year ago. Should we expect the same pace of funding to remain broadly throughout the year? Finally, if she needs to comment on your capital allocation in your capital markets business, it appears to have fallen by some 40% quarter-on-quarter. She needs to comment on what drove that.
Right, thank you very much. The first question on net interest income in Norway, yes, you're right. There is a currency effect, but also I think it's important to note that there has been considerable margin pressure on the lending side in Norway. That is something that has been for a while, but in this quarter, you can see it rather markedly. You can see it from the figures. You asked how long will this prevail, and that's always a good question. I note, however, that there are certain parts of the market that have taken quite considerable amounts from the Norwegian Central Bank, and it might also have some impact on the pricing in the markets for some institutions. As you know, we have not used any central bank funding at all or central bank help during this financial crisis. You talked about the pre-funding and the pace.
Yes, we have said that we have increased the pre-funding, so now it's 12 months. When you look at them, we have pre-funded 12 months of maturities of falling bonds. The reason behind this is that we see an increased deterioration in the financial markets in Europe. As long as that prevails, I can't see that we will take down the amount of pre-funding or the number of months that we have pre-funded. Of course, hopefully one day the situation will more normalize. As we have said, during this quarter, if you look at the financial markets, you can see, look at the iTrex and so on, you will see that the situation in the markets has deteriorated. We think it's a very good investment to be on the prudent side here. You asked about the capital allocation in capital markets. Capital markets have taken down the risk.
We have very, very small risk in our market risks in the group, but they have done some optimization of this. That has meant that the allocation of capital has gone down. Also, you will see that the risk in our insurance business has gone down. That is a very deliberate also how we work with the product mix in the life insurance business. That has also meant reduced capital allocation.
Thank you.
The next question comes from Richard Strand from Danske Bank. Please go ahead, sir.
Yes, hi. Two questions. First, about your exposure towards the Swedish corporate mortgages. You have quite a large exposure there, and you have continued to grow your lending there quite substantially over the last couple of years and quarters. Just wondering if you see yourself as getting closer to some sort of level where you don't want to grow your real estate exposure anymore. Secondly, a follow-up question on the Nordic margins, or sorry, the Norwegian margins. In what segments do you see margin pressure there? Thanks.
Thank you. You talked about real estate exposure and so on. I think it's important when you look at our figures and our balance sheet that we don't look upon it in that way. We always look for good clients with good cash flows. If those are good, we say yes to credit, and then we take the pledge as well. That also goes for corporates, and it goes for private individuals. That means that we don't look at the balance sheet having goals on how much is to real estate or to other parts because in all segments, there are good clients and not so good clients. Our whole credit philosophy is trying to pick and choose the very best clients that can repay regardless of what kind of business they are in.
The answer to your question is that we don't have any such portfolio goals when it comes to our credit portfolio. We are very happy about the real estate portfolio that we have, and we don't see any sort of structural risk in the balance sheet in that segment or other segments that we are present in. You talked about Norwegian margins. I would say it's margin pressure all over. When you look at our portfolio, we are not, as you know, we have got a conservative credit policy. If you look at the whole Norwegian market, I would say it's all over. It's also a very high margin pressure on large corporates and so on. It's very, very high pressure on very risky deals. We are not present in that market, but that's just an example. It's also general.
I mean, it has come into small and medium-sized companies, which is rather unusual. I think it has to do with the fact that the market has been very much provided by liquidity by the central banks. Let me stress that once again, we have not taken any central banks' money, but our competitors have taken considerable amounts during this financial crisis. I think that has heated up the whole situation in Norway.
All right, thanks.
Next question comes from Mr. Andreas Hakansson from BNP Paribas. Please go ahead, sir.
Yes, hi. It's Andreas Hakansson from BNP Paribas. Just a follow-up question from the meeting in Stockholm this morning on margins. You talk about the margins in Norway. You said that the deposit war is blowing up in Denmark. Can you tell us about the asset margins in Denmark? Also, in Sweden, you said that there is margin pressure on the corporate lending side, but I can't remember if you talked about what's happened with margins on the retail side, particularly on mortgages, of course. Thanks.
Yes, if we start with the last question, mortgages in Sweden have been very, very flat margins, very flat indeed. We see a small pressure on the corporate side, and it's mostly if you look at large companies, not on smaller companies. In Sweden, you also have a mixed difference on the corporate side, the type of loan that you take. You have a slight negative effect. As you see from the slides in the appendix, we are talking small numbers really in Sweden when it comes to decreased margins on corporates. As I said, on retail, it has been very flat. In Denmark, there is, as you say, on the deposit side, there is because of the structure of the Danish market, a lot of banks that can only have deposits really as their funding. They don't have access to the bond markets and so on.
That's a competitive situation. On the asset side, on the corporate side, funny enough, you can say, the structure is that there are two very large banks in Denmark. It seems like they both are very, very eager in the market. Yes, there's definitely margin pressure going on in Denmark.
Just to follow up on your point there on the tough situation for the smaller Danish banks, have you heard any indications with discussions with authorities in Denmark that you could have, let's say, a forced banking package introduced that the government's going to have to be forced to introduce another full guarantee on all liabilities in Denmark, with, of course, an obvious cost to the banking system?
No, I have no such information. You have tasked those closer to the situation.
Thanks.
Thank you.
The next question comes from Mr. Jan Wolter from Deutsche Bank. Please go ahead, sir.
Yes, Jan Wolter, Deutsche Bank, follow-up from the presentation here this morning. The duration on wholesale funding, could you give us the number that is right now, Q1 and Q4, please? The second question is, in your view, what is the maximum proportion of covered bonds as a percentage of wholesale funding or any other reasonable metric? The third question is, the annual validation of the IRB model, is that now over, or are there other effects lowering risk weights going forward? By that, I mean meaningful effects apart from the usual up and down that we see quarter-on-quarter. Thank you.
Thank you. On the duration of the wholesale funding, that is something that you must say is a wrong question because you can only look at the funding in relation to your assets. That's the way we look at it because you have to have, of course, a cash flow planning. You have to know what you are going to fund. The whole process of our liquidity planning has the starting point of the asset of the balance sheet. There we, of course, communicate how much we have pre-funded, what we need to do, and you can see how our balance sheet has developed. You can also, of course, from that conclude that our prudence in terms of liquidity planning has even increased in this quarter, both in terms, of course, of the liquidity reserve and also the amount of pre-funding done. You talked about validation.
This is a formal process with the Swedish FSA. According to the rules, you should validate all the models in a very sophisticated and in-depth way yearly. This we have done, and then it's certified by the Swedish FSA, which then agrees to the methods that have been used and so on. It's a very formal process and very technical. You won't see the validation process again until next year. Having said that, there are, of course, other effects in terms of risk weights. I know that you know this very well, but just to repeat, of course, how the credit ratings migrate is one thing, advanced method we touched upon and so on. Yes, risk weights will move during the year. When it comes to validation as such, that's a yearly procedure.
You talked about the amount of covered bonds and how much covered bonds one should or could use. Our covered bond share is down to 19% of total assets and 22.5% of our funding. That has decreased. It was some 24% in Q4. I don't want to say an exact number. I'm sure you've seen, for instance, the New Zealand rules saying that it should be a 10% ceiling. New Zealand is a special market, but I think Australia has implemented something to the same sort. There has been a lot of discussion on this in the U.K. and so on. I think this is an issue that becomes more and more important. For the senior bondholders of the bank, it's very important that you keep the levels down. We, of course, have quite some room to issue more covered bonds. I think this is a very, very important issue.
I mean, you wouldn't want to wake up one day and find that any bank had sort of 35%, 40% in using covered bonds. That in my mind would be a problem for the future.
Okay, thanks, Lotte. If I may, the liquidity coverage ratio requirement that we have now in Sweden, where you must report the LCR to the Swedish Financial Supervisory Authority, does that still allow you to invest the SEK 100 billion extra in liquidity buffer in something else than central bank deposits and still comply with that? Could you move those SEK 100 billion to something else like government paper or something else in principle?
When you asked about the liquidity coverage ratio and the impact of the extra SEK 100 billion.
Not the impact, but you've obviously put those SEK 100 billion in central bank deposits, more or less. My question is, given the LCR requirement that we have now, you must report to the Swedish Financial Supervisory Authority. Would you be able to, in principle, move those SEK 100 billion to something else like government paper and still comply with that requirement?
Yes, yes. I mean, LCR is not a problem for us. That was not the reason at all that we increased the liquidity reserve and so on. I mean, if we would like to take out the extra SEK 100 billion from central banks, we would have no problem handling the LCR. You have also to understand that the LCR is something that will come into effect in the future. We are already in a situation that LCR is no question at all for us to comply with.
Okay, great. Thanks.
The next question comes from Mr. Mats Liljedahl from Nordea. Please go ahead, sir.
Yes, hello. Just a follow-up on the capital allocation. If you could in any way specify what you have done to take down the risks in capital markets, and also if this is linked somewhere to the decrease of the derivative portfolio and also activities. We note that allocated capital is up around SEK 7 billion in Sweden or the Swedish banking operations in the quarter. Where did that come from? Should we combine this in any way? Thanks.
The capital allocation model in the bank is such that we both allocate the capital that you need from the minimum capital requirements as a base, and then, of course, we allocate all the rest of the existing capital in the bank to our different business operations. As you've seen, the capital generation of the bank has been very good. We have generated quite a lot of capital, and, of course, that's allocated out to the different units. When you get an increase in the total capital of the group, all things being equal, the allocated capital to different business units goes up. You asked about Handelsbanken Capital Markets, and I just touched upon that they have optimized their market positions to further take down their market risk exposure.
We are, of course, very keen to be a top investment bank with all capabilities for our clients, but we don't seek to have any positions on our own or for our own sake, so to say. The position taking that we do is totally in relation with the business that we do for our clients. It's this process that Handelsbanken Capital Markets has been successful in taking down the need for capital by reducing further the market positions. We're talking rather small numbers, so don't be dramatic about this. This is really fine calibration of what they do.
Okay. We just note that, I mean, if you build capital, it seems like Sweden is taking the large part of that because we don't see allocated capital going up in the businesses outside Sweden. If that had any reasoning, if you had any reasoning behind that, why Sweden takes the main part of it?
No, of course, capital, I mean, you see that the credit volume has grown in Sweden. When you look at capital outside Sweden, of course, you have the currency effect that we talked about and so on. It is nothing strange. We haven't changed any principles or anything. It is just a matter of the total group capital going up and allocated to the business that needs it for the business, and the rest is allocated to all the units.
Okay, thank you.
The next question comes from Mr. Ronny Rehn from KBW. Please go ahead, sir.
Hello. It's Ronny Rehn here from KBW. A few questions, I think many have been asked. First one, when you adjust your internal models, you said it's basically done in coordination with the Swedish Financial Supervisory Authority. So basically, they're signing off still on you reducing risk-weighted assets. What does it do to the debate of potentially reviewing those risk-weighted assets? Would it make sense since they're basically signing off on lower risk-weighted assets right now? Would it make sense that they come out at, I don't know, in three months' time to say, "Oh, we're now revising it all upwards?" That's sort of the first question. Secondly, sorry, where is the capital level debate headed at the moment? What is sort of the latest thoughts from Riksbank and the Swedish Financial Supervisory Authority regarding sort of minimum capital requirements? Is it 10%? Is it 12%?
What's their thoughts on potentially using [co-costs, etc.]? Lastly, on the corporate loan demand in Sweden, I've seen that you obviously increased your corporate commercial real estate book again, but the sort of unsecured corporate lending was still down. What's the latest trend there? Thank you.
Thank you. The first question about the yearly validation method, this is not something that you can choose to do or not to do. You are obliged by the rules to do it, and you're obliged to do it in a mathematical, prudent way. There is no choice. You have to do it, and you have to do it accurately. If you do it accurately, of course, the Swedish Financial Supervisory Authority says, "Yes, this is accurately done and certified." We do not have any choice. We cannot choose here. The figures that you see, you asked, "Is it wise to take it down?" and the debate and so on. The risk weight is what the risk weights are. It is very easy to understand because if you do not have defaults, the risk weights, of course, go down. We have a very long track record.
It is not a matter of choosing risk weights or so on. It is mathematical formulas trying to predict the future by taking all the historical figures and, on top of that, putting quite a lot of safety nets. The figures are what the figures are. You talk about what is the latest thought on capital. I think you should maybe ask the authorities on that. As you know, some time ago in a hearing, it was said from the Swedish Riksbank and also from the Swedish Financial Supervisory Authority and Finance Minister and so on, that maybe Sweden should have different rules to European rules. After that, you have seen maybe in the press and so on remarks on whether Sweden, from a legal point, even could do something different because the European rules normally say that there should be one ruling in all of the EU.
That is a debate that is probably currently ongoing. There has been no news since that came out or, from what I have seen, any official remarks or so on from the Swedish authorities on that. Corporate loan demand, you asked about real estate and other types of lending. When we say yes to credit and if there are pledges that are possible to also take, we take those. We do not say yes or no to credit depending on the pledges. We do it solely on the basis of the cash flow of the client. Therefore, we do not have any firm views on how much real estate we should have or other types of corporate lending. We try to choose the best clients, and then they have the real estate that they have.
If we look in the market, I do not think at all you can differentiate from a client point of view that there are different sorts of activities in different segments that are lying behind what you see. I think when it comes to corporate loan demand, as we state in the report, we see a slight increase, but it's too early to talk about the real trend. Yes, we see a slight increase in Sweden.
What do you think is the main reason for the corporates to kind of hold back still? Do they sit on too much cash? Are they, I don't know, uncertain about the future? What is the main reason from your point of view?
I think that investments have not yet really come on, and also the fact that corporates were very skilled at taking down their need for cash when the downturn came. They put themselves in a cash-rich position and a good position. Therefore, the need to borrow when the business cycle has turned up has been delayed, so to say. You see some early signs.
Okay, clear. One last quick question. When you speak about the sort of European funding market and the problems there, how do you see this on a day-to-day basis? Do you find your own negotiation tougher, or do you see competitors that can't fund at all, like we know for Denmark? How does it reflect on the market on a daily basis?
When it comes to our own position, we only have one problem really with our funding. That is that we see such a large demand for our papers, and we don't have, as you know, a great need to issue. Some investors get a little bit sorry that they can't buy our paper. When we did a transaction, for instance, in our first transaction in Hong Kong in Chinese yuan, a yuan currency, that was oversubscribed 6.5 times. We have to always choose when we issue which market so that we keep investors happy with us. Some of our papers, and quite a lot, only have a bid side, and there is no one willing to sell. You can see this in the CDS spread. When you look at the European and the Southern European situation, you can see it very easily in the iTraxx.
You can see it also in the kind of amounts that different banks in Europe can do and so on. You can also see that some European banks have been forced to go into considerable amounts of issuing into covered bonds. That is a dead end in the long term because if you continue to do that, at some point, you really run into deep problems because you can't issue any senior unsecured bonds after that, because you deteriorate the position of the senior bondholders more and more.
Right. When you look at it, could you go the way that you run purely on deposits and covered bonds and don't do any unsecured at all? Depositors are usually less sensitive to how much covered bonds you have. That's sort of, I mean, at least retail are protected by deposit insurance, no?
No, maybe I misunderstood you, but it's totally on the contrary. I mean, you should always have unsecured funding. That is which I previously talked about. That is, I think, the only funding source, reliable funding source that you can have to fund corporate loan growth in a business upturn. You should not use covered bonds overly much. I think that's very important.
Okay, clear. Thank you very much.
Thank you.
The last question comes from Mr. Nick Davey from UBS. Please go ahead, sir.
Hi, yes. Good morning, everyone. Just one final quick follow-up question if I can. Back to the capital question, which I guess we ask you every quarter. When you kicked off your presentation, you mentioned that you would wait for Basel III to be ironed out. You would wait for a reaction from the funding market before reassessing your capital position. I guess the question is twofold. One, what should we expect from you? Should we expect a new, through the capital. Cool,
Capital target later in the year or a potential to reaffirm the old capital target? Will you communicate loud and clear on this? And should we wait for Basel III before that happens? And second of all, just briefly, what exactly are you waiting for? Which ratio is particularly still in your thinking? Is it the leverage ratio that you think might be implemented early in Sweden? There was obviously the 10%-1 2% range issued by the Swedish Financial Supervisory Authority, and you issued a statement less than 24 hours later in this quarter. You're clearly a percentage point above the top end of that threshold on a Basel III basis stated. I guess if you could just give us a sense as to what you're looking for when the final Basel details are nailed down. Thank you.
Thank you, Nick. I think you answered the last question very well yourself. I think it's a combination of those things, really, and the other sort of details. There's quite a lot of the details up in the air, and I think the whole question has to do very much with Sweden and what the Swedish decision is. Should Sweden have different rules to Europe or not? That's a very important part of the clarification that has to be done. When do we expect the answer? We hope, it's always hard to predict political processes, but we hope that this will be clarified this year. Of course, you have the G20 summit in November, which is one important point where, if you hear behind the curtains, I think there's a lot of forces going on in order to have a clarification at that point.
Again, it's in the hands of the regulators. What kind of measurement would you expect and so on? Once again, I don't want to speculate. I mean, if we were to change our goal, how would that goal look? You have to know the rules, really, before I could get any sort of intelligent answer to that.
Okay, thank you.
Thank you very much for attending this. Of course, you are very welcome to call us and also have meetings and so on in order to answer all questions or discussions that you would like to have. Thank you very much for attending.