DNB Bank ASA

OSE:DNB

Earnings Call Transcript 2018-Q1

[Thomas Midteide, executive]

[Audio Gap]

if you could do that later. But first of all, CFO, Rune Bjerke; and CEO Kjerstin Braathen will guide you through the numbers today and show you the results of our customer activities in the last quarter.

[Rune Bjerke, executive]

Thank you very much, Thomas, and good morning to all of you. And to who -- I tried to figure out how to start this presentation because the numbers are solid. We are comfortable. But the most important element in the presentation here today is to really continue on the story by emphasizing on the overriding target for the whole group, namely, the minimum 12% return on equity target. And if you look back to the first quarter last year, you can clearly see that moving from 9.6% to 11.2% this quarter on a trailing 12 month basis, return on equity, you clearly see that we are closing the gap to the target and we are improving quarter-by-quarter. This development obviously brings a lot of comfort into our own ambitions and we will try to go through the underlying operations to show why we have become much more comfortable.

If you look at the number for first quarter, we delivered 11% return on equity, up from first quarter last year, and looking at earnings per share, you see that we lift the result by more than 25% in the quarter. And this comes despite the fact that we have some headwind related to one-offs, NOK 899 million in negative effects coming from the basis swaps as well as the market to market valuation [indiscernible] capital. So there are many drivers behind the sound performance in first quarter.

NII is up, costs are down, we actually have a positive contribution from loan losses amounting to NOK 330 million related to credit quality, macroeconomic conditions and also the fact that we have prepared for the new IFRS accounting regime in a way that actually make this happen. It's also important to say that we have had loan growth from last year at 4.6% and if you adjust for seasonality, looking at the first quarter, we are on track.

This quarter we also provide a new tax guidance. We have made a new estimate on what we expect taxes to be in 2018 and 2019, and we revised the estimate from 23% to 20% for these 2 years. We had strong performance in all business segments. And to start with personal customers segment, you can see that the pretax operating profit is up by more than 10% compared to last year. It's not that impressive if you compare first quarter with fourth quarter, but you have to take into account the fact that we have 2 fewer interest rates -- rate days in the first quarter. So the underlying activity is strong. Money transfer fees are up, significantly up, and all the initiatives we have implemented in 2017 seem to work.

We have tried to highlight on the private banking development this quarter. Just to tell you the story about how we are building assets under management, up from about NOK 50 billion in 2013 to more than NOK 100 billion in first quarter this year. And we actually managed to grow the assets in first quarter, despite the volatility and market turbulence as well and we have more to come in the quarters ahead.

The SME segment has impressed the organization once again. All-time high results. And if you look at the development, SME is up by more than 10% in pre-tax operating profit as well, but adjusted for the loan losses, the improvement is actually higher than 25% compared with first quarter last year.

And if you look at the development from 2013, and at that time we actually reorganized in DNB. We splitted the LCI segment into 2 parts, one SME segment and we kept the big corporate international clients in the remaining part of the segment. You can clearly see how this focus have worked. Lifting the return on equity from below 12% to more than 17% in 3 years and the volumes have grown significantly over the time. And if you look into the content on the SMEs today, I mean it's really fascinating to see that we have a market share amongst startups in Norway higher than 40%. So this position has been built step by step and we expect a lot in the quarters to come as well. In this quarter, the large corporate clients have managed to climb and to present pretty decent result despite turbulence in the market.

The main reason for the sharp improvement has to do with the fact that we have write-backs, close to NOK 600 million in write-backs for this segment in the quarter. But it's also very, very important to stress that we have been through a rebalancing operation where we've reduced volumes since first quarter last year by almost 11%. And at the same time, these employees working in the segment have been able to keep the net interest income stable despite the reduction in loan and deposits.

We work closely incorporation driven DNB Markets and we have seen that this corporation tends to increase profitability. DNB Markets itself delivered more than NOK 1 billion for the quarter, but they were not as successful as the other segments when it comes to improvements. They delivered on the basic target, but we expect more in the quarter to come. [ We thought ] NOK 1 billion is not enough if you look at your colleagues in the other segment.

Life insurance has also been able to perform well in the quarter, NOK 381 million in net result despite volatility and market turbulence and we are seeing a trend where the increase in defined contribution contracts lead to increase in commission and fees through the different segments and this development will be more and more visible going forward.

The pace of change in the financing sector is increasing. The way we work and operate have to change. We are facing new competitors every day, not only small fintechs but also the global giants like Apple, Facebook and others, PayPal, they are penetrating parts of the value chains belonging to banks. That's why we are taking a lead role in the transformation of how we operate. That's why we have managed to cooperate with the other saving banks in the creation of Vipps. That's why we have presented a proposal for merger between Vipps and BankAxept and BankID and we expect that merger to be approved before summer. If we make this happen, we have a much stronger position to meet the new competition.

And side by side with a buildup of new platforms like our Save app, we basically provide the best investment platform for third party product suppliers, but also eventually later on to third party customers. We have to think outside the box to open up in a different way and to corporate to make more value in existing infrastructure from employees in our bank. The business models need to change as well and we need to seek partnerships. And we have been successful in our partnership with Facebook by introducing a more smart and sophisticated way to penetrate the housing market through advertisements and we're actually more efficient than the other classified companies right now.

This leads to an increase and stronger position for our real estate brokering arm as well as our supply of mortgages. On the other hand, we need to expand our own value chains. That's what's happening in 2018. And you probably have heard of the initiative to launch our own media house. I know that this was a questionable move from a bank like DNB, but it's a fact that last week we actually had 750,000 unique visitors on our own news sites. Obviously this can lead to new business as well. And that's why we need to look for new opportunities based upon everything we have inside our organization related to competence and infrastructure. We have now set the new organization. We have opened up for a more agile way of approaching customers and also partners and we are working closely with Start-up Lab and fintechs to create new services and products for our customers. We are also investing in some of the companies we are partnering with and the new organization is a very strong tool for becoming more efficient.

We realize that the focus on sustainability is stronger and stronger every day, not only from the customers' behalf, but also from investors. We have been able to gradually integrate sustainability in everything we do inside the bank. We need to integrate sustainability in our business, not only to talk about it and to take part in different initiatives. The Board of Directors have pinpointed [ 2 out of the UM ] sustainability goals as focus areas, namely diversity and sustainable development. And it's satisfactory to see that we actually are ranked as one of the top 10 banks globally related to our ESG initiative. And we are also named as an industry leader in this respect. If you look at what we are doing to adjust or to adapt to this sustainability expectation from investors and clients, we have one example related to oil sand. We do not enter into business with clients having more than 15% of the revenue coming from oil sand activities. This goes for our credit activities as well as for our investment activities. Such kind of examples will be more and more visible going forward.

When it comes to diversity, I will just say that the board has a very tough regime of expectations to management. It's not only about representation in group management which I am pretty satisfied with, 50% men, 50% women, but it's the way we actually attract to talent. The way we deliver on potential for a career development for all types of diverse groups. We have to reflect our clients and I think we are on way to do that in a very, very well position. Kjerstin, why don't you dig deeper into the details?

[Kjerstin Braathen, executive]

Thank you, Rune and good morning ladies and gentlemen. Coming back to the growth for the group during the first quarter, the underlying growth is 1.2% and annualized 4.6%. Personal customers is growing by 0.7%, which is in line with the growth last year and we need to bear in mind that Easter had a seasonal effect in the first quarter this year. SME continues to grow very strongly, ends up with 2.1% for the first quarter. Large corporates and institutions, you can clearly see the shift from a steep rebalancing last year now into a situation where the underlying growth was 1.4%. We will continue to rebalance and somewhat reduce our exposure in the cyclical industries but this will be at the slower pace than previously. So all-in-all, we maintain our expectations on the outlook for growth this year and indicate around 3% to 4% for the year.

Over to the margins. If you look at the volume weighted margins, these show a stable development during the quarter. You all know that money market rates have increased, and you can see the effect of this if you look at the lending margins and deposit margins, but combined spreads remain stable. We repeat what we have said previously. In the short term, we are relatively neutral to movements in the NIBOR, but it is important to say that increasing rates is a positive for many areas of our business, one of them in particular being the life insurance business.

When you look at the net interest margin, however, we see an increase of 8 basis points this quarter. One of the main drivers is lower funding costs. There is also an effect from change in the asset mix and an effect from 4 basis points from reclassification -- reclassifying revenue from our short-term liquidity dispositions with central banks and financial institutions.

Going forward, in the short-term money market rates may put some pressure on the weighed margins, but when it comes to the net interest margins, we expect them to be more or less stable, potentially with some more upside in the short-term from funding. So adding up volumes and margins, the result is a strong net interest income this quarter that is up by NOK 144 million compared to the previous quarter.

Positive contribution from spreads funding and other elements more than outweigh the slight negative impact from currency effects and volume. 2 less interest days, you were prepared for, have a negative effect of NOK 171 million and we also have a very positive effect of NOK 259 million from the reclassification I addressed on the previous slide. And I would like to say that while this is a reclassification, it does demonstrate a stronger quality in our earnings as these for the most part are stable and recurring revenue.

Fees are out of the box up from both previous quarter and the same quarter last year. You will see that we have also reclassified guarantee commissions, which is definitely a fee related revenue. And if we adjust for this, fees are down by 4% compared to the same quarter last year. The really strong point on the fees this quarter is money transfer and banking services in personal customers, in SME and also in LCI. This is the result of broad initiatives to price products right, to reduce cost amongst other related to discontinuing the offering of banking products through the retail network in Norway. It's also a result of lower costs and more efficient payment value chains. The strong delivery in money transfer is offset by a slower quarter in the investment banking division. This is due to a volatile and slightly less active market. Easter again has a seasonal effect and activity is picking up into the second quarter. Clearly investment banking, the result of first quarter in itself is below both ambitions and expectations for the year. We know there is -- it is related to volatility in the market and we have to see this over more than one quarter to see a representative development.

Lastly, I would like to mention here asset management, a very sound development, more than 13% growth compared to first quarter last year. And a strong contribution also from the life insurance business.

Over to cost efficiencies, always high on our agenda. Costs are down by NOK 863 million compared to the previous quarter. Of this NOK 600 million is related to nonrecurring effects that led to the higher cost we had in fourth quarter. In this quarter, you can see that we have somewhat lower activity on the investment side and there is also lower cost from marketing and traveling and restructuring cost. Investment activity will vary somewhat from quarter to quarter. Overall, our ambition is to have an investment activity level, which is in line with the level we saw last year. We continue to work hard on cost and are committed to our target of having a cost base of less than 40% of our revenue.

Over to the losses this quarter, and as Rune already pointed out the losses are a positive contribution to our results this quarter by NOK 330 million. Personal customers and SME, very solid quality and losses way below normalized losses. The larger movements also this quarter comes in the large corporate and institutions. The bigger movements are this quarter related to the offshore industry. There are some new names moving into individual impairments. But these do not generate a loss on a net basis because they've already been reserved for under the stage 2, which we previously referred to as collective impairments. Beyond that, there are positive effects from solving restructuring situations on certain customers and there are also positive effects from reduced volumes and positive migration overall, which sums up in LCI having a net positive contribution this quarter of close to NOK 600 million. All in all, this sums up to a profit for the period, which is 24% better than the same quarter last year. Return on equity, you have seen 11%. Cost to income ratio, 43.4%. If we adjust for the negative effect on the market to market, we are at a cost to income ratio of 40.4%.

Capital is another strong point this quarter. CET1 ratio is up from 16.4% to 16.6%. Bear in mind that that also includes the one-off effect -- the one-off negative effect of IFRS 9 of 28 basis points. And the other larger movement in the CET1 ratio is related to the results generated, currency fluctuations and the growth that we've seen in the customer areas.

This underlines our ability to go for profitable growth opportunities that we pursue in all sectors and customer areas and underlines our ability to continue to deliver on our dividend policy. And on that note, we earlier this week received an approval from the General Assembly, both to pay out the dividend from the life insurance company that has been announced as well as the one for holding and a proxy to buy back up to 4% of our shares in the coming year, and we're now awaiting an approval from the SSA. Leverage ratio continues to be strong, 7.2% and underlines the fact that we are one of the, if not the most, solid banks in Europe.

Quickly towards the end, we are on track to deliver on our targets. We maintain our guiding in all areas. I should mention also that in view of the transition to IFRS 9, we have decided to stop the impairment guiding as such. Losses will fluctuate from quarter to quarter, but given the situation, we see today and the macroeconomic outlook, we expect losses for the year to be less than what we refer to as the historical run rate of 17 basis points that we talked to our Capital Markets Day.

Last point already mentioned, we revised our tax guiding down from 23% to 20%.

So with that we open up for questions.

[Thomas Midteide, executive]

Absolutely. As usual, we'll have the Q&A session. And if you could be so kind to wait for the microphone so that the web audience can hear us. We'll start with Johan Ström and then Jan Erik and I think we'll have the question on the topic of life insurance maybe.

[Johan Ström, analyst]

That's correct. Johan Ström, Carnegie. So first of all on the life insurance business. I noticed that the solvency margin increased by 14 percentage points during Q1, which is quite a lot. This capital in life insurance business, is this part of the CET1 ratio reported in Q1? And if not, how should we think about sort of the capital and how it flows to the holding company? Could we see 4 quarters with strong capital buildup in the life insurance business, which we need to take into account with regards to the dividend?

[Kjerstin Braathen, executive]

The capital buildup of such in the life insurance company is not visible in the current core equity 1 ratio. In fact, as we specified when we announced the full year earnings and the enhanced dividend for the life insurance company, the effect on the core equity 1 ratio comes only when the dividend is paid out. So we have decided to pay out a dividend of NOK 1.5 billion and this will strengthen our core equity 1 even further beyond what we see today. The strengthening of the solvency ratio is substantial in the first quarter and it's due to higher interest rates and volatility adjustments. And as we've said we aim to continue to pay out dividend from the life insurance company and this strengthens the core equity on the holding level and dividend capacity.

[Rune Bjerke, executive]

Let me just add to repeat what has been said previously. We intend to pay out excess capital, excess capital for the life insurance company to the mother from DNB to the shareholders. And excess capital will be paid out one way or the other.

[Johan Ström, analyst]

That's very clear. And then just on the revised tax rate, can you specify the drivers for this, elaborate a little bit more?

[Kjerstin Braathen, executive]

Yes. The main driver for this is related to the allocation of interest really between the U.S. and Norway. And there are some other factors, but the main one is allocation of interest between U.S. and Norway.

[Thomas Midteide, executive]

Excellent. And we have Jan Erick, ABG.

[Jan Gjerland, analyst]

Jan Erick from ABG. I just have 3 questions on -- first on the MiFID and investment banking as have you seen any changes in the customers' behavior or the margins when it comes to investment banking revenues and in MiFID implementations, which means that you have opened up your how you receive revenues and fees from customers? And secondly, if you could explore a little bit on the higher investment expectation for cost during this year so that that we should expect still a high level of investments for reduce cost also in 2018? And finally on the buybacks, have you prepared any formal pre application or did you send it yesterday?

[Rune Bjerke, executive]

Yesterday or this morning, an application was sent. And we expect that application to be processed and handled by the Norwegian FSA and that an answer will be received in due time before summer. The 2 other questions?

[Kjerstin Braathen, executive]

MiFID [ and activity ].

[Rune Bjerke, executive]

MiFID, it's a little bit too early to conclude when it comes to the effects from MiFID. We saw that in the first 2 quarters. There were signs of not confusion but uncertainty about how to continue the relationship between the banks and the clients, but now it looks like it becomes more and more ordinary business again. So it's too early to conclude. But no visible significant effect so far out of MiFID and as we have stated in previous quarters, we expect the total take to be a little bit small than it actually has been -- it has been over time. On the other hand, the best players, the biggest banks in the different geographical markets might have the opportunity to get the bigger piece of the cake.

[Kjerstin Braathen, executive]

And I can answer on the investments. They may fluctuate a little from quarter to quarter, but overall, our expectations currently is that we will make investments approximately at the same level as we did last year. Within that, we always work to increase the portion of the investments related to new business opportunities, and increased revenues as well as cost efficiencies. But there are obviously also element of compliance related investments in the basket. We have said and should repeat again that when it comes to investment, in an industry that is so much in transformation, it's not about minimizing investments, but it is also about investing at the right level and this is something that we continuously [ have a high rate ].

[Thomas Midteide, executive]

The next question from Vegard Toverud, Pareto.

[Vegard Toverud, analyst]

I also have 3 questions if I may. First on tax. Why is the new guiding on 20% so specific for '18 and '19? So what should we then expect for 2020? Is at the same level or how should we interpret this specification over '18 and '19?

[Rune Bjerke, executive]

This is because the longer time horizon you actually introduce, the more uncertainty you actually have out there. We had concentrated on 2 upcoming years to be sure that we don't take it too much granted what happens after a long period of time. We have no information that actually we will offer that tax estimate in 2020, but it's too early and it's too far ahead to be precisely guiding.

[Vegard Toverud, analyst]

Okay. On pension, I might remember this incorrectly, but when you changed the pension for all your employees, there was a temporary boost in the pension costs or at least it was communicated back then as temporary. Is it temporary or is the pension cost that we are now seeing the new level we should expect going forward?

[Rune Bjerke, executive]

Pension costs should come a little bit down after 3 years according to the plan we had. So I don't think anything has happened with those estimates and the projections we actually created at that time. So from 2020, it should be a little bit lower than we actually have today.

[Vegard Toverud, analyst]

And lastly on the strong money transfer and interbank fees. What is the reason for the strong performance this quarter?

[Rune Bjerke, executive]

We said that after the cap on interchange fees, we needed to look into the whole value chain for payment infrastructure in all segments and we did so. And Vipps have the establishment. Vipps was one part of the strategy to both increase revenues and also to reduce costs. When Vipps reduced cost for transactions for payments through cellphone, they have actually also been able to reduce costs from transfers between banks. So if you use for example now the national scheme or the processing outside Visa and MasterCard, you do it less [ costly ] today than 2 years ago. On the other side, we have tried to avoid deviation in our pricing policy to customers and to introduce more proper price regimes in all part of the value chains for the 3 segments. So hopefully this would be even more visible going forward and it's the right incentives both for clients and for those who use transactions as a tool in their daily business.

[Thomas Midteide, executive]

If you could please turn the microphone to rows back to Thomas Svendsen, Nordea Markets.

[Thomas Svendsen, analyst]

I know that you are about to complete this asset rebalancing of the cyclical industries. Would it be possible to sort of quantify the lower risk on your asset side compared to the business model like it was some years ago?

[Rune Bjerke, executive]

I mean it's really hard to quantify, but if you look at the share of shipping for example it's reduced from 7% in 2015 down to 4.2% right now. If you look at oil-related exposures down from 8.7% to 5.5%. And the less activity, we have in the most volatile segments, obviously the implications on the risk structure is more visible and concrete. But we are not giving numbers as such for the transformation.

[Thomas Svendsen, analyst]

I was thinking maybe a reduction in the expected losses or something like that to help us.

[Kjerstin Braathen, executive]

Expected losses are now also influenced by IFRS 9, so it's a bit hard to find comparable figures. I think the best way to approach is actually to look at the total exposure in the cyclical industries and try to make some sense of normalized loss in those areas versus the new ones. But having said that, IFRS 9 as such will not change the losses. It may make them somewhat more volatile. But we won't lose more money because of it. So having a lesser portfolio that is volatile leads to less normalized losses, but unfortunately we can't give you a number as to how much.

[Thomas Svendsen, analyst]

Question number two, on the Capital Markets Day you said you have to have bid flexibility to sort of optimize lending margins or total margins including SME lending margins. Do you still think that this is the case after several Norwegian banks now have flagged aggressive growth ambitions in the segment?

[Rune Bjerke, executive]

I cannot comment on pricing as such, but if you look at statements given by other banks in the news, you clearly see a different perspective than you are describing. That's my comment. We have tough competition in the market. There will be tough competition. We are positioned to take part in that competition. On the other hand, I think banks have to act rational.

[Kjerstin Braathen, executive]

And I would also like to add that our competitive position has to do with much more than pricing and increasingly the more heterogeneous this sector is and you mentioned SME, the bigger the room is to deploy other elements that really accounts for the SMEs. We see one of our strong competitive edges being our capability in risk management and derivative services, another is industry competence. So there is much more than price that actually leads to the development you see in the return on allocated capital in this area.

[Thomas Midteide, executive]

So I don't have any more questions on my lists. Last chance to -- yes, Jan Erick, you always deliver. Thank you.

[Jan Gjerland, analyst]

When it comes to MiFID on the trading arm, especially [ with ] NOK 1 billion revenue, is this how -- when did you implement the MiFID picture to the customers who actually can then see how much he does pay in Norwegian kroner per transaction [ on referencing a ] bond or a swap or anything more difficult transaction rather than the MiFID income you talked about earlier on the investment bank side? So when did you implement it and what have been the outcome so far? Is it still like customers trade as much with you as previously or are they now arguing about pricing?

[Rune Bjerke, executive]

They are not arguing at pricing at all. I mean it's a visible and transparent price picture and according to MiFID they can see what fees they are paying, they can see what charges we make on transactions related to currency. So the key change is actually transparency and it's open now for customers in the end of the year. They can look at all their fees and commissions they have paid throughout the year according to MiFID. So transparency and visibility are the 2 major changes for the clients and that will potentially and probably lead to a more competitive landscape out there. On the other hand, it will also be more business to do due to the transparency and also due to the new products and services and digital offering we are delivering.

[Thomas Midteide, executive]

And we have a next question from Vegard Toverud.

[Vegard Toverud, analyst]

Just a follow-up on that on new services and offerings, especially the digital ones. We are moving closer and closer to the PSD2 and the offerings will likely then start to come to the market quite soon. Will you focus your offerings on offering them through the Vipps platform or your own platform?

[Rune Bjerke, executive]

I think, we have to use different platforms. That's the key. We have the Vipps platform together with the saving banks. We have our own platforms. We probably will develop new platforms together with others and ourselves. So this is part of the development. You need more than 1 platform, you need more than 1 strategic partnership and you need to a lot together with different players. But Vipps is obviously a very important part of the payment infrastructure strategy. But savings up, for example, the investment offering we are delivering today opens up with the third party product suppliers and it will eventually be opened up for all banks customers and that's the DNB savings app.

[Vegard Toverud, analyst]

Is it easier for you to open up for that on your own platforms than doing it via the Vipps or would you say it's easier the other way or the same?

[Rune Bjerke, executive]

I mean it's a strategic -- it's a strategic question. I mean we are doing a lot together with our partners, but we are also doing a lot on our own.

[Kjerstin Braathen, executive]

And we can add that we are preparing for this through our open banking strategy where we are developing APIs both for our DNB related platforms, but also to commercially open up in the market for other entities to connect into and there, for every decision for every API, it is a strategic decision. Whether it's easier or not it's more about the choices we're making and they will become increasingly important as we start to see the effect of PSD2. But as with MiFID, I think it will take time before we actually see how this will develop and we will make decisions as we go along.

[Thomas Midteide, executive]

Okay. I guess that concludes the Q&A session. Thank you so much for coming and have a fantastic day.