DNB Bank ASA

OSE:DNB

Earnings Call Transcript 2020-Q2

[Operator]

Hello, and welcome to the DNB second quarter call. My name is Jess, and I'll be your coordinator for today's event. [Operator Instructions]

I will now hand you over to your host, Rune Helland, to begin today's call. Thank you.

[Rune Helland, executive]

Thank you so much, and hello, everyone, and welcome to DNB's analyst call for the second quarter. Here in Oslo, we are with the CEO, Kjerstin Braathen; CFO, Ottar Ertzeid; the Group Risk Officer -- Head of Group Risk Officer, Ida Lerner; Head of Personal Banking, Ingjerd Blekeli Spiten; Head of Corporate Banking, Harald Serck-Hanssen.

And before we start the Q&A, Ottar, will give you a short introduction. Ottar?

[Ottar Ertzeid, executive]

Thank you, Rune. In today's presentation, we demonstrated on Slide 3 that Norway has been quite successful in controlling COVID-19. After the gradual reopening of the society, activity levels have picked up and growth in the economy has picked up as well. It is with -- through the revised estimate for the economic outlook in Norway, we received from the Central Bank and also the statistics bureau in Norway, and pointing to the positive direction through the second quarter. They now expect a positive GDP growth for the second half of the year.

The policy rate in Norway was reduced to 0 in May, but only a month later, the Central Bank increased the rate [ half ] going forward, projecting rate increases again in the second half of 2022. Unemployment in Norway spiked at 10.4%, but has come down to a level of 4.8% at the end of the quarter. We see that housing projects within Norway have picked up, and a lot of the positive sentiment is possibly -- probably driven by the fact that most Norwegians have adjustable rate mortgages. And the rate on those loans has almost been halved through the rate actions of the Central Bank, increasing disposable income for households in Norway.

Looking at the numbers for the second quarter, we see that net interest margin has declined and net interest income, similarly in line with our previous guiding of NOK 1.25 billion effect from the level we saw in the first quarter, meaning that the numbers in NII for the second quarter is fairly representative for what we expect going forward. We reduced rates on loans before we reduced loans on the profits, and that's why the reason -- that's the reason this is fully reflected into the 2Q numbers.

Looking at commission and fees, that was an area where the increased activity in Norway is clearly visible. Commission and fees are 5.6% lower than the second quarter last year, but more than 7% up from the first quarter. The pickup in activity is clearly visible in real estate broking. It was back to almost the same level as 1 year before. Activity in investment banking is the same high level as in the second quarter last year. Asset management fees are up both year-over-year and compared to the first quarter, guarantee commissions growing nicely as well. The only area we see a meaningful impact from COVID-19 in the numbers is money transfer and international use of cards due to travel restrictions, still limiting activity in that profitable area of banking services. But overall, activity and commission fees have developed more positively than we expected 3 months ago.

The significant negative mark-to-market effects we saw in the first quarter due to the weakening of the Norwegian kroner currency and widening credit spreads have been largely reversed this quarter with the opposite numbers visible in the second quarter numbers.

Looking at impairments, they came in at NOK 2.12 billion, 88% of which is from the oil, gas and offshore segment and mainly within offshore, where in this segment, we saw a migration. Meaning at stage 1 and 2, impairments decreased; while stage 3, impairments total more than NOK 2.7 billion. Offshore constitutes less than 1.7% of the portfolio, but remain the most challenging segment.

In the other corporate segments, total impairments totaled NOK 168 million. We saw net reversals in stage 3 and an increased impairments in stage 1 and 2 as a result of negative migration for certain travel-related industries.

Overall for shipping, the segment was stable. With regard to personal customers, the impairments were back to a low level of NOK 82 million, reflecting the robust portfolio. All in all, we repeat that we still expect losses to be highest in the first half of this year and reiterate that the overall portfolio is robust and well diversified.

Taking a look at capital, common equity Tier 1 capital increased 50 basis points during the quarter. The headroom above the minimum requirement is now at an all-time high. And the headroom is also 100 basis points higher than at the end of the last year. The proposed dividend of NOK 9 per share and also 50% of the profits for this year are not included in these numbers.

To sum up, the cost-to-income ratio for the quarter was in line with our financial ambitions of 40%. Return on equity and earnings per share are negatively affected by both higher than normal impairment provisions and also the Central Bank's zero policy rate. But however, as I pointed to, the Central Bank indicated that they will start raising the policy rate again in 8 quarters from now. Return on equity is also negatively impacted by higher average equity. Dividends are usually paid in the second quarter, while dividends for 2019 will be considered at the Extraordinary General Meeting in the fourth quarter this year. But nevertheless, return on equity increased to 8.7% for the quarter, reflecting the strong pretax operating profit before impairments of NOK 8.4 billion, which is actually up more than 3% from the second quarter last year and demonstrates the resilience in earnings over time, which has have been a point we have reverted to several times before. Earnings per share, up 34% from the fourth quarter coming in at NOK 3.06.

[Rune Helland, executive]

Thank you, Ottar. We will open up for questions.

[Operator]

[Operator Instructions] The first question comes from the line of Nick Davey.

[Nick Davey, analyst]

I'll go with three, please. The first one on asset quality. So I understand the comments about the robust portfolio and the general level of confidence. Just a s***** question about IFRS 9, if you don't mind just helping us to understand better the portion of your loan book that's sitting in stage 2 at the moment, I think 9% or so. Could you help us understand the outlook on that chunk of the book? What it -- what sort of triggers have been hit for some of the migration in stage 2 earlier in the year and your confidence or not that the book could migrate into stage 3 later in the year just because that's obviously quite a big swing?

And the second question would be around capital return. And I know it's early, and there's no crystal ball, but I just wonder whether you could talk about priorities for capital distribution in the next couple of years. If we think that the rate impact has taken away 2 percentage points of ROE, do you think for as long as rates are at this level, you have enough cash generation to pursue growth plus dividends plus buybacks? Would you think that's a bit too much pressure? And sorry, the third question then would be just quickly on exchange rates. At the current level of the kroner -- to say, the dollar, could you just help us with the impact of net interest income or revenues for the second half of the year?

[Kjerstin Braathen, executive]

Should I start with the IFRS 9 then? Because I think it's important to highlight that what we -- when looking at the impairments of H1 and 2, those are completely generated from a model-based approach. While when you transfer a customer then from stage 2 into stage 3, we go into an individual impairment discussion and look at the actual situation we have in terms of security package as well. When we won't give any guidance in terms of outlook in impairments going forward. But as we stated in Q1 and continue to state now, we expect the majority of the impairments to be taken in the first half of this year. And also bearing in mind that the IFRS 9 also stipulates that you should have a forward-looking assessment looking into the coming 3 years.

So really, what we are taking upfront in stage 2 should also be a reflection of what we expect going forward transferring also into stage 3.

I can address the second one, and then maybe Ottar can answer the last one. In terms of capital return and strategy and priorities, there are no changes as to our previous communication. I mean, firstly, capital generated through earnings contributes to a robust and resilient capital level in line with the requirements, that would be priority #1. Priority #2 is to invest back into the business in terms of organic growth, where we have said that we target both in the short-term and medium longer-term growth as well as in the area of 3% to 4% per year. And then excess capital under normal circumstances will be distributed to shareholders. Firstly, through cash dividend, where minimum 50% of the results should be distributed in cash dividend and any excess capital, we look to distribute that through share buybacks. So that remains consistent. But as you all know, I mean, this year is different, where the decision on 2019 dividend has been postponed until the fourth quarter. So we won't have full clarity until then, but we can also then remind you the statements that have been reiterated by the Minister of Finance, where they also after the segments that came from the risk...

[Ottar Ertzeid, executive]

European Systemic Risk Board.

[Unknown Executive]

The Systemic Risk Board in Europe encouraging institutions to hold back on dividends, the Minister of Finance referred back to their statement in March, where they encourage institutions to hold back until the uncertainty is reduced. And of course, level of -- there is still a level of uncertainty, but I think we can clearly say that it's been reduced compared to what it was 3 months ago. But again, the decision won't be made until fourth quarter this year. The last question, I didn't...

[Ottar Ertzeid, executive]

The last question was on the FX effect on net interest income. On Slide 10 in the deck today, we showed that the FX exchange rate effect on NII was NOK 118 million in the second quarter and in that quarter, we had a 5.5% average appreciation of the Norwegian kroner. So what's to expect going forward if the FX rates were to stay at today's level, it's actually 6%, even lower. It will have a similar further effects going forward on NII.

[Nick Davey, analyst]

It's a negative, is that right? It's an offset? It's a reversal?

[Ottar Ertzeid, executive]

Yes, yes. [indiscernible] strong [indiscernible] means a lower loan book, U.S. dollar loan book measured in NOKs and thus, lower NOKs revenues.

[Operator]

The next question comes from the line of Antonio Reale.

[Antonio Reale, analyst]

This is Antonio here from Morgan Stanley. Just two or three questions and follow-ups, if I may, please. The first one is on fees, which, of course, have been an area of strength pre-COVID. And you were guiding to a 4%, 5% annual growth, I think, in your plan. Now obviously, the outlook has changed, of course. And the quarter, however, has showed some signs of recovery. Could you perhaps walk us through what you expect for the second half of the year? And beyond some of the activities are, of course, affected by some more structural drivers. So I wonder how we should think about your ambitions here also medium term? That's the first question.

The second question is on the cost side. You've regulated your cost income ratio target of below 40%. Could you perhaps walk us through the levers you plan to use? And how front-end loaded do you expect this to be? If I remember right, I think you had a cost reduction of NOK 1.52 billion from 2020, 2022, could we have an update there on basically where you see more flexibility, please? And the last point is on risk-weighted assets. They've been lower quarter-on-quarter, mainly as a result of a lower credit and FX, if I understand correctly. However, on the credit side, you're guiding for a 3%, 4% loan growth and started to see some credit migration. So I'm just wondering how we should think about risk-weighted assets inflation in the second half of the year.

[Kjerstin Braathen, executive]

Thank you, Antonio. I'll start, and I'll hand it over to Ottar. Just some comments on the fees side. Yes, indeed. I mean second quarter has been a tremendously strong recovery in many areas that are matching the results of second quarter '19, and that's in a quarter where 2 of the months we were substantially impacted by lockdown. So what does this mean going forward for the remainder of the year? I think just measuring by the current temperature, we can say that on the housing market, it continues to be very active into the month of July. And given the economic outlook, the level of confidence among consumers and the activity, we believe that, that market should continue to normalize throughout the year.

In Investment Banking, there is seasonality, third quarter in general being a slower quarter than the second quarter. But given also a world that develops in accordance with the current outlook beyond the quarterly seasonality as what we see and read today very much supports a return to normal. The category that is impacted, and that will continue to be impacted is banking services and money transfer related to less traveling activity abroad, and that is usually an important source of income, both in the second quarter and in the third quarter.

Spending patterns in Norway are back to normal. But people travel less. And even though we are opening up in the midst of July, we expect less travel activity than normal. So that will be that will be impacted also in the third quarter.

Asset management, a very promising development. Net inflow in all of the 3 months represented in the quarter, a very strong underlying trend. And of course, the uncertainty there lies around the performance and potential success fees on the products that are managed, which is a bit too soon to say. Insurance on the life side, I would say, not so much impacted. Non-life insurance, it's been a turbulent start to the year, much better results this quarter than the previous quarter. In terms of sales, it's at the same level as last year, and we expect to build that up over time. So all in all, a big chunk of it is really showing promising development back to normal with a strong trend. But I don't think we can say that we're back to square one in terms of guiding for the year. I mean first and second quarter are impacted, but it does look much better in terms of the outlook.

[Ottar Ertzeid, executive]

Yes. With regard to costs, we launched a program at the Capital Markets Day in November indicating accumulated cost reductions of NOK 1.5 billion to NOK 2 billion this year and the coming 2 years and pointing to areas like automation, distribution due to digitalization and also new ways of working. And I think the COVID-19 experience has just confirmed the high relevance of all these initiatives. And we are working on these initiatives and we'll continue towards -- during the coming 2 next years as promised on the Capital Markets Day.

So really nothing new on top of that, I would say, other than confirming what we already planned for and that those plans were highly relevant.

With regard to risk-weighted assets, I think there was some negative migration in the quarter, reducing capital by 20 basis points. Underlying ROA are negatively impacted, but the higher provisions had the opposite effect of actually reducing risk-weighted assets in stage 3 but it's fair to say that with the negative migration in the portfolio, there will be some negative migration in RWAs. On the other hand, the numbers also demonstrate the contribution from the profit generation we have each quarter, adding to capital this quarter as well.

[Operator]

The next question comes from the line of Sofie Peterzens.

[Sofie Peterzens, analyst]

Here is Sofie from JPMorgan. So I just wanted just on loan growth. You reiterate your 3% to 4% loan growth, the loans were relatively weak this quarter, partly because of FX. But how should we think about loan growth going forward?

The boost in our customer growth was relatively flat quarter-on-quarter, but we saw a decline in the corporate loan book. What are the trends that you're seeing here on the corporate side? And then my second question would be on consumer lending. How should we think about consumer loan growth outlook and also asset quality, especially in Sweden, where you have been growing on consumer or leasing side? And then my final question would be on the offshore book. We saw almost a 30% increase in NPLs, and the NPL ratio is now over 20% in the offshore book. But coverage is only around 37%. Should we expect more provisions for the offshore book? Or are you happy with the book as it is covered now? And if so, what are the main reasons?

[Kjerstin Braathen, executive]

Okay. Thank you for your questions, Sofie. Loan growth, yes, we reiterate 3% to 4% without guiding specifically on the mix of the growth, but we can share some comments on each of the segments. Personal customers, this was a relatively flat development in the second quarter, but it's important to highlight that the activity and growth picked up towards the end of the quarter quite substantially. So we also have a high pace coming into the month of July. So we do expect attractive and profitable growth in the sector for the year, however, probably somewhat lower than we saw last year. SMEs is a bit better concealed now with Corporate Banking being as one, but SME saw a growth for the quarter of 1.8% and have attractive prospects for the year. Given the activity that we do see.

With regards to larger corporates, it's an area where we both shed some regard to currency fluctuations as well as wanting to deliver on the strategy to originate and distribute, where we do sell off exposure after underwriting. So it's an area that is more lumpy, where we've managed capital relatively tightly, both in view of currency effects that leads to the growth year-to-date for the group being 2.7%. And also in view of the uncertainty and lack of transparency with regards to RWA migration, which has expected -- which has developed better maybe than we fared during the quarter when it started.

So overall, loan growth, we reiterate 3% to 4%. We do see profitable opportunities in all 3 segments.

In terms of consumer loan growth in Sweden, I think you're referring to car leasing activities. There has been some growth in the quarter, but we're comfortable with that book, low-risk across that we view together with our exposure across that sector across geographies. Of course, we're following very tightly any exposure related to cars and the trends that we see in the market and have on several locations in recent years adjusted on our appetite to take residual value to just mention an example.

Offshore coverage ratio of 37%. Yes, I think what we can say is that the reserves that we currently have on the book reflects fully our view of the sector. And incorporates considerations for an outlook where a positive move in that market is expected to be somewhat down the road. Saying that, we continue also to highlight that the situation in the market is challenging and that there could be development in individual and specific situations. But we have fully reserved in accordance with our market view for the sector in our books as they are today.

[Sofie Peterzens, analyst]

Okay. And just on the offshore book, there have been some Bloomberg articles that you had quite significant exposure to Chesapeake that filed for bankruptcy. Have you thoroughly researched for that exposure as well?

[Kjerstin Braathen, executive]

I'm sorry, Sofie, we can't comment on specific names.

[Operator]

The next question comes from the line of Ulrik Zurcher.

[Ulrik Zürcher, analyst]

Ulrik from Danske Bank. Two first quick ones on net interest margin because you said there would be roughly NOK 5 billion hit on the 0% key policy rate. I was wondering if just sort of Polish deposit legacy in Q1, it seems like your interest -- net interest income is down NOK 1 billion. So should we expect net interest margin like somewhat of a compression in Q3 again? And then secondly, how stationary do you consider your new deposit level? If you like, if Norway now we don't get a second COVID wave and so forth, will then the deposit level decline again? Or what do you view the future mix between your wholesale funding and deposits going forward over maybe 2 years?

[Ottar Ertzeid, executive]

With regard to NII, we showed on Slide 10 in today's presentation that interest on equity and margin were down NOK 1,297 million compared to the first quarter which is in line with approximately 1/4 of the NOK 5 billion you referred to, which had the first quarter as a starting point. So there's approximately NOK 5 billion was the fact for the customer repricing. And there are also, of course, other NII effects like volume growth on deposits and loans, could be other margin developments, FX effects, et cetera. The NOK 5 billion was the effect of the customer repricing, the lower interest rates we have seen in Norway over the last few months.

[Kjerstin Braathen, executive]

On deposits, I think there are several trends to keep in mind when considering the increased deposit base. One is a pure reaction to COVID, people and business wanted to stack up on their liquidity to be robust in meeting the challenges. The fact that we are getting so much of it, I think we should take some credit for in being very robust and having had a confirmation from both Moody's and S&P on our ratings. And you also see that we are competitive and attractive for our international clients when it comes to attracting deposits.

Second quarter is usually seasonally relatively high on deposits. I would expect some of the impacts of the immediate need to save if we continue in a positive direction that, that may level off to a certain degree. But part of it may remain as we continue to compete for deposits and as long as we're profitable, that is an attractive source, both for funding and to make sure that we have a good profit base to support our lending activity. So for now at least, we are attractive, I think, beyond just the immediate trend of saving as we see it.

[Operator]

The next question comes from the line of Riccardo Rovere.

[Riccardo Rovere, analyst]

Yes. Three or four from my side. First of all, I wanted to better understand upon, again, on NII. When you mentioned the NOK 5 billion, does this number refer only to the downward repricing of the loan book or does this include also any mitigating action on the deposit side? Just to be 100% sure again correctly. This is my first question.

The second question I have is on risk migration, if finance did it correctly, we stated there was some negative risk migration in the quarter in risk-weighted assets. If I understood it correctly, should we expect anything more in the coming quarters or what we have seen so far that's all?

Third question I had is on from the short-haul perspective losses in the capital has constantly gone down, it was NOK 6.5 billion at the end of the year, then NOK 1.2 billion, then now is NOK 660 million. So implicitly, there's this number going down, to me is telling that you are charging more than what your internal model would indicate. Is it a right assessment? Or am I completely wrong?

And then on the -- on, if I may, on the dividend. If the situation improves, let's say, particularly in Norway, without improving too much in the rest of the continent in Europe, do you see Norway going solo in allowing a dividend payment? Or do you think that would be just impossible if no one else does it?

[Ottar Ertzeid, executive]

I can start with NII. There is a NOK 5 billion effect on net interest income. It's the net effect of both loan and deposit repricing. In the second quarter, we reduced deposit rates 7 to 8 weeks later than on deposits. So that's why we say that the full effect of customer repricing is really reflected in the second quarter numbers, and you can actually use the second quarter numbers as a basis going forward.

[Kjerstin Braathen, executive]

In terms of risk migration, we are not specifically guiding on risk migration. But I think the learning and the experience we've had through the second quarter is an important point of reference where you see some risk migration and the capital cost, if you will, of 20 basis points as a result of this, that's alongside future economic outlook being revised to the positive. The uncertainty is substantially reduced compared to when we entered the second quarter. However, there can be customer-specific situation or changes to this picture that triggers migration for certain customers from stage 2 to stage 3, and this would, as a consequence, lead to risk migration. But that needs to be combined with the general macroeconomic outlook.

In relation to the dividend question, I think the important reference is to go back to the statement from the Ministry of Finance early July, where they responded to, as I think I mentioned earlier, to the advice from the Systemic Risk Board in Europe that encouraged a full restraining from dividend for all banks. The Ministry of Finance in Norway just referred to their previous statements where they were not that restrictive, but encouraged institutions to wait until the uncertainty -- until the level of uncertainty was reduced.

Again, today, I feel we can say that the level of uncertainty is reduced and we do expect and believe that the level of robustness and solidity will weigh heavily on the regard of any dividend payment, but I must stress that this decision will only be discussed in the fourth quarter, and then it will be up to the Board.

I'm not sure we grasped your question on short-term perspective losses and the numbers you...

[Riccardo Rovere, analyst]

No, no, no. The shortfall -- when you look at the capital, when you look at the capital you have the shortfall to expected loss deduction, which is -- which was at the end of the quarter, 656 -- NOK 655 million, and it was too negative so a deduction of NOK 600 million. But that is negative by NOK 2.5 billion at the beginning of -- at the beginning -- the end of last year, beginning of 2020. So the deduction you are having from the capital of the amount of provisions that you have not charged through the, let's say, through the P&L with respect to what your models would suggest, has constantly gone down in the first 6 months of this year. Meaning that, if I understand it correctly, what has gone through the P&L in terms of credit losses is actually larger than what your models would indicate, so that deduction has gone smaller and smaller. Is that a fair assessment? And should we expect risk to go to 0?

[Ottar Ertzeid, executive]

I think in this year, we have taken increased loan loss provisions, and those provisions have reduced the difference to the capital calculations. So we actually had a lower capital deduction as a consequence of the higher provisions we have taken on our P&L. And that has reduced the difference and reduced the capital reduction. And that is a part of the 10 basis points we show in today's presentation, explaining the 50 basis points improvement, we had 10 basis points lower deduction in capital, and that's partly coming from exactly the item we are pointing to. That's reflecting that we have taken huge provisions this year.

[Operator]

The next question comes from the line of [ Phil Juneau ].

[Unknown Analyst]

My question would be on bond issuance plans. Could you maybe give an update on which bonds you plan to issue this year, especially across the capital structure and also across currencies, please?

[Ottar Ertzeid, executive]

Yes. The Minister of Finance, this month, granted our approval to merge the bank and the holding company, making bank the ultimate parent company in the bank. That means that the bank is an MREL capital or senior nonpreferred capital going forward. I think it's fair to say that we are considering starting issuing senior nonpreferred from the bank towards the end of this year, but only at a smaller amount this year. We have until the first of January 2024 to comply with the MREL requirement of having NOK 157 billion in MREL capital. We also plan to issue some COVID bonds in the second half of this year. In currency, we also will depend on which market is most favorable at the time will make it easier.

[Unknown Analyst]

And on subordinated bonds like Tier 2s, AT1s, any plans there?

[Ottar Ertzeid, executive]

No. No, nothing for AT1s and nothing on subdebt. We raised -- we refinanced the NOK 4 billion subdebt in May, but no, there will be no such reasons this year for subdebt for AT1.

[Operator]

The next question comes from the line of Jan Erik Gjerland.

[Jan Gjerland, analyst]

Jan Erik Gjerland from ABG. I just wanted to confirm or check your volume side. You have a very strong volume growth in the future and second in the corporate sector, together with the Ocean Industries. How much of that is really underlying growth and how much is FX? And if it's not fully FX, how much of that will then be sort of a final take? Is the average a little bit higher than you normally would have done? Or is this your final take in these kind of syndicated loans? That's my first question.

[Kjerstin Braathen, executive]

It's NOK currency-driven, to put it that way, as the Norwegian kroner has strengthened through the quarter. But I think it's fair to say that we have done some more business in the future in tech area than we've done in ocean. There may be selected deals there that are early phase in terms of underwriting and that we will syndicate throughout, but nothing to the extent that it's relevant to comment on that, I think, in terms of the exposure overall for the bank.

[Harald Serck-Hanssen, executive]

Can I have a minute to just add a little bit, Jan Erik. It's Harald. If you may, if you look at the -- what we show in the Fact Book on Page 27 and 29, we show the EAD development within the different subsectors. Obviously, if you compare with the end of first quarter, there's a lot of currency distortions in those numbers. But I think the important point to make on the large corporate side is that we do have a lot of flexibility in terms of how we manage the overall portfolio, both in terms of the size of the underwriting we take, the proportion we syndicate, we also do other types of risk-sharing now with life insurance companies and so on. So that gives us the flexibility to manage and calibrate the exposure on numbers on the large corporate side to take into account the currency migration, the RWA migration as well as the growth potential we have on the SMEs and the personal banking side.

So a little bit back to what -- I think it was Nick who talked about the currency effect on the lending volumes in your first question. And the thing is we would have been able to grow faster on the large corporate side in the second quarter than we did. So we just had to manage the use of capital in a conservative way in order to build in sufficient buffer for currency and RWA migration. So we have the platform in terms of geography and industries to grow faster than we have done in the first half, if that should be desired.

[Jan Gjerland, analyst]

Okay. On the deposit side in the personal customers, that was coming off very much. So how much of repricing did you do in deposit side in the quarter? Did you do anything or everything is now coming in Q3, gaining your NII from here? If I understood correctly.

[Ottar Ertzeid, executive]

Deposits were repriced in late May and then again at the start of July. And that is 7 to 8 weeks later in loan share reprice. But on the other hand, we didn't -- but the full effects, the effects of all deposit and loan repricing is equal to approximately NOK 1.25 billion, which is in line with the guiding we have provided. So there should be no net negative drag from the repricing going into the third quarter. I think that's the most important thing to remember.

[Jan Gjerland, analyst]

On the funding side, you briefed us on the last fall, I think, and that has sort of dragged the net interest income a little bit down NOK 30 million to NOK 50 million in the last couple of quarters. Is that still the case for the third quarter? Or is that back to 0, so to speak, because you are then coming into the third quarter of last year, which you did the prefunding? We didn't gain on funding because you can then actually take away some prefund of earlier funded levels, is that the case?

[Ottar Ertzeid, executive]

The funding -- the senior funding we did in the fourth quarter of last year counts at Emerald Capital and will gradually be replaced by the new senior nonpreferred capital. But overall, we do not expect any nominal increase in long-term funding costs as a consequence of this.

[Jan Gjerland, analyst]

So it's not another quarter of a drag in Q3 from this Q4 last year prefunding?

[Ottar Ertzeid, executive]

No, there might be some currency effects on that as well, but there is issued no new senior funding this year. So there will be no additional effects from new funding impacting the third quarter number.

[Jan Gjerland, analyst]

Okay. Just some two small finals then, could you give us the split of the associate income, the Export Finance, Vipps, Fremtind and [indiscernible], is that possible? Or is that something we don't even disclose at all? And I have a follow-up, please.

[Kjerstin Braathen, executive]

No. We don't disclose the details of that, Jan Erik. We give them as a group. But what we can say is that Vipps is moving in the right direction. They've been able to more than compensate for the loss of revenue they had from less traveling , and Fremtind, it's been a turbulent start to the year, given the nature of the crisis that the world is in, but a strong expectation for improved results in the second quarter. And Export Finance, I think there are some reversals of negative in terms -- in the first quarter that are impacting the second quarter numbers. So just some comments on the direction, but we don't give the full details.

[Ottar Ertzeid, executive]

These companies will report numbers in a bit later as they have to report the numbers before we can provide more details.

[Jan Gjerland, analyst]

Okay. Finally then on the life side, is 80% solvency ratio without transition rules a problem for the end of life or not?

[Ottar Ertzeid, executive]

Well, the life insurance company has a solvency rates with traditional rules of 176% and the traditional rules apply until 2032. So that's not a problem for the life insurance company.

[Operator]

The next question comes from the line of Martin Leitgeb.

[Martin Leitgeb, analyst]

Yes. It's Martin Leitgeb here from Goldman Sachs. Could I just have a couple of follow-up questions on the various comments on capital and capital distribution from here? And then firstly, you mentioned in your earlier remarks that the head on the capital requirement is now the new time high. Could you just tell us, at what kind of capital level you would be comfortable running the bank at? Is it 18% or could it be in the current environment given the requirement is 15.7% that you would be comfortable running the bank at 17%?

And given the number of comments made on a couple of P&L items going forward, I was just wondering, how do you expect the core Tier 1 ratio from today's perspective to evolve for the rest of the year?

And then finally, the third question, just in terms of resumption of capital distribution and then the potential EGM in the fourth quarter this year, could you just tell us, firstly, do you still need any regulatory approvals for such a potential distribution? Or is it [indiscernible] approval you would need? And how does the process look from here through distribution?

[Ottar Ertzeid, executive]

With regard to the 15.7%, that reflects the reduction in the counter-cyclical [ buffer ] we have seen in Norway this year. And then at the same time, keep in mind that, that requirement can be increased again in the first quarter of '22 by the earliest. But obviously, keep in mind that we probably, at some stage, need to be back at 110 basis points more than the 15.7% or back to at least 16.8%. And on top of that, we need some headroom for RWA fluctuations and business opportunities, but we haven't specified how close to that limit we should operate. So no good-sized amount or headroom about that.

[Kjerstin Braathen, executive]

And it's important just to remind everyone that 15.7% includes 100 basis points of Pillar 2 guidance.

[Ottar Ertzeid, executive]

Guidance.

[Kjerstin Braathen, executive]

In terms of capital generation ability through the P&L during second half, I believe that was your question. I think it's a difficult...

[Martin Leitgeb, analyst]

If I could, I'm trying to get a direction.

[Kjerstin Braathen, executive]

A specific one. But I think we'd like to go back to one of the key points we've made earlier and that we repeated today, and that's a resilience in earnings before impairment, where we now started to show the 12-month earnings before impairments. And even 6 months into this year, given the changes we've seen, you can see that earnings have been holding up. Yes, there is the rolling impact, but that's on NII, but that is fully reflected into this quarter's NII.

So given the outlook we see today and even that we, in both first and second quarter this year, have generated an aggregate of 80 basis points of the capital, of which 40 has been reserved for dividends for 2020. I think that should be a good reference point also for you to think about the second half and our ability to generate capital from earnings.

Capital distribution, we don't need any approval as long as we satisfy the requirements on the capital side that we do amply. There have been the statements and the signals that are out there that confirms the authority of the Board to make the decision on making a recommendation to the General Assembly in the fourth quarter. There is no outstanding approvals that are needed in order to pay out.

[Operator]

The next question comes from the line of Jacob Kruse.

[Jacob Kruse, analyst]

Jacob from Autonomous. Could I just ask, I guess, three questions. The first one was you talked about the Q2 NII level as a sort of a representative run rate. So do I think that to mean that the deposit lag repricing that you did that you had in Q2 will not rebound with a positive effect in Q3? So basically, there is not an additional headwind that we have to compensate for in Q3 on that one? And the second one on NII was just, could you comment at all on what margins you're seeing relative to your back book on new corporate loans on the large corporate and on the domestic SME side? And then finally, if you could say anything about the size of your U.S. and Canadian shale book?

[Ottar Ertzeid, executive]

I can start with NII. The reduced deposit rates late than loan rates, meaning that was an extra negative drag in the second quarter. On the other hand, we did not reduce loan rates from the first day of the quarter. So we didn't have the full effect of the loan repricing in the second quarter. And these 2 elements, they can switch other out, meaning that the net effect of both loan and deposit repricing is similar to what we expect to see in the third quarter as a result of repricing of loans and deposits. So that's why we say that we can use that due to as a starting point.

[Kjerstin Braathen, executive]

In our oil and gas portfolio, we have a geographical split of 2/3 related to the North Sea and 1/3 related to the U.S. Of that, we only have a very limited exposure towards the shale.

[Jacob Kruse, analyst]

Sorry, when you say limited, that's less than 1/3 or something like that?

[Kjerstin Braathen, executive]

Well, overall in terms of, if you look at oil and gas, 1/3 is related to the U.S. and the limited part of that 1/3 is related to shale.

[Jacob Kruse, analyst]

Yes, exactly. So if I take that third, when you say limited, that's less than half or less than 1/3 of the 1/3 book that you mentioned.

[Kjerstin Braathen, executive]

We have a few producers that have a part of their production related to shale. And so it's difficult for me to quantify that more specifically. But if you say that 1 producer, for instance, has 70% based on [ notes ] that say I have roughly 30% to shale. It's that kind of -- we don't have a very few or no customer that has purely shale, but they have a proportion of the production related to shale.

[Harald Serck-Hanssen, executive]

We have taken -- it's Harald, the Head of Corporate Banking. We have taken a very careful approach to shale, both for environmental reasons and because we know that they are much more vulnerable to the short-term fluctuations in the oil price. And as we've stated, on the oil and gas side, it's really the North Sea Basin that's our home market where we concentrate most of our resources, so yes.

You also had a question with regard to the potential repricing on Corporate Banking. I think it's fair to say that we're seeing a certain repricing, in particular, in the U.S. market and in Europe. Obviously, there's been a stronger repricing in sectors such as oil-related and shipping, where there are a few banks competing. In the Nordic market, the repricing has been somewhat lower driven by the, I would call it, the relationship banking approach of the Nordic banks. And also, there's been a flight to quality, which means that there has been less repricing potential, but we do see, in average, on similar risk, we do see a higher average margin on the front book and the back.

[Jacob Kruse, analyst]

And just could you quantify that at all, the sort of blended benefit that you're taking on the front book relative to the back book?

[Harald Serck-Hanssen, executive]

No, I can't really give you any concrete evidence because it's also been a very fast-moving target, to be honest. You know that we did deals maybe in April, beginning of May. We did deals that would be maybe 50, 75 -- 50 to 75 basis points higher than what we would have seen before the corona crisis, but then margins came down again moving into June. And as I said, there's a wide discrepancy between the different geographies and the different industries. So it's hard to give you any more exact figures on that.

[Operator]

The next question comes from the line of Nick Davey.

[Nick Davey, analyst]

Just a couple of quick questions to follow up, please. The first one, Harald, just listening to one of your answers earlier, you were suggesting you have -- you're operating with some sort of capital cap maybe within the corporate customer business. So I just wondered if you could talk a bit more about that, just so I can understand the extent to which you might hold you back from growth if you sit with slightly higher levels of risk-weighted assets. I just want to make sure I understand that one.

And the second question, just to understand rate sensitivity in both directions. Just in case your Central Bank has another change of heart and starts to bring forward the date of a potential hike, could you just help us understand the NII that you get off your allocated capital? What is that sensitive to? Does it need an actual base rate hike for the interest to come in higher there? Or is it sensitive to LIBOR or some other market rates? Just any more clarification on that would be helpful.

[Ottar Ertzeid, executive]

I can start with the latter question. We have very little direct interest rate exposure. So any rate changes with the Central Bank or in LIBOR will have very limited P&L effect on the bank, where almost all of the effect comes from changing the customer prices on loans and deposits. And when the Central Bank -- when we move these loans and deposit rates, yes, historically it's seeing an effect of approximately NOK 1 billion for each 0.25 percentage points rate changes. But again, it only materialized when we changed the customer rates on loans and deposits.

[Harald Serck-Hanssen, executive]

And when it comes to the growth volumes, I mean, the starting point is that both for strategic considerations as well as due to historical return on equity, we've decided to give priority to the personal customer segment and the SME segment in terms of capital allocation. So that basically means that we have no restrictions on as long as it's profitable growth, we allocate capital there. And then in order to reach the bank's overall growth targets, we can use the large corporate segment as the -- as a way to calibrate our overall volumes. And we can do that both based on how much new business we take in and how much we distribute. And obviously, in an ideal world, we would have a distribution capacity. That meant we could take in as much new business as we could generate. But when the situation -- circumstances are changing as rapidly as they've done in the first and second quarter, we've had to be somewhat careful in our use of capital on the large corporate side to make sure that we had kept a buffer, even if there were wide fluctuations in the currency rate as well as the uncertainty with regard to risk-weighted assets.

And as our group CEO said initially, the reduction -- or the migration on the risk-weighted asset side has been somewhat lower than we had fared going into the second quarter.

[Ottar Ertzeid, executive]

I think it's fair to remember that in March, we saw a significant depreciation of the Norwegian kroner currency, boosting lending volumes in Norwegian kroner terms quite significantly as we reported in the first quarter account. On top of that, there was uncertainty with regard to the utilization of revolving credit facilities and overdraft facilities which are also increasing at the same time. Both of these have now been reversed during the second quarter. The Norwegian kroner has reverted to a lower -- to a stronger level and utilization of these [indiscernible] facilities and [ RCS ] are back to the same level at the start of the year. This is reflected in the development of the loan volumes in May and June, and also the reasoning for our earlier comments.

[Operator]

We have one more question in the queue, if you're happy to take it.

[Rune Helland, executive]

Yes. Okay. We'll take one more question, please.

[Operator]

The final question comes from the line of Riccardo Rovere.

[Riccardo Rovere, analyst]

On consumer finance, in Q1, you charged more than NOK 700 million. And the explanation, if I remember correctly, was that the unemployment in Norway was going through the roof at 300,000 people registered for unemployment at the Norwegian wealth administration. But most of them were on temporary layoff, if I remember correctly, the so-called permitting. Now the registered unemployed people have had -- the last number I have on the back of my mind to June is 130,000, maybe 135,000. If the trend goes on like that, should we expect DNB to start having reversal out of the NOK 700 million charged in Q1? This is the first question.

Then the second question is on the AT1, if the level of AT1 you have today is fair? If you are okay with that and if the cost of AT1 impacting your overall profitability is what we have seen in Q2, and we can assume that to remain more or less unchanged for the next few quarters?

[Ottar Ertzeid, executive]

I can start with the AT1. We raised -- in March, you had a maturity on U.S. dollar AT1. We refinanced that in late November at very attractive prices. And that's why the AT1 interest rate cost is lower in the second quarter than in the first quarter. In the first quarter, we have sort of a double set of our costs going forward, the first quarter numbers is representative, and we have no plans for additional AT1 capital raisings this year.

[Kjerstin Braathen, executive]

When it comes to the consumer finance part of the portfolio, I would like to just highlight that we haven't seen any negative development in credit quality in that portfolio during the quarter, rather the opposite actually. So the reason why we still have those impairments related to consumer finance is also that, of course, we need to take an active approach in what seasonality and what we expect in terms of usage going forward in the coming. So that's related to IFRS 9 stage 1 and 2. But it's important to highlight that we do not see any negative development at all in that part of the portfolio.

[Rune Helland, executive]

All right, all right. We have to stop there. However, we would just like to thank you for your good questions and your participation. And we would like to wish you all a very good summer. Thank you.

[Operator]

Thank you for joining today's call. You may now disconnect your lines.