Svenska Handelsbanken AB (publ) (SHBA) Earnings Call Transcript & Summary

Good morning, everyone. This is Kazim Andaç from European banks team. With me, my colleague, Atul Hanamante. And here with us today Mr. Carl Cederschiöld, Chief Financial Officer of Handelsbanken. Mr. Cederschiöld, I will leave the floor to you for introductory remarks. We will then try to address certain key issues through a Q&A. Mr. Cederschiöld, please.

Good morning, everyone. My name is Carl Cederschiöld, and I'm since about 2 month the new CFO for Handelsbanken. My background is, I've been working in the bank since 1998, primarily within investment banking for the last 6 years in the asset management side and running that operation. I'd like to start with a few initial comments about Handelsbanken in this very special period. We believe we showed in Q1 a very, very resilient result with low earnings volatility and our initiatives to focus the bank and reduce costs progress according to plan. And we had very low loan provisions with an underlying credit quality that improved even further in Q1. On top of the small actual provisions, we did a change in calculation of expected losses in the IFRS 9 model and ended up, all in all, with 8 basis points of total provision for the quarter. We get a lot of questions around that, and we will most certainly get back to that one later on today. But I would just like to remind you that Handelsbanken over many decades have had significantly lower loan losses than our peers, that we entered into this crisis with a very solid credit portfolio also when compared to our closest peers. One needs to be very humble, but in general, we feel comfortable about our asset quality in the bank. The bank has growth aspirations. And in early crisis, we've been able to grow also in muted markets through our business model, which leads to higher customer satisfaction. In the initial phase of this crisis, our branches have been extremely active with the customers, advising them and understanding their individual situation, most of the times, obviously, in digital meetings at remote places. The growth ambition is one reason we think that our very strong capital position is a good place to start. Short term, we can probably expect a slowdown in growth due to the large uncertainty certainly from the very strong March growth we saw. We can also expect a short-term negative impact on margins as we have talked about. In early crisis over time, we've seen margins widening, but it will always take some time for that to materialize. With these initial remarks, I hand over to Kazim at Deutsche Bank to start the fireside chat. Thank you.

Thank you very much, Mr. Cederschiöld. First, perhaps, as you also rightfully touched base at the beginning of your remarks, the COVID-19 impacting the asset quality outlook. Can you please mention the approach taken on impairment modeling and macro assumptions in the first quarter with respect to IFRS 9? And perhaps it will be great if you elaborate the drivers behind this, how conservative are your assumptions? And lastly, related with the topic perhaps is, does your approach takes into account regulators' encouragement to await excess procyclical effects when applying IFRS 9 standards? Does it also take into consideration new EBA forbearance rules? Please, Mr. Cederschiöld.

Sure. Well first of all, obviously, we start with the macro scenarios, and they are the ones we disclosed in our annual report. We increased the probability of the downturn to 30%. But then again with our very -- with our history of very low historical loan losses, the correlation between macro factors, GDP and unemployment to loan losses is very small. So that makes it very challenging to model our future credit losses. And even if we adjust the GDP very fiercely, it doesn't make that much to our PD values. So during the GFC 10 years ago, our loan losses peaked in 2009 at 21 basis points, and they were actually concentrated to a few individual names. So the overall portfolio quality was hardly affected by the downturn. So when calculating expected losses on portfolio level in a model that provides some challenges for us. And that was the reason why we did this manual overlay stress on the vulnerable sectors and household lending. So what we did was we forced the PD values to increase, as we have described. When it comes to the assumption and everything, I think it’s good to start with -- we started this crisis with the lowest share of nonperforming loans of any European bank according to EBA, and that's obviously a good starting point. And we have had no increases in underlying actual loan losses in Q1. Rather the contrary actually, in Stage 3 provisions improved in Q1 or was lowered. So even when we forced the PD values to fourfold, expected losses did not increase much. And this is obviously related to the fact that we have low loan to values and a lot of collateralized lending, so low loss given defaults in general. And I think the reason to this is obviously our business model and the very strict view we have on credit risk. So when we calculate the expected losses, we make assessment on the information we have. And yes, we have assessed a 60% probability of this -- of the vulnerable sectors happening. And that's obviously deals with the regulator's encouragement to avoid excessive procyclical effects, and we're also dealing with the forbearance in accordance with the new rule there. So I think that's, in general, is the way we've been approaching this.

So obviously, you think the impairments set aside for the quarter are sufficient, bearing the longer-than-expected duration of COVID-19 crisis. So is it fair to assume lower loan losses from second quarter, again, under an assumption that your base projection sustain?

I think it's -- the way we approach to this, obviously, when we sat down ahead of Q1 report and we went through what assumption we were going to have, we painted a picture which was very, very dark for Q2 and Q3, but starting opening up lately in Q3 and opening up even further in Q4 and then normalization process in 2021. Obviously, now a few months later, we are more certain that GDP will be lower than we thought before. We're not there -- we also perhaps see a gradual opening up, and then we will have a lot of uncertainty during the autumn. So I think we need to be humble here. And should the crisis prolong for a longer time, we will obviously reflect on -- increase the sectors we deem vulnerable. And also, we might increase the stress levels. But so far, I think it's too early to tell if we're going to need to do that. And --

Have you seen any acceleration on -- sorry.

We don't give guidance for cost of risk, obviously, but the 8 basis points in Q1 was the best assumption we could do at that time. And we should remember that we had no increase in underlying actual loan losses in Q1.

Okay. And so far in the second quarter, have you seen any acceleration of new NPL formation or the quality remains as it is?

I mean the sectors we highlighted in the Q1 report is oil, tourism, travel, some parts of the manufacturing and also retail, excluding food. And they are the ones we deem most vulnerable. Looking at statistics in Sweden for corporate defaults, they were -- statistics were up -- defaults were up 30% in April versus April 2019, but 50% of these companies ending up in default, according to the survey, were in deep financial problem already at the year-end. And as you can imagine, we wouldn't have many of those corporates in our book. So the corporates, in general, have been helped by many of the various measures from the government and authorities for now. So we haven't seen any dramatic development in general defaults. And our customers typically also, we like to focus on customers with strong owners who can support the companies with new equity, and we've actually seen that in some cases already.

Okay. But if you move to the margin and NII front. How do you see mortgage and corporate lending margins developing in second quarter? How do they impact it from the recent funding cost developments?

Yes. As we mentioned in the Q1 report, we think margins will suffer in Q2. And the reason for that one is obviously, the sharp increase in funding cost once markets open up again. During March, when markets were closed, we kept lending to our core clients, and we had quite a high growth in customer lending. And we financed that one with the liquidity reserve. So when we -- markets were opening up and we started refinancing ourselves, that came more or less to a cost level, which is roughly 1% higher than pre-corona levels. So this will be visible. The majority of the funding is obviously down short term, so that will gradually level off during late summer, early fall time. But nevertheless, we've also issued a 5-year euro senior bond, EUR 1.25 billion, and that was also funded at roughly 1%. So margins will suffer in Q2.

Okay. And as you highlight the growth front, corporate loan growth has picked up significantly towards the end of March, which is expected to, to an extent, support NII in the second quarter. So my question is, has corporate loan demand started to level off by now? How sustainable is the demand from these loans you see? Are they mainly bank's drawdowns? Do they have limits for liquidity purposes? And then lastly, related with the same topic, of course, how attractive are they? Can they, to an extent, offset the impact of higher funding cost that you mentioned?

Yes. Yes, the sharp increase in March continued to some extent in April, but at a slower rate. And it is typically large and medium-sized companies drawing down on existing commitments to secure their liquidity. And that obviously means that the prices do not capture the higher funding cost. They were at prenegotiated levels. So in early crisis, margins obviously have widened over time, but it doesn't happen overnight. And initially, there's usually some margin pressure from the volatility in markets. So these commitments are typically not very long term, but they're also expected to be gradually repaid once the companies fund themselves more in the market again. It's a bit too early to tell if the margin is going to widen sooner, but definitely, the growth has leveled off from April.

Okay. Just very quick because I remember from the earlier discussion we had with the first quarter results on the SME lending front. Regarding the subsidized loans for this subsegment SMEs. Have you started to see increased customer demand, which would possibly also back NII expansion because it was quite subdued, if I'm not mistaken, in the first quarter or towards the end of the quarter?

Yes, and it still is. It is a lot wait-and-see moment. And the subsidized loan has not taken off to a large extent. And we do believe that many of the companies are evaluating their own cash flow situation before they go to the bank to borrow. So far, very, very subdued.

Okay. And on the mortgage front, have you seen any relief in competition lately under this current, let's say, unprecedented circumstances? And separately, my second question is, given the recent decline in home prices on the back of lower consumer confidence, is it fair to assume a deceleration of mortgage loan growth at least in the near term?

Yes, I think the difference to this crisis to the past one is that the competition landscape is more fierce this time. Banks in general are fairly well capitalized and have good liquidity situation. So competition remains pretty much where it has been. We don't see any major changes. We would obviously expect mortgage loan growth perhaps to slow down over time. But so far, statistics actually show transactions are still going on in Sweden, perhaps more than expected. But it is fair to assume a slowdown going forward.

Okay. And on the Riksbank rate hike back in December, you quite proactively enlisted your list prices by 25 basis points. So my question here is to what extent this has reflected in bank book mortgage rates? That's my first question. And then my second question is related with the policy rate outlook. What is your expectation there? I mean how likely is that Riksbank cut its benchmark base below 0, let's say, in the foreseeable future?

Yes. First of all, we saw obviously that the mortgage margin in Q1 was fairly stable. So that means to some extent that the hike filtered through in our figures. Lately, we've seen in the statistics that the average price on new lending has increased a few basis points for us. And our chief economist expect their expense rate to remain at 0 for the next few years. So no change there, we believe.

No major change, actually. Yes. And then regarding the Riksbank decision, possibly in the coming, let's say, months or a quarter, I mean, how do you see the behavior there? Or what is your base assumption there regarding the benchmark rates?

No. Our assumption is that it's going to stay at this level for foreseeable future.

Okay. And then is there any chance you share with us your estimate or NII sensitivity to, let's say, policy rate movements, let's say, 25 basis points? So you already highlighted it's not in your base, but let's say, a 25 basis points of decline in benchmark rates, its impact on NII. Is there any sensitivity that you can share with us?

No. We normally don't guide on these issues, no.

Okay. Okay, that's fine. And on the funding strategy, what is your MREL requirement as announced by the regulator? And my second question on this topic is, is there any target for your senior non-preferred bond issuances this year and perhaps 2021 that you can share with us?

Yes. We -- obviously, we always want to be well funded, and we have strong liquidity reserves. We take some short-term cost for that now, for sure. But funding-wise, it's business-as-normal fairly. Levels have come down again but are not back to the levels we saw pre-corona crisis. We do see that our funding cost advantage versus peers has increased again. It goes both for banking peers, but also, obviously, to our customers that go -- if you look at the levels they fund themselves in the capital markets, they have not decreased to the extent ours had. The MREL requirement or rather the requirement for senior non-preferred issuance is still communicated from the authority to be around EUR 9 billion. However, with the banking package in place at year-end this year, it could imply a lower volume than that. So the time horizon has also been pushed 2 years until the end of 2023. So that means we're in no rush whatsoever with issuance, and we will continue slowly and gradually to build the decision that we already started with it.

Okay. If you move to capital outlook and payout policies, well, CET1 ratio declined to 17.6% in first quarter, mainly as a result of the risk-weighted asset inflation, via corporate loan growth and the pension liabilities IAS 19 impact. The buffer over the high end of your target now stands at 70 basis points, 7-0. So how comfortable are you in terms of capital headroom over the requirement? That's my first question. And then the second one is, is it fair to assume credit risk migration could cause further pressure on capital ratios to risk-weighted assets in the second quarter? And then maybe lastly, is corporate loan growth expected to weight on risk-weighted assets? And when we are calculating the additional contribution of corporate loan growth, on what risk weight should we assume for these loans? I mean 30%, 40%. How should we see them?

Yes. We are in a good capital position, definitely. And in a crisis like this, our bank wants to have strong buffers to be able to grow and, at the same time, weather any potential storms coming. So that's why we said that the fact that we are above our target range will not cause any particular action in Q1. Corporate loan growth to large corporates typically consume more capital than for secured property loans. The credit risk migration had a negative SEK 5 billion impact on RWAs in Q1. The models we use are obviously more through the cycle now than a few years ago, but any credit risk migration will still be visible in the RWA. In Q1, the migration took place within the strongest risk classes primarily. So that's what we see so far.

Okay. And when we are assuming a risk rate there for the corporate loans on new lending, is it fair to assume something like 40%? Or there's no guidance yet?

No. No, no, we don't guide on that, as you know.

Okay. Okay, okay. And can you please highlight the capital headwinds ahead, perhaps Basel IV, the impact of Pillar 3 on -- related to commercial-related exposure? Anything else that we should take into account?

Yes. Well, first of all, the Swedish CRE floor, when implemented, will most likely add some 40 basis points in Pillar 2 requirements. And then you have the Norwegian CRE floor, which will be put into Pillar 1, so that increases the RWAs. And the buffer to the requirement will also decline by 40 basis points. So on the other hand, the SME factor in the updated banking package will, when implemented, provide some tailwind to RWAs. So Basel IV as well, when we look at where RWA will go, we have already gone a long way in Sweden with the risk weight floors for mortgages. Another similar type of increase will come from Basel IV, taking RWA to a level above SEK 900 billion from the level at SEK 750 billion today we have. So the important thing is, however, what capital requirement will end up being. So when we do a conservative assumption today, it seems that our current capital level is more or less in line with the requirements of a fully phased Basel IV.

Okay. Okay, okay. Do you want to add anything on the banking package in Sweden, your expectations? I mean that possibly lift the capital requirements higher, but anything else we should add there related to the banking package?

I think it's a bit too early to say. But obviously, the Swedish fintech, let's say, keeps repeating that in general, they are happy with the capital levels of Swedish banks. And there will surely be changes to the various buffer requirements, but not necessarily ending up in a higher level required. So it's a bit too early to tell.

Okay. And on the dividend front, how should we think about the dividend outlook? I mean, yes, external shareholders' meeting is expected to be held later this year to decide on the 2019 dividend. This has already been deducted from the capital. But on the other hand, you accrued 40% out of 2020 in the first quarter. So really appreciate if you guide us on how we should think about the dividend outlook going forward. I mean, '19, of course, we don't know yet where we end up. Whereas in 2020, should we assume like 40% for the full year? I would appreciate if you can guide us on this.

Yes. You should not view the 40% as a forecast. The reason we anticipated that one is that the rule book would have stipulated around 75% payout ratio accrued unless another decision were taken. And so now we've taken the decision to accrue 40%. We took a similar decision in 2016 and then for 50% payout ratio. Again, without that having been a forecast for actual dividend. And the reason for this is that we are back with a growth ambition, and we don't see that 75% payout ratio is where we want to be. So that was the reason behind the 40%. It will not to be seen as a forecast but rather adjusting the stipulated rule book.

Okay. Okay, I think there are no questions coming from the web. So I continue with the cost efficiency, cost outlook. So with first quarter 2020 results, you reiterated your cost guidance for 2020 because for stable AML and development spending year-over-year. And as again most previously announced, gross savings of total SEK 1.5 billion in annual expenses is targeted for 2020 and 2021 as well. So do you see any risk to the cost savings under this crisis environment? That's my first question. My second question is regarding the cost initiatives. What is the amount that has been already agreed to or addressed so far out of SEK 930 million restructuring reserve? And then lastly, what portion of the remaining restructuring reserve is expected to be used this year?

Sure. No, we have some minor delays in some of the international operations closing down, but no real risk to the overall picture, so we keep on staying to the guidance there. So far measures implemented until Q1 will reduce the annual cost level by SEK 350 million, of which SEK 160 million has funneled through the cost side in Q1. So on a quarterly basis, SEK 40 million; on an annual basis, SEK 160 million. So that's a bit above 10% of the total cost program there. SEK 107 million of the SEK 930 million reserve has been used. And we don't make any forecast of the remaining use of the reserve per year. But it's a large reserve that really enables us to achieve the level of cost savings that we have talked about.

Understand. Okay. You already mentioned about the initiatives regarding the noncore businesses, but can you please give us some color on the overall progress since the kick start of the initiatives? There may be some delays, I understand, but I mean if you just summarize how the bank is progressing there, that will be great.

Well, the various geographical close downs are underway. The Baltics have come the furthest. Asia takes a bit longer due to the lockdown, but it's progressing. Germany started the formal process quite recently, and that takes the longest time. But in general, the route to becoming a more focused bank continues. And we saw already in Q4 some exposures leaving the bank as a result of that one. So fairly on track.

My last question is on Oktogonen. So how should we think about the contribution to Oktogonen in 2020? Is it fair to expect a certain amount reserved for this year? Or yes, I mean, whatever we can get as a guidance, yes.

Yes. We said after Q4 that we believe the cost trend was promising, that there were a good chance for resuming provision in this year. However, it's always a Board decision to take in April the year afterwards. In Q1, the corona crisis had just broken up, so we wanted more visibility in the trends as vis-à-vis our peers. So we will come back in Q2 and inform about potential provisioning then. But as we've been answering other ones, we would like to see us starting opening up a positive jaw behind income and cost again.

Okay. Yes, I mean, Mr. Cederschiöld, I think this concludes our discussion today. We would like to thank you for this detailed discussion and any information on key topics. So yes, hope to meet another time and thanks for sparing time.

And my pleasure. Thanks a lot to all of you.

Thank you very much. Have a lovely day.

Thank you.

Thank you.