Danske Bank's (DNSKF) CEO Thomas Borgen on Q2 2016 Results - Earnings Call Transcript

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Danske Bank A/S (OTC:DNSKF)

Q2 2016 Earnings Conference Call

July 21, 2016 08:30 AM ET

Executives

Thomas Borgen - Chief Executive Officer

Jacob Andersen - Chief Financial Officer

Claus Jensen - Head Investor Relations

Analysts

Mads Thinggaard - Svenska Handelsbanken

Willis Palermo - Goldman Sachs

Jan Wolter - Credit Suisse Securities

Johan Ekblom - Bank of America Merrill Lynch

Jakob Brink - ABG Sundal Collier Norge

Daniel Do-Thoi - JPMorgan Securities

Omar Keenan - Deutsche Bank

Jacob Kruse - Autonomous Research

Riccardo Rovere - Mediobanca Banca di Credito Finanziario

Presentation

Operator

Good day and welcome to the Danske Bank's First Half Year Results 2016. Today's conference is being recorded. At this time, I would like to turn the conference over to the CEO, Thomas Borgen. Please go ahead.

Thomas Borgen

Thank you, operator, and I thank you all for taking the time to listen into this call today. Other participants in today's call is our CFO, Jacob Aarup-Andersen, and Head of IR, Claus Jensen.

Please go to slide 1. In today's call, we have the pleasure of presenting Danske Bank's financial results for the first half of 2016. We aim to keep this presentation to around 15 minutes. After the presentation, we will open up for a Q&A session as usual. Afterwards, feel free to contact our IR department if you have any - any more questions. Slide 2, please.

Despite challenging market conditions, Danske Bank posted satisfactory financial results for the first six months of 2016 with a net profit of DKK 9.4 billion and a 12.4% return on shareholders' equity. The results were in line with those from the same period last year. Market conditions in the first half of the year included more widespread negative interest rates, volatile financial markets, low-to-moderate macroeconomic growth, and therefore, relatively low activity, especially within asset management and generally, subdued demand. Our results demonstrate the strength of our diversified business model, however, and show that the continued execution of our strategy of becoming a more customer-centered, simple and efficient bank is yielding results.

The macroeconomic environment varied somewhat in our main markets with Sweden still showing high growth and Norway leveling off, although still at a decent level supported by more stable oil price in Q2. Finland and Denmark continued at around the same growth rate of just below 1%.

The outcome of the UK referendum on EU membership will probably cause lower economic growth in UK and to some extent in Europe, but it's too early to predict the exact effects. The Nordic markets will probably be affected less than other continental European economies. Our operations in Northern Ireland account for about 3% for lending and any lower UK activity will have only a marginal effect on our performance going forward.

Developments in the financial markets were a key theme in the period. The very negative market sentiment we saw early in the year with widening credit spreads and general risk aversion was followed by stronger customer activity at the end of the first quarter as the ECB's monetary policy initiatives in March reinforced investor confidence.

Customer activity remained higher throughout the second quarter and had a significant effect on our trading income. We saw good progress in lending activities as volume grew 4% over the level in the first half of last year. The increase came from Business Banking in all markets and we continued to see solid growth at Personal Banking in Norway.

Sweden began picking up speed as a result of our partnership agreement. The trend was more flattish in Denmark and Finland. In Denmark, customers continued to move up unsecured lending to mortgage lending.

We are very pleased to see the customer satisfaction continues to improve as this is a priority for us. We have made significant progress in the past six months and we met our goal of paying the top two at most business units in most markets.

The picture on costs may appear somewhat blurred as we had extraordinary lower expenses in Q1 and somewhat higher expenses in Q2. However, we are on track to make the bank even more efficient and bring expenses further down as we have done steadily over several years.

Our credit quality remains solid and impairments were very low. Finally, we were able to maintain a very healthy capital position in the period due to solid earnings and diligent business optimization. All in all, a satisfactory period in a challenging environment.

We feel that we are making good progress towards our ROE target of at least 12.5% by 2018 at latest. The various components leading to 12.5% may change slightly but that reflects the strength of our diversified business model.

I will now turn the presentation over to our CFO, who will take you through the financial results in more detail. Slide 3 please.

Jacob Andersen

Thank you, Thomas. Let's take a look at the main items of our financial results. Net interest income came in at DKK 10.7 billion. This was almost unchanged from the year before as lending growth of 4% and lower funding cost mitigated margin pressure.

Net fee income was 10% lower than in the same period last year where we benefited from strong customer activity including extensive remortgaging. In the second quarter, subdued investment activity and a declining assets under management from lower asset values also had adverse effects.

Net trading income came at DKK 3.7 billion, down 15% from the level last year where we benefited from extraordinarily high customer activity. The figure reflects negative credit value adjustments of DKK 0.6 billion and also a gain on the sale of Visa Europe of DKK 0.3 billion.

The improvement in client activity that we saw at the end of the first quarter after a period of difficult market conditions continued throughout the second quarter when trading income rose 34% over the level in the first quarter. Other income rose primarily because of property sales in the first quarter.

Operating expenses were down 3% to DKK 11.1 billion mainly because of lower net contribution to the Danish Resolution Fund and lower depreciation of intangible assets, although we also saw increased cost related to regulatory requirements. The cost/income ratio came in at 48.3%, slightly higher than the year before. Finally, credit quality remains strong. We saw a reversal of DKK 0.1 billion in the first half, an improvement of DKK 0.4 billion from the level last year.

Slide 4 please. At our two Nordic banking units, Personal Banking and Business Banking, we saw satisfactory developments in the first half of the year. Income was lower than in the same period last year. However, when we benefited from exceptionally high investment activity and remortgaging activity, the underlying business continued to improve as we saw an inflow of new business at both units. Our focus on cost efficiency and strong credit quality also continued to support our strong performance.

Starting with Personal Banking. Personal Banking delivered good results with profit before tax up 37% to DKK 2.4 billion. Total income came in 8% lower than in the year before because of decline in fee income. In 2015, activity-driven income, particularly, remortgaging activity in Denmark was very high. Expenses were down 12% owing primarily to lower activity, lower depreciation of intangible assets, and changes in cost associated with guarantee funds. Impairment charges showed a net reversal of DKK 0.2 billion, mainly because of higher collateral values in Denmark.

Total lending volume was up 2% because of gains in Norway and Sweden where lending volume rose 23% and 8%, primarily because of partnership agreements. In Denmark, where volume was almost stable, the trend of higher mortgage lending and lower lending on the conventional loan products continued in the first part of the year. In Finland, demand remained sluggish and volume was almost stable.

At Business Banking, we continued to see good momentum in all markets. There was good activity growth in Sweden and Norway with lending volume rising 12% and 14% respectively. In Denmark, lending rose 9% excluding Realkredit Danmark. And in Finland, where we've seen increased activity in the past three quarters now, lending was up 12%.

Overall, profit before tax declined 5%. Total income was down 6% from the level in the first half of 2015 when customer activity in Denmark in particular was very high. Lower customer activity had an adverse effect on fee and trading income, whereas NII benefited from higher lending volume despite the pressure on margins. Expenses were almost unchanged as cost efficiency measures were partly offset by higher regulatory costs. Impairments showed a small net reversal, mainly driven by continued reversals in the Danish commercial property segment.

Finally, our business in Northern Ireland. Here, we showed satisfactory development in the first half of the year, although a change in the exchange rate of about 14% had an adverse effect on the results. Total income was down 4%. Before loan impairment charges, property was up 5%. Adjusted for the depreciation of the currency, the items were up 4% and 13%, respectively. Expenses were down 9%, 2% adjusted for the exchange rate, reflecting our focus on cost efficiency.

As for impairments, we posted another reversal of charges on the basis of better conditions in the property market, although the reversal was smaller than in the same period last year. We do not expect the UK referendum on EU membership to have any significant short-term effect on our business in Northern Ireland, which accounts for 3% of total lending of the group. It's still too early to predict the longer-term effect, although uncertainty of our future growth has increased.

Slide five, please. At C&I, profit before tax declined 26% from the extraordinary high level in the same period last year. Market conditions were challenging mainly in the first two months, and this led to a decline in client activity and negative value adjustments. Conditions improved by the end of the first quarter however, and client activity increased in the second quarter, particularly for our FICC business and Capital Markets. Total income declined 9% mainly because of lower trading income as a result of lower activity and the negative effects of CVA. Lower fee income owing to a decline in activity was offset by an increase in net interest income.

Expenses were up slightly, owing primarily to increased cost for the Danish Resolution Fund. Impairments, which by nature fluctuated C&I, amounted to DKK 0.3 billion mainly because of collective charges against oil-related exposure.

At Wealth Management, where we have gathered our activities within asset management, pension savings and private banking, the performance in the first half of the year was affected by difficult market conditions that caused lower customer activity and a decline in assets under management. Profit before tax at Wealth Management was down 18% from the level in the same period last year where it was unusually strong. Fee income was down 7% mainly because of lower performance and risk allowance fees whereas management fees, as you know, the largest component of our fee income, was stable.

Trading income was DKK 150 million lower than in the same period in 2015 when it was unusually high, owing to a lower investment result in the health and accident business. Assets under management fell 4%, owing to declining asset prices. The drop in asset prices was partly offset by a positive inflow from net sales and premiums of DKK 25 billion. Finally, allocated capital was around DKK 3 billion lower as a result of lower solvency capital requirements at Danica Pension.

Slide six, please. Moving on to expenses. Operating expenses in the first half of the year amounted to DKK 11.1 billion. That's 3% lower than in the year before due to lower net contribution to the Resolution Fund and the Deposit Guarantee Fund. The decline also reflects lower depreciation of intangible assets. Expenses in the second quarter were higher than in the first quarter due to seasonality and a couple of positive one-offs in Q1. We also had some extra expenses related to the ramp up of our efforts on the regulatory front, especially for anti-money laundering activities, which remains a key focus area for the group. In addition, our sale of property in the recent years is leading to some higher rental costs. Finally, the increase in the number of FTEs from the year before arrived from additional in-sourcing activities as part of our cost efficiency initiatives and from new hirings in compliance functions.

Slide seven, please. The positive trend in credit quality continued in the first half of the year. We had a net reversal of DKK 0.1 billion against a charge of DKK 0.3 billion in the first half of 2015. The loan loss ratio, including non-core activities, was minus 2 basis points for the period. Personal Banking showed the biggest change from the first half of 2015. The positive trend was driven by higher collateral values mainly in Denmark where the housing market improved.

At Business Banking, we saw a small net reversal in the first half of the year, driven by the commercial property segment in Denmark. Our agriculture exposure, particularly in the dairy segment, remained challenging, and we booked impairment charges of around DKK 0.3 billion in the second quarter against this. In the second quarter, collective charges increased DKK 50 million against both oil-related exposure at C&I and second-round oil effects at Business Banking. This brings our total collective charges against oil-related exposures in C&I and Business Banking close to DKK 0.7 billion.

Slide eight, please. At the end of the second quarter, the common equity tier 1 capital ratio was a solid 15.8% on a reported basis. The increase from 15.0% at the end of the first quarter was owing mainly to a significantly lower total REA. The credit risk exposure amount was down DKK 17 billion despite increased lending. The decline owed mainly to a new accounting treatment of our ownership shares in LR Realkredit and Danmarks Skibskredit, but it had no effect on the core tier 1 ratio because there was a corresponding reduction in our capital.

Market risk exposure was down DKK 24 billion and that was the most significant change in the total REA amount. The decline can be attributed mainly to reduced positions at C&I. The leverage ratio was 4.3% according to transitional rules and 4.0% when the new rules are fully phased-in.

And a final note on capital. As part of our ongoing capital assessment, we have revised our capital target. In light of the current regulatory uncertainty, our new core tier 1 capital ratio target is 14% to 15% in the short to medium term. We have revised our total capital ratio target to around 19%. We will reassess the targets as regulatory requirements become clearer.

Slide nine, please. We maintain our outlook for net profit for 2016 to be in line with net profit before goodwill impairments in 2015. Our net interest income, we now expect somewhat less pressure on margins for the remainder of 2016 and we will benefit from volume growth and somewhat lower funding costs. However, in the light of weak activity levels and uncertainty in the financial markets, we now expect fee income for 2016 to be lower than in 2015. Our addition for a return on shareholders' equity of at least 12.5% in 2018 at the latest remains unchanged.

Slide 10, please.

Thomas Borgen

Okay. Those were our initial comments and messages. We are now ready for your questions. And as usual, please limit yourself to two questions. If you are listening to the conference call from a website, you are welcome to ask questions by email. Operator, we are ready for the Q&A session.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] We have questions over the telephone. Will I take the first question?

Thomas Borgen

Yes. Please go ahead.

Operator

We will take our first question from Mads Thinggaard from Handelsbank Capital. Please go ahead.

Mads Thinggaard

Yes. Hi. This is Mads from Handelsbanken Capital Markets. I have - my two questions are - I mean, the first one is aimed at your revised NII guidance. On the Q1 conference call, you guided NII for 2016 flat to up. How should we translate this revision of the NII guidance? Does that mean it's still flat to up or is it just up or is it significantly up now?

And also, it seems - I mean, looking at your new way of management division, it seems it's off to perhaps a bit of a slow start. And I noticed your fee income in Norway and Sweden, where you are growing lending volumes a lot, appear to be still on a quite low level. Do we have any upcoming initiatives within Wealth Management that could kind of change the income level on fee income in Norway and Sweden? Those were my two questions. Thanks.

Thomas Borgen

Okay. Thanks very much, Mads, for your question. When it comes to the NII, you correctly referred to our old statement being flat to the risk on upside. We are now guiding that NII is going to be higher than previously.

We can see that our growth - volume growth seems to be higher than expected. And at the same time, we see somewhat less pressure on the margins and that's primarily outside Denmark. And we can also see that the pressure on deposit margin is partly mitigated by the favorable development in the hold-to-maturity portfolio.

So the final thing, which is something we alluded to several times is also about we see that we need to take effect now is that the refinancing at lower rates than the old funding is starting to come through in the NII. So all that combined makes us more comfortable on the NII going forward.

If you want, we can go it later. If anybody has that [indiscernible] various markets, but that's the overall guidance we're giving.

Mads Thinggaard

Okay.

Thomas Borgen

When it comes to the Wealth, let's all remind ourselves that this is a unit which has been established three months ago and we needed to have some time to put in place the various platforms. We have a very good starting platform with a very well-functioning Life business with Danica, we have Danske Capital, which performed well for many years, and we have an exceptionally strong Private Banking division. I think the slow start of this quarter, which is only one quarter, is more a reflection of the uncertainty in the market. We are very comfortable with underlying macroeconomic trends of wealth accumulation in the Nordics towards 2020 and we believe we have a very good starting point. So our ambitions, our strategy has not been changed, but you need to look it beyond one quarter.

Mads Thinggaard

Okay. But are you going to focus more on this area on bringing up the income and cross-selling now, I mean, in this year? And do you have something that could make a change at this point?

Thomas Borgen

We are constantly looking to optimize our franchise. We have established the wealth unit as a significant signal to the organization and the market that Wealth Management in the wider extent is a strategic area for us to focus on. So, that goes without saying and that continues as we laid down in the communication to you in connection with Q1.

Fees are generally something we will constantly work on and have constantly worked on, and it's more and more important as we are expecting to work in a low rate environment for a prolonged period of time. Again, we cannot distance ourselves from the market activity. So, if there is lower market activity, it will have some impact on our underlying fee business. However, fee business is something we will and will continue to work on, and I'm very positive in the long run on the fees, but it can fluctuate quarter-to-quarter.

Mads Thinggaard

Okay. Thanks.

Operator

We will now take our next question from Willis Palermo from Goldman Sachs. Please go ahead.

Willis Palermo

Hi. Thanks for the presentation. Thank you. My question - I have two as well. The first one is on capital and your revised guidance or revised targets. I was wondering what triggered this over the last three months compared to the previous target. I understand there are some more uncertainty, but is there anything specific to what you're thinking about and does it change at all the capital policy for the end of the year?

And the second question is on NII again. I was wondering if you could give a bit of color on the Danish mortgage rate and reprising your ongoing and what kind of impact you're expecting by the end of the year. Thanks.

Jacob Andersen

Okay. Thank you very much. I'll start with your capital question. So, I think it's a completely fair question. If we just take a step back on the capital side, we do have a very strong capital position, even adjusting for our recent buyback. That gives us a lot of flexibility both to fund profitable growth, it allows us to absorb any increases in REA from a market risk and counterparty risk, which we know are low at the moment, and it allows us at the same time to continue to reward our shareholders.

We have an ongoing assessment of our capital [indiscernible] and we have assessed that the current high regulatory uncertainty, especially the debate around Basel IV, has led to a need for a bit more prudency and, therefore, we adjusted our targets. You know that we up until recently had around 14% as our target and 14% to 15%. So, it's a slight adjustment. Once we have more clarity on the main regulatory unknowns out there, we will reassess our target levels again, but we felt it was prudent to do this adjustment.

Thomas Borgen

Okay. And then your question on NII, and you alluded to Danish mortgages in specific, we have communicated previously that approximately one-third of our mortgage market is being reprised and two-thirds are not being reprised, and it's particular the short end of that curve. That's what we call the F1, F2 and F3s.

If you just do the mechanical calculation, that will, all things being equal, have an NII impact of approximately DKK 300 million on an annual effect. However, we believe that certain clients will move out from the short end of the curve to longer duration. So exactly the dynamic effects, we don't know and we just have to wait and see.

So the mortgage market in itself is not the main driver for the revised guidance on NII. The main revision is that we see less margin compression on the lending side and we see flattening out margin operation on the deposit side. And I also alluded both the growth in basically all our markets and that we have a very solid hold-to-maturity portfolio. So I think it's a combination of all of these factors, which makes us comfortable that NII is now going upwards.

Willis Palermo

Okay. Thank you very much.

Operator

We will now take our next question from Jan Wolter from Credit Suisse. Please go ahead.

Jan Wolter

Yes. Hi. Jan Wolter here, Credit Suisse. Thanks for taking the questions. Given that the company is already around 80 bps or so above the top end - the new top end capital target here of 14% to 15% and that the bank is already paying out close to 100% of this year's profits, how does management see that payout over and above the current DKK 9 billion in buybacks? Could that be a way to adjust the capital structure closer to the target level or is that a less likely scenario? That's my first question.

Jacob Andersen

Okay. Thanks, Jan. It is correct that we are above the 14% to 15% level. If you look at REA developments from here, we would expect credit REA to move up with lending growth, but we also caution that market risk is low from historical purposes at the moment, so you should take that into account as well.

We have changed nothing around our payout policy. After we have met our capital ratios and funded good profitable growth, we will, as our policy states, continue to distribute between 40% and 50% of our net profit and dividend to shareholders. If there is excess capital beyond our capital target, then we will distribute back to shareholders. We will not at this stage be drawn into a debate about the size of our distributions next year, but I can hear you alluding to the fact that we have a good capital decision and we agree to that.

Jan Wolter

Thank you. And is it so that the company doesn't need to call an AGM or EGM rather to take that decision, it's a board decision to change the buyback?

Thomas Borgen

Yeah. It depends. Yeah, share buyback is something the board approves and then sorry - recommends and then the FSA approves it. And everything with dividend is, of course, the AGM decision.

Jan Wolter

Okay. But...

Thomas Borgen

So, nothing yet.

Jan Wolter

Thank you. It's a board decision to approve the - or board proposes it to the FSA and the FSA approves any further measures on capital in terms of buybacks.

Thomas Borgen

Exactly.

Jan Wolter

Thank you. And the second question is there on costs. So, if we look at the guidance, I think the company has had below DKK 23.2 billion for the year. I think this implies a fairly more pick up here in cost to above the DKK 6 billion per quarter level. Is that how investors should think about Danske Bank's cost base in the near term or how should we think about it, especially in the light of higher regulatory cost? Thank you.

Jacob Andersen

Thank you, Jan. No, that's not how you should think about it. Let me give you some color here because obviously, as Thomas alluded to in the beginning of his introductional remarks, we did have a very strong cost performance in Q1. At the Q1 time, we did flag that there was some one-offs in those numbers plus some seasonality. We also highlighted that we expected increase in regulatory costs and continued need for digital investments, and that the Q1 number therefore was too low a run rate.

These are indeed the affects you are seeing in Q2. Besides the removal of one-offs and the Q1 low seasonality being removed, we did see a ramp up in regulatory cost in Q2 as we invested extra to deliver on our ambitious agenda, especially within AML. Some of those costs are mainly external consultants, for example, will fall away in the coming quarters.

So, if I can give you the following approach in terms of looking at our cost for this year, you are right that we are guiding for lower absolute cost than last year. I think there are two ways of approaching the expected level of cost in 2016. First of all, we are still comfortable with the guidance we've given you in the return on Equity Bridge where the midpoint shows a DKK 1 billion lower absolute cost over three years, with the majority being realized this year. That's the first point.

You can also approach it this way. If you'd say the total cost for the first half, so both Q1 and Q2 together, then you have a decent run rate, which you then need to add some usual Q4 seasonality too and adjust for potentially higher or lower activity that depends on your own assumptions from that perspective. But I think those are two good ways of approaching the number.

Jan Wolter

Okay. Many thanks. Very clear.

Operator

We will now take our next question from Johan Ekblom from Bank of America. Please go ahead.

Johan Ekblom

Thank you. If I could just come back quickly to the capital and the market risk exposure amounts. You clearly had an ambition to reduce the capital consumption of corporate institutions for some time. So, what we saw in this quarter is clearly some of that is derisking around UK referendum and things like that. But should we expect all of it to come back on, or can you give us any guidance as to what is permanent and what is maybe a temporary decision?

Thomas Borgen

It's a good question. You are exactly right in that we have worked over several quarters, actually a couple of years now, to adjust the business model to C&I to be more capital light. And we did also due to the adjustment of how to allocate capital put some more capital allocation towards the C&I during 2016. So, that's reduction you see in Q2 in particular is as planned and according to the strategy. You should not expect it to come fully back. But that type of capital consumption may fluctuate slightly between quarters due to their activities in the market. But overall, capital management and capital constrainment in a C&I business is and will remain a key priority for C&I. So, the long answer - I'm sorry - the short answer is, yes, this is low, maybe too low short term, but overall, the trend is in place.

Johan Ekblom

Perfect. Thank you very much.

Operator

We will now take our next question from Jakob Brink from ABG. Please go ahead.

Jakob Brink

Hi. It's Jakob from ABG with two questions, please. The first one is regarding the funding cost tailwind into the second half of the year. I know you gave us a slide with your expected redemptions and issues, but could you maybe quantify a bit just to help us what could be the positive impact in the second half of the year compared to the first half of the year from lower funding costs?

And second question, sorry to come back to this, but your changed guidance on capital, I think you said, Jacob, that it was prudent to change it now. But what is it exactly that had made you change your mind? And also, if I'm not mistaken, you have actually acted according to roughly this target before i.e. when you said 14%, it has really been around 14.5% or maybe even 14.5% to 15%. Now you changed it to 14% to 15%. So should we then actually assume higher than 15% or how should we actually [indiscernible] this change? Thank you.

Thomas Borgen

I will ask Claus to your first question.

Claus Jensen

Yes. We have completed DKK 34 billion and that is more or less half of what we will have of redemptions in 2016. So, what is rolling off for the rest of the year is to a higher extent, covered bonds, and to a lesser extent, senior. There will be further tailwind on the funding cost side. And if we should quantify that, that will have an impact of approximately DKK 150 million.

Jakob Brink

On a full year basis or in the second half of the year?

Claus Jensen

Second half of the year.

Jakob Brink

Okay. Thanks a lot.

Jacob Andersen

Okay. And then, I guess, on your capital question, I think you asked if you should now expect us to be above the 14% to 15% going forward. No, we've given this capital target range for clarity from your perspective.

You're also asking what triggered it, right? Why now? There is not one specific trigger event. As I said, we've been assessing our capital levels, and it's only prudent that we do that as a major player here. This is not something that's been driven by a single event. We have obviously discussed this with the FSA as you would expect us to do. We have a very good dialogue with the FSA and the Danish FSA acknowledges our new targets and the solid capital position of the bank. So it hasn't been triggered by something specifically. But we think this is a prudent level and it provides more clarity.

Jakob Brink

Okay. Thank you.

Operator

We will now take our next question from Daniel Do-Thoi from JPMorgan. Please go ahead.

Daniel Do-Thoi

Hi. I just have - thanks for taking the questions. I just have two questions. The first one is on NII. The second one is just on your current buyback program. On NII, I guess, just over half of your first quarter and quarter increase at the group level was booked within Treasury this quarter. Can you just give a little bit more detail on what is driving this and also how sustainable it is? I think previously, Thomas, you mentioned something about the hold-to-maturity portfolio.

And then the second one on the buyback. I mean if I look at in your report, you bought back about DKK 3.6 billion since the start of February till the end of June which if I calculate it correctly is the run rate of around DKK 700 million a month. To get to the DKK 9 billion by year end, I think you'd need to up the run rate quite a bit around 30%. How much flexibility is there to increase that run rate or to perhaps acquire larger blocks in the market? Thank you.

Jacob Andersen

Well, I can answer your question related to the share buyback program and it's actually not possible for us to have any influence on the share buyback program. As you know, this is done according to the Safe Harbor rules. And it's solely up to the operator to execute on the share buyback program during the year.

Daniel Do-Thoi

Okay. But the target remains completed within the calendar years. Is that correct?

Thomas Borgen

No. February.

Jacob Andersen

No. No. When we came with the full year result, we said in a year which means February next year.

Daniel Do-Thoi

Understood. Thank you.

Thomas Borgen

And the first question. First of all, you should be cautious in putting too much emphasis for what term on the various components of the margin combination, as we have adjusted and we'll continue to adjust, what we call internal transfer pricing. So said, we can tell you that the hold-to-maturity which you asked specifically seems to be holding up well even in a low interest rate environment. So, it's just a confirmation that even though the rates have come down, it has not and do not seems to affect negatively on our hold-to-maturity as we will need to refinancing maturing asset comps alone. The average tenure is approximately three years.

I think it's more important to comment on that the drivers - underlying drivers of the NII is, as I have alluded to, a solid and healthy volume which is slightly higher than expected, less market compression both on the lending and on the deposit side. And then we're just being through on the refunding side. So, I think that's the main drivers of us now guiding NII from flat to up to more up.

Daniel Do-Thoi

Okay. So, there's no sort of...

Operator

We are currently experiencing a momentary interruption in today's conference. Thank you for your patience, and please continue to hold.

Pardon the interruption. This is the operator speaking.

Thomas Borgen

Yes.

Operator

Okay. So, there was a silence there on the line for the moment. Are you okay to continue with the questions?

Thomas Borgen

Yes, we are.

Operator

Okay. One moment. Okay. So, Daniel Do-Thoi, his line is still open for his questions.

Daniel Do-Thoi

Okay. [Indiscernible] I think that answered most of it. So, there's no - so, basically, no fundings there or any kind of benefit from positioning in the quarter? Can I then, also, just confirm the tenure of three years, is that relatively unchanged to, let's say, what it was 3, 6 or 12 months ago? Thank you.

Thomas Borgen

Yeah. Yes.

Daniel Do-Thoi

Okay.

Thomas Borgen

Yes and yes.

Daniel Do-Thoi

Great. Thank you very much.

Operator

We will now take our next question from Omar Keenan from Deutsche Bank. Please go ahead.

Omar Keenan

Good afternoon. Thank you very much for taking the questions. I had - I guess most of my questions were answered, but I just had two more. One on fee income, and then, secondly, your view on interest rate policy in Denmark.

So, firstly, on fee income, if I look at the first half and I annualize the fee income performance then, I'm getting to a figure around DKK 13.5 billion. And as we know, there's seasonality in the fourth quarter from the performance fees which is a couple of hundred million that can go up to maybe DKK 13.9 million, DKK 14 billion. Just wondering if you could give us an updated view around what you think the fee income growth potential is. Obviously, you've given the [indiscernible] ROE ladder. But do you expect any kind of bounce back in fee income or is this the run rate that we should expect? And then, my second question was what your thoughts were on the Central Bank policy rate in Denmark.

Thomas Borgen

Yeah. Jacob Aarup will do the first one.

Jacob Andersen

Thank you. So, let's start with the fees. With the new guidance, yes, we are guiding fees lower, but we're not going to give you a specific number that we are believing in. I think just taking the first half and which we have made very clear, we think it reflects subdued activity. I think it would be probably be the wrong assumption to just annualize that. You also alluded to the fact that Q4 is always strong on the fee side due to specifically the booking of performance fees in our investments businesses, et cetera. So, this year is due to the subdued start of the year. It will be a little bit of an odd one out in terms of book rates, but we do expect the usual seasonality around fees. Then you asked about where do we see fee growth rates.

Omar Keenan

Sorry. Could I just ask a quick follow up on the fee income? You said that, yeah, the first half was affected by the subdued activity. I mean, do you see that changing in the second half?

Jacob Andersen

Well, that's a good question. We don't have any forward-looking indicators that goes out in terms of the fees for the next six months, but we - but that being said, we have seen throughout our channels that the uncertainty also leading up towards Brexit, et cetera, has led to especially on the investment side more subdued activity. People have been sitting more on their hands. And I think that's a feature you also heard from some of our colleagues in the market seeing the same sort of trends.

Omar Keenan

Yes.

Jacob Andersen

Our numbers look - on a year-on-year basis may look more hit by that significant fact that we had a very strong first half last year where especially Denmark had remortgaging activity at very high levels. So, that gives us a tougher comp to work with.

In terms of longer term fee generation, we don't have any changed view. We - as just Thomas alluded to, we have full confidence in the - especially around the Wealth Management story where we see a structurally growing fee pool. We have previously mentioned 7% to 9% as the structure to growing fee pool from that segment. So we do see good fee growth from 2017 and onwards.

Thomas Borgen

Okay. And then to your second question of the interest rate policy in Denmark. As far as we know, it has not been changed. They set the rates according to their fixed currency pick of the Danish kroner to the euro. The interest rate is today at minus 65. There was a slight inflow in Danish kroner during just before and under the UK vote on EU exit. But that was intervened by the Central Bank by currency intervention. It is our economist view that the Central Bank will keep the present rates at minus 65 throughout the year, and we'd rather like to do interventions if there is some pressure, in other words, interest for the Danish kroner. So that's the main policy we have.

If they would move on costs, they may move down back to the old low level of minus 75 but it is not our take and no other market participants who believe they would cost any further than that if they all will cost to minus 75. The economic effect of a 10 basis points cut if that would happen are marginal.

Omar Keenan

Okay. Thank you very much. [Operator Instructions]

Operator

We will now take our next question from Jacob Kruse from Autonomous. Please go ahead.

Jacob Kruse

Hi. Thank you. Sir, just two questions as well. First, on credit loss side, could you say anything about how much of your loan loss reserves or reserves that are strictly related to house prices, i.e., how much would you recover if house prices recovered back to peak levels basically in Denmark and Ireland? And my other question was just on the cost target. Just to clarify, you say we should look for a DKK 1 billion of cost reductions versus 2015. Is that versus the DKK 23.2 billion cost numbers? So, at DKK 22.2 billion cost target is that effectively what you're guiding for? Thank you.

Jacob Andersen

Why don't we start with the cost, Jacob. So, what I was - when I speak about DKK 1 billion down in absolute cost over three years that refers to the level in 2015. So, that's DKK 23.25 billion that you alluded to. So, that is the number we are talking about. Just to make sure the reference is correct and we are saying the majority of that will be in 2016.

Jacob Kruse

Okay. And does that still fit within your midpoint ROE guidance with the other revenue line? Was that - because I seemed to remember we were looking at below DKK 22 billion cost number to back out the 12.5% ROE given your other revenue guidances.

Jacob Andersen

When - I think there is an important point there which is to remember we have restated Wealth.

Jacob Kruse

Right.

Jacob Andersen

So, please have a look at that as well because that led to an increase in our absolute cost. It didn't lead to any change in our net income but we went from a net line around the insurance business. So we used to have a one liner called net insurance income, and now we have grossed up the number. So we both have the total income and total cost from insurance. That has led to a larger absolute cost level without changing our net income. So, I think that's the effect when you refer to the below DKK 22 billion.

Jacob Kruse

Right. Okay. Great. Thank you.

Thomas Borgen

And your last question was on the effect from better housing prices.

Jacob Kruse

Yeah. Yeah.

Thomas Borgen

It's very difficult to give you any precise indication because there are actually quite many moving parts here. But we have previously stated something around that there is of course a positive development in credit quality once we see better housing prices. But we also have to admit that we have seen quite a strong development in the Danish market, and we have benefited very much from that. You can see that on our impairment dynamics over the last year or so.

So, there is, of course, a limit for to what extent that we will continue to benefit from higher collateral values. There is no [indiscernible] areas not so much within residential real estate, but primarily within commercial real estate where we could see an effect coming from better pricing of commercial properties.

Jacob Kruse

And is it possible to size that pool of recoveries?

Thomas Borgen

No.

Jacob Kruse

Okay. Thank you.

Thomas Borgen

Okay. Can we have your last question please?

Operator

We will now take our next question from Riccardo Rovere from Mediobanca. Please go ahead.

Riccardo Rovere

Yes. Just - thanks for taking my question. Just one. Yes, the bank has just stated that [indiscernible] area are tilted to the downside. Shipping and oil and gas are not exactly living their glory days in the Nordic countries. So, if I'm not mistaken, during the call, you stated that at the current stage, it is too early to state what the risk could be in Northern Ireland from Brexit.

And in the meantime, you are raising your internal capital target to somewhere between 14% and 15%. But in the meantime, you have capital return strategy of paying out basically 100% of your earnings. And if I'm not mistaken, you also stated that from the current levels, you expect risk assets to go up maybe a little bit in market risk. And maybe, also credit risk should grow in line with the volume growth. Now, if this is the context, how sustainable you think [indiscernible] capital return strategy that allows no capital accumulation, unless this comes from lower risk-weighted assets?

Thomas Borgen

That was a question with a lot of assumptions, a lot of angles and a difficult one. But I think what you were saying is what is our capital strategy, if I understand you right. The strategy is very clear and very firm at the present stage. Short-to-medium term, as Jacob has alluded to several times, we find it prudent to have a capital target between 14% and 15%, which is taken into consideration, debt uncertainty which we all see and maybe also taken into account uncertainty of what we refer to as Basel IV. But nobody else know really what a Basel IV will end up to be. It's also a confirmation of what our practice has been that we have held a capital slightly above 14%.

Secondly, we are very clear that we have a dividend policy between 40% and 50%, which should be very stable through any cycles. Thirdly, if we have capital beyond the capital position, the dividend and healthy growth, we will distribute that back to the shareholders in way or another. If for any reason in the future, we do not have excess capital, we will not distribute excess capital. If we have excess capital, we will distribute excess capital. That's why we have a clear dividend policy. That's why we have a clear capital policy. And that's why we're saying if beyond that we have excess, we will distribute it back but that will, of course, change over time.

Riccardo Rovere

Okay. Very clear. Thanks.

Thomas Borgen

Thank you.

Thomas Borgen

Okay. Thank you, all, for your interest in Danske Bank and for your questions. As always, you are all welcome to contact IR Department if you have more questions as you have time to look at the financials in more detail. A transcript of this conference call will be added to our website and IR app within the next few days. Thank you very much and have a good afternoon.

Operator

That will conclude today's conference call. Thank you for your participation. Ladies and gentlemen, you may now disconnect.