Standard Chartered PLC

LSE:STAN

Earnings Call Transcript 2018-Q3

[Operator]

Welcome to Standard Chartered's update for the third quarter of 2018.Today's call is being hosted by Andy Halford, group Chief Financial Officer; and Bill Winters, group Chief Executive.[Operator Instructions] At this point, I'd like to hand over to Andy to begin.

[Andrew Nigel Halford, Group CFO & Director]

Thank you very much, Sharon. And good morning or good afternoon to everybody, depending upon where you dialed in from.Hopefully, you've had a chance to have a quick look at the quarterly statement. A headline, therefore, I think it's -- [ it sure is ] following.So income growing 5% year-on-year, with every client segment up between 5% and 8%; and on a risk-adjusted basis, actually the income, after credit impairment, up 11%. Costs well under control and cumulatively on a constant currency basis growing slightly less fast than income. And the cumulative basis within the third quarter itself actually, income up 4% and costs flat. Credit impairments halving again year-on-year, having halved the previous year, and remaining stable in the quarter. And finally and importantly, profit up 25% and the return on equity rising a further 150 basis points to over 6%.The statement focuses primarily on the year-on-year comparisons, so I'll spend a bit more time covering some of the more recent quarterly trends; then touch briefly on costs and investments, credit quality, capital, et cetera; and then hand over to Bill to conclude so that we have plenty of time for Q&A.So just looking back a bit of context, starting with the macro picture and by reiterating our belief that, despite the background geopolitical noise, we continue to see potential to grow high-quality income from areas where our clients tell us we are the most differentiated. We said at the interim stage that we were cautiously optimistic on global economic growth, and that very much remains the case.At the interim stage, we also said that uncertainties resulting from escalating trade frictions and geopolitical risks were emerging. And we have seen the indirect effects of that to some extent in the second half in the form of lower investor sentiment in some of our markets. At an operating level, that most obviously affected our Wealth Management business and parts of Financial Markets, where we are seeing some clients transacting less, deleveraging and generally adopting a slightly risk-off attitude. Sentiment in Wealth Management tends to be cyclical, however. And we remain confident that this will be a core growth driver and area of strength for us in the medium term, particularly given the successful shift we have been making into the more affluent segments in our markets, where at our core we have always had a strong value proposition. And on the Financial Markets side, although client activity has been a little more subdued since the strong start to the year, the return of market volatility usually creates profitable growth opportunities for us.And the final macro theme I wanted to touch on is U.S. dollar liquidity, which in our model remains for now reasonably elevated, meaning that volume growth in Trade and Corporate Finance across most of our dollar-denominated lending businesses in the third quarter continued to be more or less offset by margin pressure. As dollar liquidity reduces, however, then the more challenging conditions for some of our local or regional competitors may create interesting opportunities for us to deploy our strong capital and liquidity to support our clients and drive profitable growth. But if we don't see good opportunities at the right return, then we have always been very clear that we won't jeopardize our hard-won foundations. We are committed to grow shareholder value. And our 5% to 7% medium-term income growth guidance reflects our belief that we can continue to do that without pursuing low-quality income for income's sake.Stepping back, our recent performance shows just how much more resilient we have become as a group in the last 3 years in the face of uncertainties such as these. We grew income year-to-date within the range that we indicated at the start of the year. And although the rate of growth slowed down slightly in Q3, it was within a percentage point to the year-on-year increase we saw in Q2, with the difference being the softer third quarter performance in Financial Markets that I mentioned and particularly challenging conditions in Africa and the Middle East. The rest of our businesses performed pretty steadily in the third quarter.In Africa and the Middle East, income was down about $90 million in Q3 to $600 million, having delivered just under $700 million each quarter consistently over the last 1.5 years. From a product perspective, about half of the reduction in the quarter was from Financial Markets, but that in turn was driven mainly by macroeconomic and geopolitical divisions that remained pretty challenging in most markets across the region; and to some extent, our own de-risking actions as a consequence. The region remains a key focus for us. And we are maintaining our ambitious plans to roll out the digital bank platform that we developed in the Cote d'Ivoire over the coming year or so.Our improved performance over the last year also reflects our focus on generating better returns on our risk-weighted assets and balance sheet generally. The net interest margin was 5 basis points higher year-on-year. And net interest income grew strongly, which is offsetting the headwinds that I just mentioned affecting some of the fee-oriented businesses in wealth and Financial Markets. Our liability-oriented Cash Management and deposits businesses, for example, continue to benefit from our efforts over the last couple of years to improve the quality of our deposit mix in a rising interest rate environment. And you can see that in the consistently strong quarterly trends in the product table near the back of the statement. On the asset side in the balance sheet, strong competition has meant it has not always been possible to reprice in full. This is particularly evident in the third quarter in slightly lower income from Mortgages, for example. As we look forward, we expect rising rates should continue to benefit us as monetary policies normalize, although as we've indicated before, sensitivity is likely to reduce as clients increasingly expect banks' pass-through rate rises. It's important to note that rate sensitivity will vary by market. However, in our largest market Hong Kong, for example, despite escalating trade tensions and strong competition for deposits, we maintained double-digit income growth with a good performance across all client segments driven by cash, wealth and retail deposits. Our balance sheet there remains highly liquid with an advances-to-deposit ratio of around 60% compared to a market average of 75% and a CASA-to-total deposit ratio at 74% compared to a market average of 54%. And the recent prime savings rate increase had a slightly negative impact given we hold more Hong Kong dollar CASA deposits than prime-based mortgage assets. However, overall, we stand to benefit from further rises in HIBOR, while the Mortgages, which instantly make up less than 5% of income in Hong Kong, margins were lower but volume and pricing remained steady.The franchise strength in Hong Kong has shown its worth recently with our cost of funding there increasing to slower rates than the published Hong Kong dollar composite benchmark, resulting in the net interest margin in Hong Kong increasing both year-on-year as well as in the third quarter.Putting it all together. As I said, we generated just over 5% top line growth year-on-year whilst at the same time reducing risk-weighted assets and credit impairments and keeping costs in the third quarter below the second quarter and only a touch higher than they were in the last year. Indeed, they were flat if you adjust for currency variations. As a result, the group's return on equity, our primary focus, continued to grow nicely in the period, whilst the return on tangible equity in Q3 increased by nearly 2 percentage points compared to last year. Despite these figures, we know we need to continue to drive returns higher. And we are developing plans to do exactly that, which Bill will come to shortly.Moving now to costs. We take the view that, if an investment will fundamentally improve the franchise, then we will be disciplined in creating the capacity to go ahead and do it. I'll just give you a couple of live examples of where we have invested and the benefits we are seeing. First one is in India. Robotic processing is taking information in from clients' onboarding applications to populate our back-office systems automatically. This eliminates manual processing, saving around 18,000 hours annually; increases accuracy; enables in-built sector enforcing; and reduces the risk of incorrect routing. And secondly, our new Wealth Management portal that we launched in Singapore in the first half is one of the first digital advisory platforms in Asia. Since launch, 44% of fund transactions now take place on the platform. And it is being rolled out Thailand first, then to Hong Kong, then to other markets. This offers a seamless digital experience that increases convenience for our clients whilst reducing our sales costs.Of course, creating capacity for investments in the bank as complex and highly regulated as ours is not easy and usually requires tough decisions as well as frequent adjustments through the course of the year to ensure we stay in line with our commitments. We have tightened discretionary operating expenses in several respects in the second half of the year to ensure we can maintain the pace of investment whilst keeping costs in the second half overall, excluding the U.K. bank levy, similar to those in the first half.Moving now on to asset quality, where, as you know, we have made considerable progress over the last few years. The credit impairment charge in the third quarter was 1/3 of the level it was a year ago and has remained low year-to-date, with most indicators continuing to go in the right direction. Given the increased uncertainties I mentioned earlier, we are, as you could imagine, scanning the horizon to find sort of growth stress emerging in our markets. As of today, though, we have not seen any significant evidence of that, reflected in the fact credit impairment only picked up slightly in the third quarter, but clearly given the historically low cost of risk currently, Bill and I are monitoring the situation with Mark Smith, our Chief Risk Officer, frequently and carefully.The final point for me before I hand over to Bill is on capital, where our CET1 ratio rose another 28 basis points in the quarter to 14.5%. This is the highest it has been since the concept of CET1 was introduced, meaning we are substantially above 12% to 13% target rage that we set out back in 2015 and positions us well given the increased macro uncertainty.On that positive note, let me hand over to Bill.

[William Thomas Winters, Group Chief Executive & Director]

Great. Thanks, Andy. And good morning, good afternoon, everybody. Thanks for joining us.It's been almost exactly 3 years since Andy and I launched our refreshed strategy back in November 2015. And I thought it would be useful to spend a very short period of time reflecting on what we've achieved over the 3-year period but more importantly talk about how we approach the coming years both in terms of the evolution of our business and our strategy but also in the context of obviously a changing market environment; or potentially changing, depending on how things that are in play right now turn out.Broadly, we're very happy with the progress that we made. When we reflect on what we set out to accomplish in 2015 in terms of the securing our foundations, getting lean and focused and investing for growth and innovation, we've done pretty much everything we said we were going to do. And we feel that we've demonstrated that we are able to take some pretty complicated problems and work them through into a foundation for good, solid growth for many years to come. At the same time, though, we fully reflect and recognize that we are not covering our cost of capital as yet, that we have more to do both ourselves even relative to our own sense of progress but also relative to the market's understanding of the actual potential of this franchise and what this team can deliver against that franchise. So we have spent a chunk of time this year, and we'll continue to between now and the end of the year, reflecting on those questions that we asked back in 2015, affirming that the areas that we focused on were the correct ones. And broadly, we're very comfortable with our focus on growth in Africa. Obviously recognizing the comments that Andy just made about the sluggishness in parts of this year, we believe fundamentally that that's a differentiating strength for our bank and that we will continue to invest there. And lastly, opening up in China, where we made great strides; and as recently as this week, recognized as the first foreign bank to receive a local custody license in the People's Republic, which is a basis for real growth for us in the years to come. The focus on affluent, which we come back to regularly, which continues to be a core strength for us, that affluent client segment. And the associated products and Wealth Management and related products, deposits in particular, have been growing at a very healthy pace. Together with our GCNA business, as Andy just called out, we're getting the mid- to high double-digit growth rates in those areas that will allow us to achieve our financial objectives over the medium to long term.These are the things that we set out in 2015. We think that they're still core to our strategy, but we recognize that there are things that we'll have to do differently as well. The -- both the mindset and the actions that we take when we're in transformation mode are different than the actions and mindsets that we'll take when we're really in growth mode and return optimization. And so we've agreed to continue -- to just take a step back appropriately, I think, and quite normally, after 3 years of an initial plan; and lay out for all of you, when we announce our February full year results, how we intend to tweak our plan, adjustments that we expect to make or are making or have made in order to hit a 10%-plus return over the medium term, that being as good a proxy as I think anybody can have for cost of capital.The -- we fully recognize a few of the areas that Andy called out in terms of either storm clouds potentially on the horizon. They haven't materially impacted the business that we've seen over the past 6 months, but we know that there are uncertainties around geopolitics and trade. And we called out our relative insensitivity to the specific U.S.-China trade corridor, but of course, as trade tensions rise, if they rise further, we can expect some second-order consequences that would impact parts of our business. We've seen a genuine economic slowdown in many of our African markets and across the Middle East despite higher commodity prices. And we've all witnessed the pressure on emerging markets, in particular countries that are running deficits in current account or budget, and that has affected sentiment across emerging markets to some degree. And of course, it's translated through to currency weakness in a number of our markets and a broader sense of malaise in emerging markets. Now we've not lost faith at all in the emerging market asset class or our position in it, but we recognize that there could be some headwinds, and we're watching those very carefully. But as Andy pointed out, we think we've navigated these, the bit of challenge that we've seen so far, quite well. And we have every bit of optimism that we'll continue to do so.I also wanted to comment very quickly on the ongoing investigations in the U.S. and in the U.K. We've seen and obviously you've seen a considerable amount of speculation recently about the outstanding investigation and relating back to activities that we first disclosed or investigations that we first disclosed in 2014 and that Andy and I have called out at pretty much every opportunity since as an open item. We are determined to play a leading role in fighting financial crime, yes. Since 2012, we've transformed our approach to the financial crime controls and risk management, bringing in new leadership, investing significantly more into systems and training, promoting a culture of conducting business with the highest integrity. We've seen a nearly tenfold increase in our annual financial crime compliance spending and a more-than-sevenfold increase in headcount dedicated to this commitment. In addition to these internal efforts, we're also forging public-private partnerships with regulators, financial intelligence units, enforcement agencies and other banks around the world to disrupt illicit financial flows. We recognize that there's more work to do, but U.S. authorities share our view that we've made substantial progress. And you will understand that we can't say much more on this topic, but we are engaged in constructive discussions with the relevant authorities to reach a fair and appropriate resolution as soon as practical. And of course, as soon as we have something that we can say, we will do so.But aside from these few external challenges and the referenced ongoing investigations, there's plenty of good stuff going on that we could put into the tailwind category. As much as we're concerned about the trade tension between the U.S. and China, other trade disputes seem to be resolvable. And the intraregional trade within our markets within Asia, within -- between Asia and South Asia, Middle East, Africa will be picking up. There's a clear focus from a policy perspective but also practical economic perspective on picking up those intraregional links, which play much more to our strengths than the specific weakness that could develop in U.S.-China trade.We feel very good about the progress we made in our digital agenda, and we feel great about the opportunities that we have to take the digital leap that we've opened up in a number of our markets and really drive that through to earnings growth over a period of time. Of course, the early-stage investments in digital don't produce an impact on the bottom line, but we're convinced that in the medium term they will. We think our network is -- continues to be extremely valuable. It's strong and it's differentiated, and in many ways it's unique. It -- we are driving strong growth in our client franchise, in our non-financing income, in our network income. That is leveraging this network strength, and we look forward to sharing more details from quarter-to-quarter and half year-to-half year on how that's manifesting itself in bottom line results. And that capital strength, as Andy mentioned, is a great opportunity for us. The -- a number of the markets where we operate either are or will go through some stress. We're very well positioned in those markets, having taken our medicine early on, maintaining the high level of discipline. And there could be every possibility of opportunities for us to invest some of our surplus capital into interesting markets should things get a little bit tougher.So on that note, I think I'd say broadly we've got a balanced and pragmatic approaching. We feel very good about the current environment, very good about our prospects; and fully recognize the challenges that could present themselves to all of us. We're prepared for those. We're refreshing our strategy, as I think is appropriate, 3 years after having initially launched. And we'll have some more to say about that in February, but in the meantime, we will open it up to questions.So Sharon, perhaps you could moderate that process.

[Operator]

[Operator Instructions] And your first question comes from the line of Ronit Ghose from Citigroup.

[Ronit Ghose]

It's Ronit from Citi. I had 3 areas of questions, please. First of all, big picture one, ROE north of 10%, can we quantify this in terms of time line? Is this 3 years, 5 years; a stretched target, or a realistic target? Secondly, margins. Stand-alone third quarter looks like margins are down 3 basis points. Andy, can you just give us some more color around how much -- if I looked at just Hong Kong stand-alone versus the rest of the group, what the trends are and what your expectations are for next year? I'm guessing most people have margins up next year in their thinking, but given what's happened in the third quarter, do we need to revisit that assumption? And thirdly, by region, your stand-out weakness was Africa and the Middle East. And it looks much worse than what we've seen from some of the regional banks, at least in the Middle East, and I'm just wondering how much of this is linked to business mix changes. Or some of the -- given the oil prices you alluded to, some of the bigger sort of government-related business streams seem to have picked up in the Middle East, but it looks like you're doing worse than some of the peers, local peers. I don't know if that's correct, or not. Appreciate any comments or color on those 3 questions.

[William Thomas Winters, Group Chief Executive & Director]

Thanks, Ronit. On the ROE point, we've always had the ambition of exceeding a 10% cost of -- return on equity, having moved through the initial milestone of 8%. As we approach 8%, it's appropriate to shift our focus to the next set of steps and actions that we'll take to clearly pass-through our cost of capital and obviously continue to grow from there. So we'll give you some more detail on exactly how we want to do that when we are together at the full year. Really this is the repetition of the ambition that we've had; and a recognition of the progress that we've made towards that from a negative ROE 3 years ago, when we stood up to set up our targets in the first place. Through to today, we're obviously much closer to that intermediate 8% milestone. And I'll hand over to Andy for the margin point.

[Andrew Nigel Halford, Group CFO & Director]

Yes. So Ronit, let me take margins and then the Africa & Middle East question. So yes, you're right, the margin's slightly down in the third quarter and, as ever, with certainly markets with quite a sort of complicated story there. Bottom line is it does not deter us from the belief that over time we should be getting margins to be moving forwards and upwards. There are a couple of sort of factors in here. One is that, in the second quarter, we did see a little bit more movement of money from the current accounts, savings accounts into time deposit. And that slightly pushed up liability mix. In the third quarter, we actually saw that trend settling down. So whilst we can't rule out more of it happening, I think there is sort of a flow-through of a slight correction there as we went up the interest rate curve. So that, I'd hope, will operate as we move forwards. By geography, Hong Kong actually slightly improved margin. We saw margin pressure a bit more in India and in China. The Hong Kong story is quite a complex one because you've got the effects of the increased interest rates on Mortgages, many of which had then got a cap on them; and the prime rate moving in the period. But conversely we have a significant amount of customer deposits in Hong Kong dollars in Hong Kong. But overall, we were sort of slightly up on margin quarter-on-quarter in Hong Kong and definitely up year-on-year. So I think our takeaway on margins, but things do move around from quarter to quarter. It's slightly higher liability costs because with the time deposit mix change, but that we saw settling down in the third quarter. So I think we won't repeat it going forward. On Africa & Middle East, listen, I think we have got quite a number of different political and geopolitical situations going on there. And the mix of countries in which we operate in is clearly a bit different to those that others operate. We were a little bit softer in the Middle East than we were in Africa. We were actually quite strong in East Africa. By product, about half the drop overall was in the Financial Markets area. Some of that was reduced activity. And some of it was actually conscious decision that we weren't going to participate in some of the activity and we were just sort of taking a view of risk management. And so I would look at Africa & Middle East as being something where there was quite a lot of things going on simultaneously, but over periods of time, things do tend to even out. And we have been thoughtful we're not going to take risk on where we're not comfortable with it. And that in part was a conscious decision we made during the period, but as Bill said, clearly it's an area where we see long term still very considerable potential. And we will continue to focus upon it even if it was a slightly weaker quarter.

[Ronit Ghose]

Great. And just to circle back and pin down the margin point. So some of the negative in the third quarter on margin is due to a mix shift in the second quarter because obviously you're calling out the CASA going up 70 bps in the third quarter. So this is like the negative mix shift in the second quarter hitting in the third. And I was wondering, looking to the fourth quarter for you, there's clearly quite a trend shift. I don't want to overexaggerate, but just isolated quarter, you're down 3 basis points. And one of your big local peers in Hong Kong just reported up for Hong Kong and Asia Q-on-Q. I'm just wondering whether -- again, mix isn't exactly the same, but I'm just wondering whether this 3 basis point down is the start of something for the second half, a negative trend for the second half.

[Andrew Nigel Halford, Group CFO & Director]

No, I don't think you should look at it like that. And as I say, if you take individual quarters in isolation it would -- quite difficult to extrapolate from it. Our view remains that over time we should be able to continue to get the margin up. Interest rate increases are beneficial, albeit the further one goes up the curve, then the less that is the case, but nonetheless we still see upward potential there, so I wouldn't get too worried about this as we look forwards. There were some factors in there which were flowed through from the previous quarter. Equally, we're doing a lot of work on the mix of deposits and trying to get more current accounts clearly across the overall franchise. So we continue to focus on that, and it's something that over time we see increasing.

[Operator]

We will now take our next question, and the question comes from the line of Jason Napier, UBS.

[Jason Clive Napier]

Three, please. Just beginning with loan losses, obviously very low in the quarter. And consensus for next year is about 50% above your current run rate, so I just wanted to check whether you might give us some color on any role of IFRS 9 assumption changes, perhaps your recovery levels at present. Perhaps you can tell us sort of what the run rate gross charge is at the moment. Because it doesn't feel like there's anything in your early alerts or credit quality data now that suggests that loan losses will be at that sort of level as uncertain as the environment is. Secondly, just looking at the net interest margin outlook. In the first half, you posted very strong growth in government secured wealth and FI-related lending. And I just wondered whether there was a significant role of mix in the kind of margin numbers that you're posting and whether that actually leads to lower loan losses down the track, whether that's something that might be temporary and just what role you think that might be playing. And then thirdly, and this is a simple question: I'm afraid, the product income disclosures, I find them endlessly fascinating and useful, but in trying to understand the very significant quarter-to-quarter sensitivities that the credit-side revenues in retail have to rates, I just wondered, mortgage income is down 27% in the quarter, and credit cards and personal loans down 7%. I just wonder how did you calculate this and sort of how you interpret that kind of data. Because presumably if rates keep going up, these numbers are going to keep going down.

[Andrew Nigel Halford, Group CFO & Director]

Okay, Jason, we'll take those in order. It's clearly difficult to know how loan loss provisioning would have been operating if we had not had IFRS 9. On the other hand, we do have IFRS 9. It is much more sophisticated. It is more forward looking than the previous, and yet we are seeing a very, very low level of credit impairment. That is very consistent with what we are seeing in terms of forward indicators. So the nonperforming loans, the category 12, the ones that are performing but sort of fragile and the early alerts, et cetera, have all been heading in a pretty good direction. So I think that you should look at this as not being particularly inflated by recoveries. We have not had a particularly unusual level of recovery during the third quarter. Clearly, IFRS 9, with the forward-looking element, has got more sensitivity to changes in macroeconomic outlook, albeit at this point in time we are not seeing any significant change coming off the back of that. Now on the other hand, if you go through the cycle, you would obviously observe that it is below-average cycle numbers that we have got at the moment. And clearly, one can take a view just to sort of where we are in the cycle, where we're going to be. I think our main takeaway, however, is that the medicine we applied from 2015 onwards to get the quality of the loan book into a much better position has really been paying off. And I think the quality of the balance sheet now is a huge amount better. Where we have provisioning decisions, they tend to be in quantum terms much, much lesser than was the case a while ago. And overall, we are very pleased with the progress we are making there. The loan losses, credit impairments are a small proportion of our overall income, whereas a while ago they were eating up quite considerable amounts of the top line. So I think it's behaving well. And we'll continue to focus upon it, and we'll see where the cycle takes us. On the NIMs, I mean, probably a little bit repetitive of what I said earlier, it is a combination of multiple products. It is a combination of multiple countries. And there clearly is a weighted effect of all of those when it comes up to the higher level. As I said earlier, I think, direction of travel on that, certainly both medium term we do see the opportunity to further improve the NIMs within the business. And the fact that they have gone up generally over the last 3 quarters but gone down slightly last quarter, I wouldn't read too much into that. We're very focused upon the increases there. And some of that will be product mix change, and some of it will be sort of more by country. The product table at the end endlessly fascinating, that's a memorable way to describe that table. Again, a lot of moving parts. I mean I think on the mortgage side that one should remember quite a high proportion of our overall mortgage book is in Hong Kong. And in Hong Kong, there is quite a high level of capping of rates. And in the period, we saw the caps coming in and taking some effect, but what we conversely saw was the benefit on the deposit side so that actually, when you put the two together net-net, it was a good outcome. And we actually, as I said, saw the Hong Kong margin go up slightly quarter-on-quarter and reasonably stronger year-on-year. So therefore, with these I think one needs to sort of look at them across the piece, but I wouldn't be too worried about looking at the mortgage line alone. There are considerable offsets in other lines. And in particular in our very biggest market, as we say, it's been a net positive, not a net negative.

[Jason Clive Napier]

Just to follow up on that and in terms of the way that the caps work and so on. If the consensus view of Fed funds is right for next year and we might get 3 or 4 movements over the next 12 months, does that naturally feed through into a number that could trend to 0 in Mortgages and Auto?

[Andrew Nigel Halford, Group CFO & Director]

And I would look at it more this way. Particularly Hong Kong, the biggest mortgage market, we're reasonably balanced in terms of the deposits from customers and the mortgages we have got out there. And therefore, actually changes are fairly neutral on an overall basis across the 2 different product group income streams.

[Operator]

Our next question comes from the line of Joseph Dickerson from Jefferies.

[Joseph Dickerson, Head of European Banks Research & Equity Analyst]

I guess, just a couple of questions echoing similar themes that have already been asked. But just not to hark upon it too much, but the Mortgage and Auto line, can you discuss what was the underlying asset growth associated with Mortgages and Auto, number one? And number two, you've referenced liquidity a couple of times. It would be helpful to understand in the Hong Kong market in particular what you're seeing in -- amongst your customer base in terms of liquidity preference in terms of different products on the liability side, i.e. deposits versus floating-rate notes, et cetera. Some color there would be very helpful.

[Andrew Nigel Halford, Group CFO & Director]

Yes, okay. So overall, the mortgage asset book was fairly flat period-on-period. It was something where we were quite happy to sort of take share of market but not push it too much but overall mortgage sort of fairly flat. In terms of the liability side of things, as I said earlier, we saw a little bit of movement towards time deposits and away from current accounts in the end of the second quarter, but that actually flattened out during the third quarter. Obviously, it is possible as we go further up interest rates that we could see more of that, but the recent experience actually it was that, that transference moderated.

[Operator]

We will now take our next question, and the question comes from the line of Manus Costello from Autonomous.

[Manus James Macgregor Costello]

I've got a couple of questions, please, one general and one a bit more specific. The general one is you have had some good news on capital, various bits of good news on capital today; and are running, as you say, well above your target. You're talking about investing that next year. Is it possible that you might consider returning some of that excess to shareholders during the quarters the next 3 years if you can't find opportunities for it? And specific -- my specific question was about your other impairment line. And you were talking about some transport assets taking a hit there. I wonder if you could explain that a bit more and more broadly talk about your transport asset financing business and how it fits within the group. Is that something which you're comfortable with or which you might think about restructuring in the future?

[Andrew Nigel Halford, Group CFO & Director]

Okay, thanks, Manus. Obviously, self-evidently we have got the capital ratio now up to a much higher level than we have had before and a level above where we had targeted. I think, encouragingly, a number of things have sort of come into play that have been helpful. We had a possible upward -- or downward pressure obviously, to an upward pressure on the RWAs on some loss-given default issues. Those have actually been resolved. Those did not have an adverse comp cushion, which is good. We've been doing a lot of work in the business on the returns on the risk-weighted assets and the fleshing out the models, et cetera. And overall that has got us into a better shape. Equally, we have got 1 or 2 things like exactly what will be the impact of the Basel IV, the U.S. situation that Bill referred to. And our sense at the moment is that running a little bit high probably does make some sense, but obviously over a period of time as and when those things become clearer, we will put those into the mix just in terms of deciding what is an optimal level to run at. And if we can put it well at that level, then obviously we'll give thoughts to how we get from where we are to the optimal level. And I'm sure we'll update more on that in February. And on the other impairment side, the other impairment, so that line is very much these are not credit impairments but these are impairments particularly against aircraft and ship leasing assets. And we have seen some increase there, more actually on the shipping side. That is something that we are giving some thoughts to; and again will be something, I think, we'll update more on when we come to February.

[William Thomas Winters, Group Chief Executive & Director]

I will just add to Andy's answer, Manus. So that we remain pretty optimistic and confident that the franchise that we're building will allow us to deploy capital into acceptable-returning, so the higher-returning, activities over the course of the next year. And we've clearly been shifting our portfolio from a legacy which was both low returning, obviously historically had higher, much higher loan impairments, towards the client segments that play to our core strengths. And we've been generating some good growth in those areas of core strength. Obviously, it's been offset to a degree both in income terms and in capital terms by the reductions in the more legacy portfolio. Over a period of time, clearly, that balance shifts. And we're much more focused on generating growth from the client segments that are most relevant and attractive to us. And we're pretty optimistic that we can deploy the capital that we're generating into reasonably decent-returning, higher-growth type opportunities. But of course, if for whatever reason, environmental or our own execution, we can't, then we'll look at how we return capital. So that is definitely not the base case in terms of what we see as the value of this franchise.

[Operator]

We will now take our next question, and the question comes from the line of Gurpreet Sahi from Goldman Sachs.

[Gurpreet Singh Sahi, Equity Analyst]

It's regarding Hong Kong. So first of all, on prime rate hike that just happened at the end of third quarter and then there could be another one, let's say, in December. So how much could be the impact on group margins? As Andy mentioned, it could be a bit negative given that Mortgages go up and Hong Kong dollar savings account pricing also goes up. Is it meaningful impacting the group margins in the fourth quarter and beyond? And then the second one is regarding loan growth. Obviously, a good year till date, but then given all the uncertainties and now also slower loan growth in some key areas like Hong Kong, Singapore, how do you see loan demand going into next year?

[Andrew Nigel Halford, Group CFO & Director]

Okay, so to take those in order, the Hong Kong prime rate obviously has just risen for the first time in a long time. We'll see whether it rises further. I think the simple answer to your question is that because we are reasonably well balanced between deposits and Mortgages in Hong Kong dollars, overall changes do not actually have a significant impact upon margins in Hong Kong and therefore did not have a significant impact on margins for the group as a whole. And so hopefully, that addresses that one. Loan growth a little bit more moderated over the last quarter as year-on-year has still been growing. Obviously, that is something that we are focused upon. We will not go lending where we don't accept the level of risk that comes with it. Equally, we do know that to grow the business we do needs to keep the balance sheet moving forwards. So no forward projections, but I think you should say that the momentum there is something that is key and something that we are very focused upon making sure we have a regular drumbeat on that.

[Operator]

We will now take our next question, and the question comes from the line of Claire Kane, Crédit Suisse.

[Claire Kane, Research Analyst]

Two questions, please. The first, on costs. So you confirm that Q4 will cost, ex the bank levy, $2.6 billion, which is in line with consensus. I just wonder whether you could comment, given some recent press reports, whether there's been any change to your investment spending or capitalization policies this quarter. And then my second question is around your commentary that you're on track to deliver the financial commitment you set up earlier this year. So just to confirm, are you saying you will deliver 5% income growth, at least, for full year '18, which would be a continuation of the 4% year-on-year growth in Q4 as well? And just whether you could comment: Given the NIM decline and also the loan book decline quarter-on-quarter, how we should think about absolute NII development in the fourth quarter and going forward, whether that will be such a difficult factor into next year?

[Andrew Nigel Halford, Group CFO & Director]

Okay, so costs, let's just address that one, as it didn't get quite a lot of commentary at the half year. And we have -- over the last 3 years, as you know, we have taken out a lot of costs in order to significantly increase the investments, particularly IT investment, into the business. And that, we profoundly believe, is important for business going forwards. And we continue to believe that investing into those areas is important and consequently that we do need to take costs out of the business in order to be able to fund that. There is no change whatsoever in our capitalization policy. We apply it exactly the same way of capitalizing these costs as we have ever done before. What we have done is just got a little bit tougher on some of the discretionary costs to make sure that the commitment that we made that we would see the second half costs being similar to the first half costs is what we deliver. And that is what we are working very much to. So if we can do that, then that implies that we would have sort of just over $10.2 billion of costs for the year against $9.9 billion last year. That's a 3% increase. That's roughly the level of inflation we're seeing in the markets we operate in. And that is consistent with what we also said, which is that we will try to contain cost increases below the level -- or at or below the level of inflation notwithstanding making a significant level of investment. So we are continuing to invest. We will continue to invest. We think that's the right thing for the future of the business. On your second point, on track with our financial commitments, clearly we are doing everything we can do to land this year within the ranges that we have indicated, albeit they were ranges over the medium term. They were not specific to individual quarters or years. We are just above 5% on a year-to-date basis, and we will do our utmost to try to get the full year to end up at the 5% or above-level percent if we can possibly do that. There will clearly be a number of moving parts that fit there. One is that you referred to about asset growth. Another will be about NIMs. I'm not going to forecast NIMs on a quarterly basis. And as I said earlier, the intent as we evolve the business is that we would hope that we can be progressively improving the NIM over a period of time. That may not be true in every single quarter, but that is the direction of travel that we would hope for. Credit impairments clearly are at the moment, touch wood, operating in a helpful way in terms of the bottom line. And if we can end the year with a bottom line print on the operating profit -- remember we are printing now in each quarter about the same amount of operating profit as in 2016. We were printing in a full year. So we really have ramped up the bottom line effect here. The ROE at 6.1% is clearly the highest we have had for quite a period of time unless we want to get it higher, but I think the direction of travel is pretty good. And the team here are very focused on delivering as close as we can or within those ranges as possible at the end of the year.

[Claire Kane, Research Analyst]

Could I maybe just have one follow-up just in terms of what can we expect at the Q4 with your 3-year plan? Are you going to give us similar updates on ROTE walk that you gave at the 2015 results, showing that you're going to exceed 8% ROTE in 2021? Or will it be above 10% in that year? Is that what you're going to show us?

[Andrew Nigel Halford, Group CFO & Director]

You want me to pre trail our February announcement. Listen, I think, as Bill said, we have, I think, covered a lot of ground in the last 3 years. Obviously over a 3-year period, a lot of things change externally. And as you would expect of any business, we need to sharpen up, reflect, refocus; look at the areas of opportunity; make sure we're putting resources behind them. And those are all the sorts of things we'll talk about in February. We will talk about where we think we can get the returns for the business. I haven't exactly worked out what charts we're going to use in February, but we'll progress that over the coming weeks. But I think you should see it more as being how to sharpen the business further, how do we build on the foundations we put in place and how do we get to the high levels of returns that we all know the business is capable of. Even if this is taking us a little bit of time to get there, I think it is better to do that in a safe and steady way. And we will talk further about that in February.

[Operator]

Your next question comes from the line of Robert Sage, Macquarie.

[Robert Ian Sage, Research Analyst]

I've got a couple of questions, please. The first is on going back to the segmental presentation, where one of the good-performing biz, whether by client segment or geographic region, is the Central & other items. And I guess the question is, is this presumably mostly to do with rising interest rates where it's captured within the group reporting? And is there anything particularly in the Q3 numbers that is sort of one-off in nature? Or could we see that as being a basis for extrapolating sort of future expectations? My second question is entirely different. And it sort of goes back to one of the earlier sort of questions, I think, from Manus, which is sort of talking about sort of looking at your business and your strategy where you're talking about several areas where you have differentiated advantages. But I think you're also putting into your statement today that you've learned a lot since 2015 about areas where you do not have differentiating advantages. And I was just wondering, without being necessarily specific about particular business units, whether we could be finding, when you do unfold your update on the strategy in February, whether there could be sort of further [ uplifts ] to the business that you would be downsizing, whether there could be further creations of new legacy portfolios or whether what we see today will remain intact going forwards.

[Andrew Nigel Halford, Group CFO & Director]

Okay, Robert, let me take the first, and Bill the second. So the simple answer to your question is that central and other is a beneficiary of -- to some extent of the interest rate increases. And that is a good part of the reason why its numbers are higher. There is nothing particular that I'd call out in the quarter itself, so sort of the guide going forwards, there's nothing sort of ex-ed out. But I would equally assert that does tend to be a little bit lumpy over time. It's not the most predictable line because of sheer volume of the balance sheet, et cetera, that's -- is quite significant. And so bottom line, beneficiary of interest rates and nothing particular to call out within the period.

[William Thomas Winters, Group Chief Executive & Director]

And Robert, on your second question, around areas of differentiation and besides areas of lack of differentiation. This is a body of work that we've been doing pretty continuously since 2015 with data as it comes in. And you can imagine the business in many ways was a very good business but underneath a lot of crud in 2015. And we've spent a fair amount of time scraping the crud off and at which point you check just how sound the whole is and how strong the engine is and how quickly that machine can move. And thankfully, having removed a lot of crud and upgraded the motors and streamlined the hull and things like that, we're doing a lot better than we were in 2015. But we have learned a lot of things, the investments that we've made that have really worked, the areas of focus that have worked. And some of it still lag. And you obviously can see from the results we have significant components of our business that are still well below their costs of capital by any measure. And we have others that are well ahead. And we've confirmed, I think, our key understanding about differentiated strengths in a few markets where we have sizable market share, strong brand. And obviously some markets intrinsically are more attractive than others. And we have some very attractive markets, and we have some less-attractive markets. But looking at our differentiation, we see key strengths with affluent clients. We see key strengths with corporate clients that are able to access our network or our cross-border services and capabilities in some way. And we see that we have a harder time hitting acceptable levels of return where we don't have those attributes. In some cases, we've got less differentiation but still some in a very attractive market, and that sounds fine to us. In other cases, we've got a bit of differentiation but in very unattractive markets. We're going to figure out how we can get our returns above cost of capital in those segments or those markets. And we have no doubt, as we dig further and further, some operations that are showing no signs of differentiation and perhaps not very attractive markets which we'll look to reposition, sell or otherwise focus on it on a differently differentiated strategy. But this is all the work has been ongoing pretty continuously since 2015. And we thought would bring it together in February together with some refreshed perspective on how we're going to get to a return that is a lot more exciting for all of us.

[Operator]

Your next question comes from the line of Fahed Kunwar from Redburn.

[Fahed Irshad Kunwar, Research Analyst]

Just a couple of questions. And one, margins, this might be my lack of understanding, but they're down 2 or 3 basis points Q-on-Q. And I know you've talked a lot about the funding change from current accounts to time deposits, but you said in the third quarter that kind of slowed down. So if that's not a reason that margins are down Q-on-Q, why are they down Q-on-Q? I apologize if I haven't quite understood that point, but it seems that the funding stuff has been resolved in third quarter, or at least moderated, so is there any other reason as to why margins are down Q-on-Q as much as they are? And the second question: You might defer to the strategy day, but if you look in terms of the 6% income growth for the next couple of years year-on-year -- you talk about 5% to 7% income growth revenue to down Q-on-Q. I understand the point that within the kind of market malaise you would take share of a shrinking pie, so to speak, but is that kind of growth rate realistic? Even though your competitive position is improving, if you're having across-the-board malaise in the emerging markets, is that the right kind of number we should be thinking about? Or realistically, will it be lower with you taking market share?

[Andrew Nigel Halford, Group CFO & Director]

So the -- on the margin one, just sort of a couple of things there. So what I was saying was that, late in the second quarter, we saw some of that movement between the CASA and the time deposits. Therefore, it was not particularly impacting the income in the second quarter but we ended the third quarter with that having changed, and therefore we did see a third quarter impact on income of it. And therefore, comparing second and third quarters, we have -- that is where it came through in income. And I think that another part of the margin reduction in the third quarter, more from the asset side. It's not just the liability side, a little bit tougher to pass on some of the increase in interest rates on to customers. And therefore, there were some elements of that, that was in it as well, but hopefully, the first part of that does more explain the things that I obviously did not explain clearly before. On income growth, I mean, I think you're right. We will provide an update, obviously, in February. We have got a target range out there. We've got no reason to think that we should be referencing different. We will be thoughtful about what we do. We're always going to take a risk lens to this. And if we do not think that there is an acceptable level of risk, we're not going to go and rush into these stuff just to get into a particular range. We are much more concerned by improving the quality of the returns in this business over the long-term period. But we'll do an update on the things we're going to do to deliver on those sorts of numbers in February.

[William Thomas Winters, Group Chief Executive & Director]

And I will just add that -- to the comment in response to your question about grabbing share in some situations where markets are more difficult. We absolutely intend to do that, but we don't feel -- we haven't needed to and we don't feel that we will need to lead with risk or with pricing to pick up share, but we can rather lead with focus and service. That's worked well for us and our focus areas over the past couple of years, and we will look to step that up. So we're not going to be the one that initiates a price war.

[Fahed Irshad Kunwar, Research Analyst]

Sorry, Bill. Can I just follow up with that? Can't you lead on prices, though? Because you have a structurally lower -- or your funding costs are higher, but considering your deposit base, you should have a lower funding cost if U.S. dollar liquidity is kind of tightening a lot, the U.S. -- so long U.S. dollar liquidity. Can you not kind of compete on price and take market share in that way because just competitively, your funding base is in a different place to some of your local peers?

[William Thomas Winters, Group Chief Executive & Director]

Yes. That's -- I mean I think it's the semantics. Of course, we can take share based on pricing where we have an advantage. We do that today and we'll continue to. Now we've not had an advantaged funding cost in most of our local markets in the recent past. There are sometimes of tightness in some markets, in particular in Africa and the Middle East, obviously the flip side of the challenges that we're -- we've experienced there on -- in third quarter. But my real point is we don't have a deliberate strategy to produce our margins in order to pick up share right now because we think we can pick up share by just doing a better job of what we've been doing, which is it has in fact increased our share in most of our client segments in most of our markets over the past few years.

[Operator]

And your next question comes from the line of Guy Stebbings, Exane BNP Paribas.

[Guy Stebbings, Analyst of Banks]

I have 2 questions, 1 on credit quality and then 1 back on costs. On credit quality, can I just ask about credit migration in the period? It looks like stage 3 exposures fell as a percentage of total exposure, but we didn't get a split between stage 1 and 2 for Q3, so can you just confirm there's no pickup in stage 2 in the period? I'm presuming given CG 12 exposures fell and the low credit impairment charge, that there wasn't any adverse credit migration. But that would be helpful, just to get the split there. And then on costs, if I can come back to your comments that you reduced some discretionary spend in Q3 to help meet your commitments of flat costs on H1 ex the levy, how should we think about that discretionary spend fall? Is it simply delayed into next year? Or it falls away.

[Andrew Nigel Halford, Group CFO & Director]

Yes, Guy. So no particular movement in terms of stage 2, stage 3 migration that I'd call out in the quarter. As you can see from most of the indicators, nonperforming, CG 12s, et cetera, they have these on a gently improving trend. There is nothing particular that I'd call out there that is a distortion that is not visible. On the costs, it's a bit of several things. There will be some things where we'll fly people less, where you can do more video conferences. There'll be 1 or 2 things where 6 people sort of just tighten their belts and whatever. But our overall belief that we can manage this business with the cost increase at or below inflation remains our view.

[Operator]

Our next question comes from the line of Martin Leitgeb, Goldman Sachs.

[Martin Leitgeb, Analyst]

Just to follow-up on an earlier question and income growth slowing. Risk costs, I think you've seen that before, that they are currently below full year cycle average. And I was just wondering if that means there's an increased focus on costs for yourself as a level to improve returns from here? And I was just wondering. How comfortable are you with the current cost base with the current geographic footprint? And do you see scope here for more aggressive cost measures going forward, or is your focus here predominantly on growing revenues in February?

[Andrew Nigel Halford, Group CFO & Director]

Well, it's all right, Martin. Thank you for your one-part question. That is appreciated. And I think, running any business, one can have an eye both to the top line and costs. I mean our absolute belief is there's a lot of potential in the markets in which we operate, that we need to make some investments to actually realize that full potential. And if we can take out enough costs to fund that investment, then that is the right way to go forwards. I think, if we're just heavily focused upon cost reduction, that in the long term is not a great way to grow a franchise. So our focus very much is going to be on investing into the areas where we believe there is opportunity for us and take out enough costs to be able to fund that growth, and we'll talk about both of those in February.

[William Thomas Winters, Group Chief Executive & Director]

Yes. Just specifically to your question on geographic footprint. We don't look at the question around where we operate as a -- primarily a cost question. It's a return question with a couple of key components. One is the return to the business itself, and second is the degree to which it contributes to the -- our broader network effect. So of course, we -- if we -- if and when we do adjust our geographic footprint, and we have in key products over the past few years, and we will continue to look at areas where we should be either investing more or investing less in a particular location, we're going to do that. And that could have the effect of adjusting expenses, but that's not going to be the primary driver. You're not going to see us exiting countries in order to hit artificial expense targets, but we will focus on how we get the best return from the geographic footprint that we've got.

[Operator]

Would you like to take the next question, sir?

[William Thomas Winters, Group Chief Executive & Director]

We can take one more question.

[Operator]

Your question comes from the line of Chris Manners, Barclays Research.

[Christopher Robert Manners, Co]

So a couple of questions, if I may. The first one was maybe just to follow up on Manus's point on capital. So you printed a 14.5% CET1 ratio. Given how well you did on RWAs. And maybe, of course, it may even have been a little bit higher in the quarter, but that still looks like around 200 basis points ahead of your -- midpoint of your guidance range. That will be about $5.3 billion. Say we do $1 billion, $1.5 billion to clear your legacy and conduct charges, that still gives you a $4 billion of surplus capital to the midpoint of your range. So it looks to me that a buyback could be really quite -- again you could take out a lot of your share count. A $2 billion buyback would be 9% of your share count, and you'd still be above your guidance range. So how comfortable are you with that 12% to 13% range? And do you consider that type of capital management as something you might rule with shareholders, albeit maybe people think it's right on the tail-end growth if you buy back? But yes, how do you look at that reward -- risk-reward? And the second one was really looking forward to the update in February. On the returns target, is that return on stated equity which is, I guess, what you put out in 2015 as something that's set to return on tangible equity target?

[Andrew Nigel Halford, Group CFO & Director]

Chris, your precision on your math is commendable. It's so nice to be having discussions about whether we've got excess, whereas 3 years ago it was sort of very much the other type of discussion. And we will obviously be giving more thought, as we update you in February, to what we think over the medium term, is a sensible range to continue to have capital at. As you partly referred to, there are a couple of things, but for the U.S., which we -- time will show a little bit more about what impact we will have from those. But as Bill spoke earlier, this is not all about returning capital. This is about deploying capital and how can we grow the franchise. So I think I understand the question. And we will certainly in February be updating, I think, on where our overall capital ranges we believe should be in the longer term. And sorry. Your other question was on...

[William Thomas Winters, Group Chief Executive & Director]

ROE...

[Unknown Executive]

ROE...

[Andrew Nigel Halford, Group CFO & Director]

ROE. Listen, we've said that we directionally believe we could get up and above 10% over a period of time. Again, we'll talk more about that in February, but whether it's 10% on one metric or 10% on the other metric, frankly, over long-term periods of time, the difference between the two is not hugely significant. Both of them are higher than where we are today, and that is going to be the important thing to talk to.

[William Thomas Winters, Group Chief Executive & Director]

And just to repeat what we said a bunch of times. Our target isn't to get to 10%. Our target is to consistently deliver above 10%, so.

[Christopher Robert Manners, Co]

Okay. That's understood. It was just that -- because if it was to slip to a return on tangible equity target. And that might -- if we were just looking at what was your book value and what's 10% of that, that might make a delta on where we sort of house and plan those -- take that net income number.

[William Thomas Winters, Group Chief Executive & Director]

Witnessing your demonstrated mathematical competence, I know you can make that adjustment really quickly in your head.Thanks, everybody, for joining us this morning and for your ongoing support and challenge. And we look forward to speaking to you as a group next in February.

[Operator]

That does conclude our conference for today. Thank you for participating. You may all disconnect.