Svenska Handelsbanken AB (publ) (OTCPK:SVNLF) Q2 2022 Earnings Conference Call July 15, 2022 3:00 AM ET
Carina Åkerström - President and CEO
Carl Cederschiöld - CFO
Peter Grabe - Head of IR
Conference Call Participants
Magnus Andersson - ABG Sundal Collier
Maths Liljedahl - SEB
Andreas Hakansson - Danske Bank
Nicolas McBeath - DNB Markets
Omar Keenan - Credit Suisse
Namita Samtani - Barclays
Rickard Strand - Nordea
Sofie Peterzens - JPMorgan
Riccardo Rovere - Mediobanca
Jacob Kruse - Autonomous
Robin Rane - Kepler Cheuvreux
Jens Hallen - Carnegie
Maria Semikhatova - Citibank
Piers Brown - HSBC
Good morning, and welcome to the Handelsbanken Q2 Report for the Second Quarter 2022. We're going to begin by listening to our President and CEO, Carina Åkerström presenting the Q2 figures, together with the CFO of the company, Carl Cederschiöld. After that, we will have a short break. And then we will have a Q&A session over a phone conference service, not therefore broadcast in this channel. You can find information on how you log on to the Q&A session at handelsbanken.com under the section IR, and information was also included in the press release that was published together with the invitation.
This presentation, the Q&A session rather will be held in English, presentation [ph] in English. You can do so by logging into the telephone conference service where it will be simultaneously translated. And you find the information on how to log on to that on handelsbanken.com under Investor Relations.
Now let's begin with the presentation. Carina, over to you.
Thank you, Louise, thank you. And once again, good morning. A warm welcome to you all for this Q2 report from Handelsbanken.
We have a good first quarter to report, the first six -- good six months with a record strong situation of controlled cost development and virtually nonexistent credit losses. And the capital situation is strong. Handelsbanken therefore, is well positioned to continue to grow in a successful manner and with profit in funding, deposits and asset management. If you look more from a business focus perspective on the numbers, a picture is painted of a bank which is very well-positioned and standing strong in the new global situation, and the new market we're now currently operating in.
We're growing in lending and deposits. We can see this in the net interest income, which reached the highest level so far ever recorded. It's increasing, as can be expected, in a bank like ours when market interest rates go up. And in a market with a decline in the stock exchanges, the Handelsbanken performance is above and beyond those of many other players in net fees and commissions. The net flow out from the bank were marginal and we've seen major movements in the market overall. Credit losses are virtually nonexistent.
So our asset portfolio is continuing to be at a very high quality level. Capital situation remains comfortably strong and stable. And the costs are currently at a level which we are happy with. They are going up but in the right places. All-in-all, the stability over the quarter means that the C/I ratios continue to drop. And perhaps the most rewarding point of all is the major changes we're witnessing in the UK. After a couple of years of intensive work, UK is now delivering a very strong performance.
Let's have a look at and sum up the first quarter compared to -- the first six months, compared to the last year. So this is January to June. Operating profit by percentages to C/I ratio dropping at 46%, income up by 2%, costs up by 1%. Income is driven by a record strong net interest income and net fees and commission for the six months holding up well.
When we see a drop in the stock exchanges, this is to some extent, counteracted by the negative valuation effects which can be seen on the NFT line. So cost expenses going up by 1%, adjusted for nonrecurring items, and at the same time, we're stepping up the pace in our development. And should also add whilst the overall inflation generally appears to be speeding up during the first six months, credit quality -- asset quality remained strong and credit losses, as I mentioned, are virtually nonexistent.
Let's have a look at this quarter, compared to -- 2022, we see net interest income up by 5% between the first two quarters, increase in business volumes and a positive impact of the increasing market interest rates. Net fees and commissions are dropping somewhat, but it's still holding up. NFT has an impact here as well. So all-in-all the income is down by 2% from the previous quarter. Expenses unchanged adjusted for Oktogonen and currency effects have increased by 1% which can be explained by normal seasonal patterns.
The operating profit to a change of 5%. And this is excluding the valuation effects I mentioned on the NTF. The C/I ratio amounted to 46.6% and underlying credit losses is in fact consisting of net recoveries, but we're making general reserves as a result of the current global situation. Let's continue and have a look at our lending. We grow and we see an excellent growth in all of our markets. On the household lending side, we see a stable increase to the tune of 5%.
Looking at corporate lending, we see a good development, 11% compared to previous year. And for the first five months of this year, Handelsbanken was the major net lending player in Sweden in terms of lending to corporates. It is a well-diversified business between property lending and operating companies. And if we look at deposits, we see an excellent growth here as well, by as much as 11% on the private side. And on the corporate side, we also see good development. It's an important component in the bank's business. And in the current interest rate situation, it's important. For SEK1 of SEK4 invested in Sweden deposit went to Handelsbanken.
Let's look at savings continually. We see a continued good development. The strength and the robustness we've managed to achieve and accomplish over a long time, with net inflows into the bank, as you see to the right of this slide. In fact, over more than 10 years now, an average of 25% of the net inflows in the market ended up in Handelsbanken. And gradually, we've increased our market share. We're now at a market share of 12.2%.
The market share of the net inflow from the past 12 months has been just over 40%. So the savings business is operating well given the current macro economical situation. The market sees outflows, but the bank net flows have only been impacted marginally. Now let's try and sum this up. Where we are currently in a session where income is increasing more rapidly than expenses. C/I ratios trending downwards and our expectations, of course, is for this to continue.
Let's have a look at our assets and our asset quality. As I mentioned previously, credit losses are virtually at zero with a stable portfolio, low-risk portfolio and as expected, no credit losses. And this has been the situation over the past few years. The provisions we're making linked to the reserves, partially related to the pandemic, but also of course, because there is a number of uncertainties in the world around us. So in addition to robust credit process, skilled people working in the bank, and the explanation above and beyond that is explained by the actual identification of the portfolio.
Let's zoom out to some extent and have a look at our home markets and the situation for the first six months of the year. Let's begin by looking at Norway. We continue the good growth. We've achieved an all-time high on net interest income, up by as much as 6% over the first six months. Net fees and commissions in Norway up by 5% despite the market turbulence there. And all-in-all, income is up by 6%, 0C/I ratio just below 38% and we have an excellent business where we're also increasing our development focus to strengthen customer meetings on the household and private side in particular.
And then Holland and Netherlands, we continue to see excellent growth here as well. Lending, up by as much as 21% compared to last year and income up by 16%. The C/I ratio continues to move steadily downwards.
Let's have a look more closely at the markets in Sweden and the UK. In Sweden, our largest market, here, we continue to see a stable business development with good key ratios, stable development also in net interest income. Households, mortgages, stable growth, 5%. Corporate lending, growing by 10%, and with an excellent mix, as I mentioned earlier, between property and operating companies.
Net fees and commissions, impacted by the development on the stock exchanges, but we're holding on to our position and we're continuously gaining market shares, as I mentioned earlier.
The UK, well here the major trend -- change is perhaps to be found there. We've had a long period where we've invested a great deal of effort and time, but we've seen a clear momentum in the business. And the tide appears to have turned. Income is up, costs are down and expenses still rapidly dropping. C/I ratio, which ended up at 57% compared to 73% a year ago. Operating profit in the UK is at the highest level ever for the partial year, 43%. And return on equity as much as 14%.
We also see a volume development in the UK. It's beginning to be more and more visible. On the corporate lending side, volumes are up. What we're also doing in the UK and been doing for a period is that some of the corporate lending has been -- I mean it’s sort of hiding the general development in lending. We strengthened our portfolio, in fact, by off-boarding to some extent. So all-in-all, we see excellent development in all our home markets, in particular considering the current macroeconomic situation. We're increasing business volumes. We see improved margin and keeping expenses at a good level.
Let's have a look at our capital. Then I mentioned initially that the capital situation is excellent. CET1 ratio, 18.7%, 480 basis points above the regulatory requirement and 180 basis points over the bank's target range. All-in-all we see strong development in our business to have the capacity to meet the demand of our customers thus placing the bank in an excellent position. We are well positioned in the new current situation in the world globally and in the market, and we focus on continued growth in the future. Over to you, Carl.
Well, thank you, Carina. Then we're going to look at the development of the net interest income and we will start with comparing quarters, 2021 and 2022. And you can see that net interest income is up 5%, also adjusted 5%. And if you look at the slide, you see the different components. And we see that we have a strong volume growth in our net interest income, 2% up is what we see.
And we can note that previously when we have had good numbers, we have had about SEK100 million in contribution to volume growth and now it's SEK145 million. So very strong growth during the quarter. Margins are up as well with the changes in interest but this is mainly from deposits and this is something that we see in all our markets. So we have a strong development here as well.
And the liquidity portfolio also adds SEK65 million to net interest income. We have another item, and that is NFT in comparison. And that is something that is relevant as well. But other items are more or less negligible. And the development is strong over the quarter. Over six months period, it's even stronger, up at 9%, adjusted at 7% and you see the volume contribution 3% and margins 2% up, which means that we are in a very strong momentum in this respect.
FX, currencies contributes to net interest as well, comparing the two years, and that is also what we see the difference between headline and the adjusted level, 9% up. So strong development when it comes to net interest income generally speaking. And if we disregard development in the UK, this is what we feel is a really strong component of our report.
Then looking at net fee and the commission income, more generally speaking, we know that the stock exchange development has an impact, and that is what we see here, that we have a robust situation in net fee and commission income, with an increase over the first six months in spite the stock exchanges. And here as well, you see the different components. Savings representing about 70% and our savings commissions over the quarter are down 16%.
But you can see in the slide that if we compare six months periods, we have a strong development. And underlying this, we have our capital under management that is declining less than the markets. So we see less of an impact from securities and we have flows that are higher than in the market.
Under payment fees, that is what you see in the middle, and here, we see nowadays a positive development. And we also see that we're moving away from the COVID pandemic, and this is something that is trending upwards, so which is good. And other fees and commission, more or less flat.
And then expenses, if we look at the development, we will start with the six months period, comparing the first six months to last year, and we see costs up 3%. But if we look to the left at these different steps, we see that we have FX effects up at 2%, which means that -- well that brings us to 1%. That needs to be explained. And then we have the Oktogonen, removing 1%. And then we have 2%. And we see that we here have a strong development when it comes to development expenses, which is where we are investing in the future.
And at the same time, we're making underlying businesses more efficient. And this is something that we like. We want to enable investments in the future at the same time as we become more efficient. If we look at the quarter, it's even less of a change. And here as well, we can adjust for FX and the Oktogonen. We see underlying expenses up 1%. Underlying expenses are up 1%, with seasonal variations, this is just natural and it is a very low increase in expenses. And nothing dramatical whatsoever, when it comes to expenses. We continue to invest for the future and we make our business more efficient.
And with that being said, well, I hand back over to Carina.
Well, thank you, Carl, and then if we are to summarize, we have a good first six months in 2022. We have nice growth in our business. The bank is well-positioned for the situation that we're in. NII record high, capital situation is high and credit losses nonexistent. So I have to say that we are strong, stable and that this is a very nice feeling.
And with that being said, well, I hand back over to Louis. And then we are to conclude this broadcast and there will be a short break. And then in a couple of minutes, we are going to have our Peter Grabe, Head of Investor Relations that will start the telephone conference. And information about how to log in, you’ll find under handelsbanken.com Investor Relations. So welcome to the Q&A session that will be in English. Thank you.
A - Peter Grabe
Hello, and welcome back, everyone. We are now ready to start the Q&A session. So operator, could we please have the first question?
Thank you. And the first question comes from the line of Magnus Andersson from ABG. Please go ahead.
Yes. Good morning. Starting with NII, on margins and volumes there. First of all, when I look at this Slide 22, where you have the quarterly breakdown, the quarterly NII bridge, I was just wondering if you could break down the SEK195 million there, net effect on margins, funding costs and home markets by market. It looks like it is a pretty large share on the UK. But if you could be a bit more specific there. And then secondly, just if you could confirm that the minus SEK95 million you took on your liquidity portfolio from moving it from Finland to the Netherlands, that it's included in the minus SEK19 million there in other.
Secondly on volumes, just wondering if you could say something about the sustainability of the strong corporate loan growth in Sweden. And secondly, you repeatedly talked about the strong volume growth and good volume growth in the UK. It's the second quarter in a row, but I don't really see it on Slide 18, at least in the Fact Book. So I see the margin effect, I see the cost effect in the UK driving earnings, but I don't really see volumes there. If you could say something has come in towards at the end of the quarter or how you say that?
Finally, just on a more strategic note, I saw you took a provision in the Finnish operations for potential future expenses related to the looming divestment there. Should we read anything into that at all? Why are you doing it this quarter? That's all for me.
Okay. Thanks, Magnus. I'll start, and then I think I'll need some help from Peter in a sec. But let's start then with the NII. What I can say about the margin development in the NII is that if we break it down on a general perspective, first of all, in the markets, you can say that the Norwegian market, we still haven't really thorough follow-through in margins, and that's because we have notice periods in Norwegian. In UK, as you say, we have a strong margin development driven by the deposit margins primarily.
In Sweden, we also have a fairly good margin development, not at all in the magnitude as we do in UK, but nevertheless. And in Netherlands, we still don't see a margin expansion, and that's obviously due to the ECB being a bit later on in the cycle vis-à-vis the other ones. But I'll have to ask Peter to dig into the components of the SEK195 million, which you were asking for.
And then the liquidity portfolio effect, yes, the SEK95 million is in the other margin, the negative SEK19 million. And what you can say about that is that if we see ECB hiking rates and go into positive environment that SEK95 million will most likely turn into positive over time.
Then as you say, in volume terms, yes, we see strong volume in Sweden. And looking ahead there, I mean, I think there's a lot of natural trends, obviously, around right now. But what we can say is that there are obviously a reason to be -- reason to -- there is a risk that we see a bit less of a credit expansion going on, obviously in the future. But having said that, I think that on the corporate side, obviously, they have a fairly challenging market in funding themselves via the bond markets.
So we deem that we are a bank who can support definitely our core clients and we will be there -- we will try to be there for them. And that's a really good situation to be in. So I do think that we enter a phase of the market where we could, in relative terms, take good market shares when it comes to the corporate markets. As you say in UK, no, we don't see volume growth as of yet in a good magnitude. We still struggle on the household lending there. But on the corporate side, as Carina also alluded to in the press conference, is that we have exited some volumes from an AML perspective. So you don't really see the underlying trend of the corporate lending growth there.
So we have a strong pipeline and we actually see some decent growth there as well on a gross level. The provisioning in Finland, no, you shouldn't read any long-term consequences out of that one. That's just one-offs, which we -- when we know that one-offs will come, we provision for them immediately. So no long-term consequences.
And then just to get back to your first question about the margins and funding effects per country, we write explicitly in the report in the respective segments the magnitude, so you can easily find the figures there.
Yes, okay. Thank you very much.
And the next question comes from the line of Maths Liljedahl from SEB. Please go ahead.
Yes, good morning. My follow-up there a little bit on NII. We now see a steep rate hike. When do you believe that you will actually need to give something to the client here in terms of deposits, i.e., when the rate effect abates? And I guess there's only one rate hike in the current numbers. Then yes, we could follow-up on the trading losses. I just see that there's a lot of quite big increase in derivatives in the quarter, up to SEK55 billion. Is that in any way linked to hedges? Or should I read anything into that? We can start there.
Thanks, Maths. I think obviously, there's so much moving parts right now in the NII when it comes to margins. And as you say, yes, in the early hiking season, we give fairly little to the clients. But I do think it's very, very hard to answer that question just purely on the magnitude, the price we give to the clients on the deposits.
I do believe that when it comes to the overall margin perspective, on both lending and deposit side, as I say, we've seen some increase now from a few years of actually gradual downward pressure, which I think is not -- it's definitely not an outlier. It has so far come via increased deposit margins. But the way it will play out in the future, I think it will be a matter of the competitive landscape, both in lending and in deposit terms.
We obviously track quite a bit of deposits. So from just demand and supply factor, one could argue if we need to hike it. But over time, we will play in the competitive sphere. So we will adjust to the levels which we see. But my main conclusion is that it's not that on a margin level we don't see -- it's not that we see extreme levels of margins here. But I do think you can't judge the deposit and the lending separately.
The NFT, no, you shouldn't read anything in the increased derivative volumes there. Rather, as we've said, is that we see -- we rather -- we divide the NFT into three components, more or less. And you can see it on the Slide 25 in the pack that, first of all, we obviously have a more or less markets and investment banking business model which is client-driven. And on the green bars on Slide 25, you can see that they moved down a touch this quarter, but no dramatic there.
Then second of all, we obviously have -- first of all, we provision for the life pension for the guaranteed pension system. And that's included in the light blue bars. And secondly, in these light blue bars as well, it's included all the hedging we do for all the short-term lending, et cetera. And with the movements you've seen in the currencies now which doesn't move completely in tandem, that affects that negatively this quarter.
And thirdly the liquidity portfolio, which is the pink bars then, which we have broken out on the right side of the slide where we include the NII component in gray bars vis-à-vis the pink bars, the NFT component of the liquidity portfolio. And as you can see in the dark blue line there is that it hits us quite negatively this quarter. But both the pink bars and also the light blue bars, we think there's -- definitely they will come back over time, the majority of them. So we see fairly little long-term consequences from it.
I think that when it comes to the derivatives, the volume will obviously be quite a lot affected from the market valuations. And when the movements become as big as they are, they grow in size. So you shouldn't read any long-term consequences into it.
Okay, thank you. Very clear.
And the next question comes from the line of Andreas Hakansson from Danske Bank. Please go ahead.
Thanks and good morning, everyone. Just going back a little bit to NII. We heard SEB yesterday talk about mortgage margins and the way they looked at it just assume that all mortgages were funded with covered bonds. They said that margins are going down sharply. But obviously, that's not the case. And I guess you have some 45% of your mortgages funded with covered and the rest are deposit funded. So could you tell us, on your actual funding cost of mortgages, where do you see that mortgage margins are going at the moment?
Well, I can try to start and then, Peter please fill in. I think that for many years now, we've obviously seen -- first of all, we've seen a moment where banks are being more interested in the mortgage market. So more or less all of our bigger banks are focusing on the mortgage markets now. Then we've seen the new disruptors coming in, which fund themselves -- which more or less dropped [ph] mortgages and they fund themselves via the pension funds then.
I do think that, first of all, what we've seen lately now is that the funding cost for the disruptors are being more -- it increases more than it does to the banks and the larger banks. So obviously, we fund ourselves by -- to a high degree, covered bonds, but also deposits in that market and obviously senior funding as well. So we do think that from a margin perspective, I see little structural reason to believe that the margin pressure shouldn't abate, all else equal.
So I look fairly constructive actually on the margin perspective when it comes to the mortgages. And I do think that it will, over time, the competition should loosen a touch. And all else equal, the larger banks should have a fairly decent position there. Then I must go -- allude to the answer to Magnus' question earlier on that, what will end up at the lending side vis-à-vis the deposit side? I don't know.
Yes, fair enough. Another question. There's been so much noise in the last quarter about asset quality, particularly related to, I guess, both household real estate in Sweden, but in particular commercial real estate. Since you're one of the biggest player in both fields, could you tell us what you see and what you actually believe is the correct figure?
Yes. I mean, first of all, I think we can go to the Slide 27 in the pack. We've tried to break down our exposure now. First of all, obviously, we enter a tough market now and I think you really need to be humble in these instances, obviously. And what we've done on Slide 27, we've broken down the exposure we have to the real estate. And obviously, yes, we are a big bank when it comes to lend to the real estate market.
As you can see there, we're starting from the bottom. More or less half of our lending is household mortgages. Then on top of that one, we have another 11% vis-à-vis housing co-ops. So 60% of the lending base is towards households. And then on top of that one, we have roughly 30%, which is lending to corporates in real estate. And half of that is commercial real estate, half of that is residential real estate. And the consequence of this is that we only have 12% left in lending to other corporates. And one of the key pillars, which we've always guided on when it comes to our credit policy is that we like to do securitized lending.
And I do believe that when you look into this, I think that the markets will face challenges. If it comes to household, it will be higher rates or higher inflation figures. So it will be strained. When it comes to the CRE and residential real estate, it will be rather about falling valuations on their portfolio, and it could be about the rental levels, the vacancies. What we are extremely firm on and what we've always stood firm on is that we like good clients with solid cash flows. If you obviously have solid cash flows, you are likely to be able to pay your debt.
We like the strong owners. If their cash flows move into problem, we like them to be able to pitch in more collateral. We love obviously low [indiscernible] levels and that's why we are populated in areas and we like to lend to areas which we deem feasible in that sense. And then obviously, we talked a lot about securitized and low loan to value. So that's really the pillars of ours.
And I do think that what Carina was saying, the asset quality we have, we really like this component. Obviously, you see that the real estate market are under strain now. And you can obviously -- it is a matter of that the lending rates for them at the moment are below the yields of their portfolio. And this needs to find a balance over time. And that could affect, obviously, the valuations of the portfolios. I think a bank like us with a strong balance sheet we have, with the clients we like, we're in a good situation to actually find business opportunities in this market. And we like -- it is these kind of markets where we normally tend to actually improve in the relative space.
So I don't know if you want to add something, Carina or Peter there.
No, I think that you summed it up quite well actually. And I mean, you said everything. When we stress this portfolio, we can see that we do have customers with good margins. And from our perspective now, we can't see any changes in the near time actually.
Okay, thank you. That’s it for me.
And the next question comes from the line of Nicolas McBeath from DNB. Please go ahead.
Thanks. First question on the corporate margins. Your peers yesterday made some upbeat comments on the outlook for corporate lending margins given widening credit spreads this year. So do you share similar optimism for corporate repricing? Yes, that's my first question, please.
Hi, Nicolas. Thanks for the question. Yes, I mean, I think on the corporate sector, the capital market has definitely cooled off to quite some extent. And I do think there's a risk, obviously, that you see the credit demand as well cooling off on an absolute level. But obviously, when the financing capabilities of the bond markets are going away, the relative demand on the bank financing are increasing. And we are in a good situation to support that.
We have good capital situation and liquidity situation. So yes, I do believe that there is obviously good reason to believe that the margins should increase. Because obviously, if you look -- and this is especially true when it comes to the real estate market. If you look at the financing cost in the bond market vis-à-vis the bank market, I think they're at very, very high historical levels. So that should, all else equal, obviously point to higher margins going forward.
Thanks, and then another question on mortgages and the NII. So looking at the reactions after the Riksbank's April rate hike, I think your list prices were increased quite quickly. But then looking at negotiated rates that you published, they were slower to increase. So what can you say about the timing of the repricing in your mortgage book? How large lag effect do you see from the rate hike? And do you expect continued tailwind to your Swedish net interest margin based on the April rate hike from perhaps a delayed pass-through to mortgage borrowers?
I -- please, Peter fill in, if you -- I don't think -- we won't play this as a robot. We will obviously always play it from a competitive perspective. We will adjust when we think it's feasible to adjust and accordingly to the competitive landscape. I don't -- but having said that, I mean, I think that the overall margin development now in Sweden is quite constructive. Yes, it's driven by the deposit side obviously and we still see downward pressure from the mortgage side. But as I said earlier on, I do think that looking forward, I do think it's a bit more constructive marginal landscape.
So I don't think -- we can't guide how we will behave ourselves going forward. We will rather adapt to the competitive landscape.
Yes, sure. But I mean, not trying to figure out how you'll behave going forward, but just if your mortgage book would be at a similar level as it was by the end of the quarter, would that offer further tailwinds to your NII? Or is the impact from the rate hike in April. I mean how much of that is reflected in the Q2 NII?
It's actually fairly difficult to quantify that, so I'm afraid we're going to have to pass on that question and get back when we have Q3, when we have a full quarter after the start of rate hikes in Sweden. Then we will probably have a better assessment.
Okay, thank you.
The next question comes from the line of Omar Keenan from Credit Suisse. Please go ahead.
Good morning, everybody. Thank you for making the time. My first question was on capital planning, please. So you made a comment about commercial real estate and the fact that rental yields are currently below funding costs which might lead to asset price falls. And I'd certainly agree with that statement. I was hoping you could give a bit of a sensitivity as to what the impact of rating migration might be on the capital intensity of the book.
So if I look at the property company's risk weight it's 16% today, and it was 22% in 2018. And I understand that there's some LGD flows in the book. But I was hoping you could give us some sensitivities of what LGDs might do. And also, more generally, if we get some rating migration, say, equivalent to a one notch downgrade on 20% of the book, can you give us some indication of what that does to RWAs? And just on a related point, is there anything you can tell us about the IRB overhaul? Thank you.
Thanks for the questions. Well, first of all, let me start with the capital situation. Yes, as you say, we are in a really strong situation there. We think this is really, really good to go into the markets where the demand could increase. And when it comes to the sensitivity on the capital, we've been making -- we've been trying to make a message to all of you for quite some time now that our capital situation is much, much more stable than it's been in the past. And the reason for that one is, first of all, obviously, pension system which we changed during the last years and with fairly nice timing in actually.
So with these equity drops which we've seen, that would have been a headache had it been two years ago. Then second of all, obviously, we have now risk weight floors or standardized models on roughly 70% of the portfolio. And that makes our average risk weightings on our portfolio much, much higher vis-à-vis our internal risk weights. So we could live with quite high actually risk migration or very high risk migration before it really hits on -- before it affects the capital volatility.
And the IRB, we're working on that one in UK definitely. We work with a fairly constrained PRA which is affecting the time schedule as well for it. So our best estimate is 2025 going into IRB. But as we've been highlighting as well, one shouldn't expect us to go to an advanced IRB model, rather a foundation IRB. But having said that then, I think it's extremely impressive in UK terms to run a business model now, which we're posting this quarter now 14% ROE under the risk-weighted assets calculated on the PRA methodology and the capital levels on the Swedish FSA perspective.
So that's obviously a really good situation to be.
Is there any color that you can give us in terms of sensitivity in the commercial real estate book? If we have a reduction in asset prices, at what level that impact cost driven [ph] defaults?
No, I don't think we can guide on that sensitivity, no.
Okay, thank you.
And the next question comes from the line of Namita Samtani from Barclays. Please go ahead.
Good morning. Thanks for the questions. I've got two, please. Firstly, when can we expect to hear about excess capital returns, because correct me, if I'm wrong, but there's a significant chunk of excess capital now, and the only headwind I can think of is the IRB model changes, and there's actually tailwinds such as the gain from the Denmark sales? And secondly, looking at the branch numbers, they only declined by two in the quarter, which I guess is a lot less than other quarters. So are we now done with the majority of the branch reduction? Thanks.
Thanks for the questions. Yes. First of all, obviously, yes, as you say, we have a really good capital situation, and we like that. We obviously enter quite tough markets now where with quite high uncertainty on the demand level. So we really like to be well capitalized in the situation we go into. We definitely -- we're always a bank who want to run with the highest confidence and the highest stability levels. And we do think that the markets we enter if the timing where we should play is definitely safe.
So it's a good situation to have capital to be able to support your core clients as well. The technicality is that, obviously, countercyclical buffers will be reinferred. And when they're fully loaded, that will add roughly 1.9 percentage points. It will add 1.7 percentage points vis-à-vis a year from now.
Then we have on the positive side, obviously, yes, when we closed the Danish sale, we will get the cash for that one, which will affect it positively. And that will most likely be between SEK20 billion and SEK25 billion in risk-weighted assets dropping away at least. And then we have the structural effects where the discussions are ongoing with the Swedish FSA and that's roughly hitting our capital levels today by 0.6 percentage points.
And so we are still moving towards our target range. We want to run the bank within one to three percentage points under normal circumstances. But we really do believe that the especially high demand levels we've seen actually in the past now, it's a really good situation to be in them. And if we see as well UK moving from contraction to expansion, that's obviously going to be something as well being good to be well capitalized under.
Yes, you're most likely correct, and we're only -- that we're dropping two branches this quarter. I actually don't have the figure in my head. But as you say, you shouldn't expect us to close more branches.
And I think that is important to just add again, I think that is a decision as well for the management team in all our home markets as well. So what we have done with the reduction of the branches is to make sure that we are positioned in those markets where we can have a really good business. So I think that's what you should read into this. And I mean Sweden is a really good example for that.
Okay, sorry, just going back to the excess capital question. Are you going to give us a time frame of when you're going to come back in terms of communicating to us when you're going to get back to your target range?
Yes. I mean, obviously, when we close the Danish deal, definitely, then we get even more capital, you should expect us to get back then and talk about it.
Perfect. Thanks very much.
The next question comes from the line of Rickard Strand from Nordea. Please go ahead.
Hi, good morning. First off, a question on costs. You previously talked about the SEK3 billion of gross cost savings that you have targeted. If you could give us an update where you are on those, how much is still in the making and what could be left, so to say? And also, a follow-up on that one. You previously also talked about the SEK1 billion of elevated IT spending over '21 and '22. We're now in the second half of '22, so if you could give any flavor into what you expect there in the coming years as well.
Sure. Let me start, and then Carina might fill in as well. I think the overall message which we've been saying is that we thought the bank was running a bit inefficiently a few years ago. So we needed to adjust that and we did some hefty plans actually which then -- the consequence of that one was the program around SEK3 billion worth. So we come quite far in that one. We've come a bit more than SEK2 billion in that one. And the remaining part is still the reviewing of the extra business and it's also some parts in the Swedish overall operation.
What we've also guided on then is that now when we come quite far in the turnaround of the bank, we really like the positioning we have. We do believe we're in a firm situation, both in Sweden, Norway, UK and Netherlands, and we really want to strengthen our perspective there. And that's the reason why we've been highlighting that we'd rather steer ourselves on cost to income levels. So we think it's less relevant to talk about all the gross components nowadays in the P&L. Rather, you should see ourselves targeting, strengthening our positioning in all of these home markets and also work on the efficiency part.
And yes, we obviously spent an SEK1 billion for 2021 and 2022. We will obviously come back when we have further guidance to give on that one. But view us as steering towards cost to income and we want to create even more efficiency in the bank as we run it today, but also invest for the future.
Okay. Thank you. Then a question on Swedish commercial real estate, where you grew SEK10 billion in the quarter, it looks like. Just want to hear if you could say anything about the limitations in terms of your risk appetite framework here, if there's plenty of head room ahead, or if there are any limitations there that makes you sort of cautious to participate in any future volume growth there.
As I said earlier, I've noticed that one of our peers are guiding to strict limits in the exposure in various components. We like good clients with strong cash flows. We like strong owners. We like positions where you can actually find low vacancies. We like to do securitized lending. And we like to do loan to values. So that's the credit policy we run. We don't steer ourselves on a portfolio composition or so. So we don't have any kind of fixed ceiling.
Okay, thank you.
The next question comes from the line of Sofie Peterzens from JPMorgan. Please go ahead.
Yes, hi. Here is Sofie from JPMorgan. So in terms of your loan loss provision, they continue to be very low, one basis point. I was just wondering how to kind of think about the Stage 3 coverage, which seems to kind of be trending -- continue to trend downwards and is now below 24%. And I also noticed that the actual losses continue to be much bigger than the net credit losses booked in the quarter and we have seen this trend now for a few quarters. So I mean, at what point do you think you need to kind of increase your provisions?
And how much kind of these overlay provisions do you still have that you can basically take advantage to kind of -- yes, to draw on [ph] to cover actual credit losses. So that would be my first question. My second question would be around the Swedish FSA, IRB overhaul. If you could kind of give any impacts that you expect? Or are there any reclassifications of the portfolios that you're expecting and kind of your thoughts about when we should expect the impact and what magnitude. That would be my questions.
Yes. Thanks, Sofie, for the questions. First of all, obviously, the loan loss, as you say, obviously, we have a really low net Stage 3 perspective. But I think you need to read this in the context of, first of all, we've been talking quite a long time around the restructuring of the bank is pointing to a better asset quality. And we've been working out quite a lot of what we saw earlier on as exposures with a bit of higher credit risk in. So I think we have a structural trend towards a better asset quality.
Then obviously, the net credit losses, they have a component of, first of all, obviously, the Stage 3 components. But they also have then the components of write-offs and recoveries. And every quarter, we see both a few. And we've grown used to now -- and I think I need to say knock on wood, but we have grown used to for quite some quarters now to see very, very low actual credit losses. So obviously, then the write-offs and the recoveries are actually to higher absolute numbers. And we like that.
So I think it's extremely hard to guide on anything. I don't think you -- we see -- we don't see anything today which are pointing to higher actual credit losses. As Carina was saying, obviously, the macro climate will most likely have a risk of decreasing even further. And we do obviously increase the add-ons to some extent as well. And please, Peter add something if you want to.
No, I'm just referring to your question about the coverage ratio in Stage 3, obviously, there are exposures moving in and out of Stage 3. And depending on the collateral structure of that lending, the coverage ratio varies over time.
And to your second question, the IRB overhaul, yes, we don't have any guidance to give you there. We're still waiting on the Swedish FSA and we're working with that one. So the consequence of that one, we don't see any major consequences from it.
Do you think IRB overhaul will have a very limited impact on Handelsbanken?
Okay, that was very clear. Thank you.
The next question comes from the line of Riccardo Rovere from Mediobanca. Please go ahead.
Good morning, everybody and thanks for taking my questions. I have a couple, if I may. On development expenses, they keep -- let's say, are trending a little bit higher or at least remaining stable. Are we closer to the peak of these expenses or those are supposed to continue more or less as they are for the foreseeable future? And then the second question I have is, again, on credit losses, if I may.
Before you stated that you see some strain in the real estate market. But on the other hand, you say you pointed out the LTVs in residential mortgages and in commercial real estate as being in the 50% region. Actually a touch lower, if I remember correctly. Considering this, do you think we should -- the market should be concerned about real estate market to you? Because a 50% LTV would basically imply you would need a drop, a collapse in real estate market before denting into your asset quality. Could you share -- would you agree with that? Thanks.
Well, first of all, on the development expense, as you said, yes, we've obviously -- during the last year and this year, we're obviously seeing the trend of increased development spending quite a lot. So that is moving according to plan and that's what we've been guiding on. Going forward then, obviously, the consequence on development spend going forward and into 2023, we will need to get back on. Because, obviously, as we say, we want to invest in strengthening the positions in the marketplaces we are in. We like the situation we're in. So -- but we will get back to that one on other quarters.
When it comes to the credit losses, yes, as you say, we have a slide, I think it's Slide 28 perhaps. Yes, slide 28. As you say, we show the LTV there on the commercial real estate and the residential real estate in all of our markets. And as you say, they are 50%, a very, very low component is above 75%. So yes -- and I keep coming back to that, the credit policy we have. I mean we like good clients with strong cash flows. We like strong owners. We like securitized lending. And we like low LTV. And that's many pillars of security.
So first of all, if they can't pay their bills, then the owners in many times actually do enter the picture. And that was the consequence when we moved through the pandemic. Then obviously, if that doesn't hold either, we've in very, very few times, if any, lost real money and made real credit losses when we actually took the collateral in hand.
So yes, I agree with you. First of all, the market levels need to drop hugely in order for the collateral to be lower value vis-à-vis the loan. But then on the other hand, we have ended up in the past, obviously, with situations where we have took the collateral and placed packages as a company or so and sold it off and regained all the exposure or a bit more actually.
Okay. Thanks, very clear. And if I may follow-up on another topic. On capital return, now you -- at some point, you will be given regulatory approval for the sale of the Danish operations. Tell the market something about capital return. Will you wait to have completed, including regulatory approvals, also the Finnish one or may eventually give us a better idea only with Danish one?
The way we will treat it is that when we have the cash in the bank for a component, we will be transparent the way we use the cash. So we will not speculate on the outcome of Finland before we have any clear thing there. And obviously, I understand you want the clarity around when parts of the component of the capital base. But I actually do think we're in such an uncertain time as well when it comes to the marketplace.
So we don't find it complicated that we will most likely close, obviously, the Danish business in the fourth quarter coming back then with a transparent view how to use the proceeds. And if we're in a situation today, yes, of course, we're very well capitalized. But who knows the demand side for bilateral lending for the next six months in a market where the capital markets are really constrained actually there. So we're in a good situation, but we will come back as soon as we can.
Thanks, very fair answer. Thank you.
And just to make you aware, due to time limits please limit your questions to one at a time. And we have a question from the line of Jacob Kruse from Autonomous. Please go ahead.
Hi, thank you. So just a quick one on the sale of the Danish business. So Jyske couldn’t take all of the corporate book. So I just wondered how has that been treated in Q2. Do you have a flow back of corporate lending into the core from discontinued? Or is it just accounted as it used to be and do we get any kind of shift in Q3 or Q4? Thank you.
No, they are still accounted on being up for sale, that component. So no, that will work out over time, the way we'll handle it between us and Jyske.
And how much NII do you think that shifts from discontinued into continued?
We will have to get back on that one. We don't know. I don't know the answer to that question.
And the next question comes from the line of Robin Rane from Kepler Cheuvreux. Please go ahead.
Yes. Good morning. So on the NGL losses therein and you showed the slide where you -- so let me see the slide, slide 5, the gain on the NII there with the counterpart of the loss on the NFT line, will the NII part of that normalize as well, you think, over the next couple of quarters?
Yes. I mean the -- what will normalize on that picture is most likely the blue line. If rates move up in an absolute term, obviously, the positive side on the NII will increase with that one. So the gray bar will move up. But the financing cost of it will also move up in an absolute term. So the pink bars will increase in scale as well. But the blue line should revert towards being slightly negative.
Okay. But the absolute figure of NII this quarter, was that somehow elevated by this, would you say?
Okay, all right, thank you.
And the next question comes from the line of Jens Hallen from Carnegie. Please go ahead.
Thank you, yes, and just a follow-up on the commercial real estate book. And I know you provide a lot of data and collateral seems ample. One thing I wonder if you could share with us is some kind of liquidity stress for your largest customers. I mean, at what point does that service become a strain? Do you factor in bond market closures when stressing these exposures? And how do you view that on the risk side, not on a credit risk, but as a liquidity risk for the commercial?
First of all, I think, two ways, and I don't know if I'm going to answer your question completely now, but let's try it out first. First of all, obviously, we obviously run a bank who play extremely conservative when it comes to the liquidity. We have in absolute terms, we have SEK1 billion -- we have SEK1,000 billion in liquidity reserves. And that's apart from non-encumbered assets. So -- and we really like that. We think there's a risk of liquidity continue being strained in the market. So we will definitely play it extremely conservative here.
Then when it comes to the usage of RCF for guarantees of that, we obviously saw a huge volatility in that in the first quarter, second quarter on the pandemic, the first and second quarter of 2020. We don't at all see the magnitude as that today. So we don't see any volatile component actually in the drawdowns of liquidity from the CRE. We can't talk from a market general perspective there, I can only talk from the Handelsbanken perspective there.
Sorry, did we drop you here? Do you hear me still?
Jens dropped unfortunately, so maybe he'll dial back in. In the meantime, we can just maybe go to the next question, which is from the line of Maria Semikhatova from Citibank. Please go ahead.
Hi, thank you. Just a quick question on as well, commercial real estate in Sweden. I see that your Stage 2 loans increased by SEK3.8 billion over the quarter. It seems to be residential property companies in Sweden. Just maybe if you could provide a bit more color on your criteria when you reclassify to Stage 2. If there is anything you can say what caused this migration in the quarter.
No. I mean Stage 1, Stage 2, first of all, they're model-driven. And obviously, that could -- I think we need to look into this and might get back to you. But obviously, when we change the add-on as well for the geopolitical risk that might have a consequence here. So we will look into your -- please have a call with the IR people and we'll see if we can help you, but I can't answer that question right now at least.
And we just have one follow-up from Andreas Hakansson from Danske Bank. Please go ahead.
Yes, hi. With respect to commercial real estate, there's been so much discussion around it. And you talked about the LTV that you have of 50% and the risks related to it. But in most of the CRE companies, you would have a lot of equity, hybrid bonds and then the bank debt. Could you tell us where in the capital structure would you sit? And what would have to be whilst before we start to eat into the banks. And can you tell us a little bit about your positioning within that?
Well, Peter, please assist me in this one. But I mean, and I think this is quite a -- let me answer this question like this. I think at the present, you have more history in the markets than I do, so you can perhaps correct me, Andreas. But I do think the difference between the financing cost in the bond market now vis-à-vis the borrowing cost from the bank system is most likely at very historical highs.
But you can't compare them because they're a bit apple to pears, because if we lend to a real estate company, we do it collateralized. So it both it comes with a cost to the cash flows or a stamp duty in some sense. And also, obviously, they need to post collateral. And that will be a constraint on the rating perspective on the bond programs. But when it comes to the capital structure, I guess, we need to wipe out -- obviously, you wipe out equity, you wipe out the hybrids, you go down the senior and then we have -- then we've lent senior securitized.
So I guess that's correct, but I'm looking at my companions here to assist me. But that's the way I reason it.
Yes. So if you go back to the early '90s, which was before all our time really, I mean then there were no bonds or hybrid anything before. Weren’t then the banks doing all their lending up to LTVs that were significantly above or is that a big difference now to then? Or how should we view it?
No. I think, obviously, first of all, I really need to disclose that I wasn't here then. And I think there's been a lot written about this, obviously. But I do think you have a point and I've seen it in the media as well, people highlighting this. Obviously, at that time being, when you opened up the banking sphere, when you de-monopolized the business model, obviously, the banks were chasing growth. And obviously, they were lending to very high LTV levels, sometimes actually higher than 100%.
I think that we've grown a lot. First of all, the bank's grown used to, we don't like to go above. But then second of all, obviously, the regulators have grown used to a banking system which is so large now vis-à-vis the Swedish GDP and the society. So they need to regulate it quite tough. And that's the reason, obviously, that we have both much lower LTV, but also a much higher capital level and everything in place. So I don't think you can compare the situation today at all with the '90 crisis.
Okay, thanks very much.
And we just had one more question coming in from Piers Brown from HSBC. Please go ahead.
Yeah, good morning, everybody. I'm sorry for belaboring the point, but just on property again. I mean, can you tell us just on a basic level when you do your business planning, what property price assumptions are you using for Sweden? I mean, do you assume moderate declines from here? Do you assume prices remain flat? And if you could share with us when you think about downside scenarios, tail risks, I know some of your peers published their ICAP stress test assumptions. But could you tell us, when you do stress testing, what sort of downside scenarios are you looking at for property prices in the domestic market? Thanks.
We flip through the pages here.
But the information -- you find information about the scenarios in reporting. And if you don't find it, just reach out and we'll guide you to it.
And that's -- and the reason for that one is obviously that, first of all, obviously, when we input this, we input this in the stress model of the ECLs, obviously, both the base case and the upside and the downturn. And then we obviously calculate the ECLs. And as we've been saying throughout the pandemic, we get fairly little correlation between macro factors and the outcome of the ECL. And the reason for that one is that we've gone through a lot of cycles with very low correlation to the credit losses. And that's the reason why we do the add-ons. And also, that's the reason that you might actually ask that in your question that when we plan for our business going forward.
So obviously, the way we value then the housing and the collateral and everything, that's a huge component in our decision around the credit decision. And last information, you find it on Page 34 in the report, all of these assumptions.
Okay. That's helpful. Just -- I'm just thinking back to last year, we obviously had the EBA stress tests which were done on, I think, 40% drawdown in Swedish commercial property prices. And I think in that test, you showed a 3-year impairment rate of about 200 basis points. I mean, is that just -- should we just completely ignore that? Do you think it's just not relevant to the current context?
I think all of the external stress tests done on the bank do have a very high degree of top-down perspective. And I can see the reason why they need to do this kind of analysis. But we obviously have been running a business model and really do run a business model where we try to have very little dependency between macro factors and credit losses. So you will have to -- I'm not going to judge their outcome of that one, but we see very little rationality in that when we do our internal modeling.
Okay, that’s very helpful. Thanks a lot.
I now hand the call back to the speakers.
Okay. If that is the end of all the questions, I thank you very much for participating during this telephone conference, and have a great time, and thank you for today.
Thank you, everyone.