Julius Baer Gruppe AG
SIX:BAER
Earnings Call Analysis
Q2-2023 Analysis
Julius Baer Gruppe AG
In the first half of 2023, Julius Baer demonstrated a solid performance within a challenging global financial environment marked by events like Silicon Valley Bank's collapse and Credit Suisse's takeover in Switzerland. The geopolitical strife, inflation fears, and subdued market sentiment and trading activity did not deter the bank from advancing its growth trajectory. Amid these conditions, the Swiss financial center's agility was also tested and proved robust. The company stood out with growing net new money, increased profitability, a stronger capital position, and a better cost/income ratio, all while embarking on a strategic cycle focused on growth and digital progress.
Economic trends shaped Julius Baer's operations significantly. Stock markets showed general upward momentum, with mixed performances as NASDAQ soared, and the Hang Seng Index faltered. Bonds stayed positive, and the USD weakened. This period was considered near the end of the rate-hiking cycle, with adjusted interest rate guidance provided amid an inverted yield curve and reduced client leveraging. Market volatility slumped, affecting trading income, yet assets under management grew to CHF 441 billion by 4%, partly from net new money that more than doubled in just two months, reaching CHF 7.1 billion at the end of June.
Expectations for 2023's effective tax rate have shifted, projecting between 15% to 16% due to more significant contributions from higher tax jurisdictions. This rate could climb slightly above 16% in the next year when OECD minimum tax rates are initiated. Julius Baer's balance sheet remained highly liquid, with notable cash reserves, a conservative loan-to-deposit ratio, and a liquidity coverage ratio surging over 300%. Despite foreign currency shifts, the bank concluded the first half of 2023 with a CET1 capital ratio of a strong 15.5% and a Tier 1 leverage ratio of 5.1%, reflecting a sound capital structure significantly exceeding regulatory requirements.
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Ladies and gentlemen, welcome to the Julius Baer 2023 Half Year Results Conference Call for Media and Analysts. I am Ira, the Chorus Call operator. I would like to remind you that all participants will be in listen-only mode and the conference is being recorded. The presentation will be followed by a Q&A session. [Operator Instructions] The conference must not be recorded for publication or broadcast.
At this time, it's my pleasure to hand over to Mr. Philipp Rickenbacher, CEO of Julius Baer Group; and Ms. Evie Kostakis, CFO of Julius Baer Group. Please go ahead.
Good morning, ladies and gentlemen. A warm welcome to all of you from the Julius Baer offices in Zurich, from where we present our results for the first half of 2023.
I trust you can see our presentation on your screens. And for all our participants who dialed in over the phone, you will have the opportunity to ask questions at the end of the presentation.
I am, as always, joined by our CFO, Evie Kostakis. Good morning, Evie, a warm welcome to you.
In the first half of 2023, Julius Baer has again delivered a solid performance, positioning us well for future growth. This was achieved in a challenging environment for both us and our clients. Earlier this year, we all bore witness to notable events in the financial sector on both sides of the Atlantic, such as the collapse of Silicon Valley Bank in the U.S. and closer to home, the orchestrated takeover of Credit Suisse here in Switzerland. These events triggered uncertainty in financial markets, as well as with clients.
Geopolitical and economic challenges have remained in focus and continue to fuel investment concerns. To name a few, the tense relationship between the U.S. and China; the Russian war in Ukraine that appears no closer to finding a solution; continuing fears over inflation and possible recessions are keeping market sentiment on the downside; a delay in global IPO markets reigniting and, thereby, failing to fuel wealth creation; and a general lack of volatility, which is weighing on clients' propensity to trade. Against this backdrop, Julius Baer has again proven the strength and resilience of its business model regardless of conditions. At the same time, the Swiss financial center has proven its strength and agility. I will come back to that later.
Evie will provide greater details on our solid financial results and performance in the second part of the presentation, but here are some of the highlights: net new money accelerated in the second quarter; profitability increased; our capital position was further strengthened; and we improved our cost/income ratio despite once again investing in growth at the start of our new strategic cycle. This leads us to our strategy and our newly launched 2023 to '25 strategic cycle that we have already started to execute in a disciplined manner.
An immediate focus in these first six months has been placed on growth and, in particular, investing in and developing talent. I will provide greater detail on this later. At the same time, we have continued to invest in our value proposition and taken important steps forward in our digital and hybrid journey. But before we dive into the results, let me quickly take one step back and look at the overall positioning of the bank.
First and foremost, Julius Baer's crystal clear focus on wealthy private clients, serving only high net worth and ultra-high net worth clients at scale provides us with a clear advantage for stability and growth. In these times of complexity, we can fully focus on our clients and be relevant to them with our advice. And we avoid the conflicts of interest inherent in managing multiple business lines. I have said on other occasions and maybe with the smile that it is good to be the CEO of Julius Baer. And at this moment in time, this may be particularly true.
Even with a focused business model, our revenue sources are diversified. This generates resilience over economic cycles. What do I mean exactly by diversified? Geographic diversity with our presence across Asia, Europe and South America, within this, a mix of mature and emerging markets with varied growth dynamics; our ability to cover the two main segments, most sophisticated ultra-high net worth clients, as well as a broader array of high net worth clients in a scalable manner; our integrated business model that includes being a bank and a wealth manager; and last but not least, diversification in terms of recurring versus transaction-based revenues. It is, thanks to this variety that we have been able to continuously produce outstanding results, not just in '21 and '22, which were the best group results in our history, but even now as we progress through 2023.
These strategic decisions and transformation we took in the last strategic cycle spanning 2020 to '22 have been fully validated. Our current strategic cycle is all about quality growth and the beginning of 2023 has allowed us to accelerate this track. I will provide you with more details after Evie's presentation. But first, let me conclude with a couple of words on the Swiss financial center.
We all witnessed with concern and considerable surprise the events that unfolded in the first half of this year. Switzerland successfully solved the idiosyncratic problems of one large and systemically important bank over a weekend and succeeded to do so without market disruption. And Switzerland continues to firmly lead international cross-border wealth management. This strength is rooted in our economic and political stability, the strength of the Swiss franc and in a broad ecosystem that comprises 239 strong banks. Julius Baer is now the number two listed bank by market capitalization in Switzerland.
And now, I hand over to Evie, who will provide a detailed rundown of our first half results.
Thank you, Philipp, and good morning, everyone.
As usual, on Page 7, I would like to start with an overview of those market developments that had a meaningful bearing on the performance of our business.
First of all, looking at the securities markets and foreign exchange. With some exceptions, stock markets were generally up in the first six months, but the delivery of that positive return was quite dispersed. For example, while the NASDAQ was up a whopping 39%, the Hang Seng Index was down minus 4%. Bonds relevant for our AUM, as well as the capital OCI development ended the first half in positive territory, even though in the last two months of the quarter, they trended down as yields picked up. Finally, I would like to highlight here the U.S. dollar, which was down 3% in the first six months of the year, but that decline has accelerated quite a bit in July so far.
In comparing our first half results with the results of a year ago, of course, one of the biggest drivers has been the sharp rise in interest rates. The market consensus and indeed also our own house view is that, we are getting close to the end of that rate hiking cycle, and we have updated our rate guidance accordingly later in this presentation.
The third set of graphs shows that the yield curve inversion in our three key currencies has worsened since the start of this year. This is one of the factors that has played a role in the client deleveraging that we have continued to see play out, to which I will come back when we discuss net inflows later on.
Finally, market volatility has fallen to very low levels, again, which is relevant for the trading component within our income from financial instruments, revenue line, but more on that in a bit.
Moving on to the AUM development on Slide 8. Mainly on the back of market performance and net new money, which together more than offset the impact from the stronger Swiss franc, assets under management grew to CHF441 billion, an increase of 4% since the start of the year. Monthly average AUM, important for the margin calculations, came down by 5% from the level of a year ago, but is up plus 2% from second -- 2H '22. Assets under custody went up by 11%, thereby taking total client assets over the CHF0.5 trillion mark to CHF515 billion.
Proceeding to net new money on Slide 9. As we already mentioned in May in our interim management statement, net inflows started slowly this year, but then began to pick up in the last two months of the second quarter. At the end of April, we were at CHF3.5 billion. And just two months later, by the end of June, this number had more than doubled to CHF7.1 billion.
Flows continue to be impacted by client deleveraging and the pronounced yield curve inversion that I referred to before is certainly a factor here as is the higher absolute level of interest rates, and probably also the fact that clients still feel somewhat uncertain as to the direction of markets in spite of the dispersed rally year-to-date in equity markets. Without this deleveraging impact, net inflows were at CHF9.2 billion.
We had solid inflows from a number of our key markets, including from clients domiciled in Switzerland, as well as elsewhere in Europe with especially noteworthy contributions from the U.K. and Ireland, Spain and Luxembourg, in Asia, especially Hong Kong after the reopening of the borders, as well as India, in the Middle East and also in Israel.
So let's now turn to revenues on Slide 10. The overall revenue development once again underlined the resilience of our business model. While revenues were impacted by the year-on-year decline in average assets under management and the decline in client activity and volatility, this negative impact was more than offset by the benefit from higher rates on our NII and our quasi NII in the form of treasury swap income. As a result, operating income grew by 9% to just over CHF2 billion.
So going through the revenues line by line. NII grew by 36% to CHF464 million as higher rates benefited the income from loans despite the lower credit volumes, the interest income from our treasury portfolio and the interest on due from banks and receivables from securities financing transactions. These interest income benefits were partly offset by a substantial rise in cost of deposits as clients moved cash from current accounts into call and time deposits to take advantage of the higher rates.
Net commission and fee income fell by 8% to CHF963 million. Recurring fee income declined in line with a 5% year-on-year decrease in monthly average AUM and a slowdown in client activity led to lower transaction-driven commission income year-on-year, although it was good to see activity pick up from the very low levels we experienced in H2 '22 of last year.
Net income from financial instruments at fair value through profit and loss grew by 26% to CHF596 million. The higher rates led to a significant increase in treasury swap income, i.e., the quasi net interest income to which I referred to before, the benefit of which offset the lower contribution from the more activity and volatility driven income related to FX, precious metals and structured products. Other ordinary results decreased by CHF8 million to CHF4 million, net credit recoveries on financial assets of CHF2 million, underlying the group's prudent management of credit risks and the quality of its exposure.
Turning the page to Slide 11. In gross margin terms, one can see the different moving revenue parts in a different and perhaps more digestible way. And in order to help that view, we have slightly changed the presentation from how we used to show it previously. The main graph on the left shows, as usual, the split according to the IFRS accounting conventions. From that graph, one sees, first of all, that the annualized gross margin increased by 12 basis points year-on-year to 93 basis points of average AUM, driven by large increases in the contributions from NII to 21 basis points from 15 basis points and from net income from financial instruments at fair value through profit and loss to 27 basis points from 21 basis points. This was slightly offset by a small decrease of 2 basis points in the commission and fee gross margin to 44 basis points.
On the right-hand side, you see, first of all, the split of the commission and fee gross margin into recurring fees, which stayed for now at 36 basis points and which we clearly aim to grow over 39 basis points in 2025 and the other more activity-driven commission components, which came down from a year ago to 8 basis points, even though recovering a bit from the multiyear low in H2 '22.
The second graph on the right-hand side shows the split of income from financial instruments at fair value through profit and loss into interest rate-driven treasury swap income, which went up massively year-on-year to 15 basis points from 6 basis points. And the other component, which is more driven by client activity and market volatility, which declined year-on-year to 12 basis points from 15 basis points a year ago.
The new component on this slide are the bubbles below the main graph where we combine, first of all, NII and treasury swap income or quasi NII, as I like to call it, into interest-driven income, which improved by 15 basis points year-on-year to 36 basis points, but up just 1 basis point from where we were in H2. And secondly, we combined the more activity-driven dependent items in commission and fee income and income from financial instruments at fair value through profit and loss into a total activity-driven number, down 4 basis points year-on-year to 20 basis points, but stable compared to H2. And the recurring income number is simply the one you also see on the commission and fee split on the right-hand side at 36 basis points.
Now turning to our interest rate sensitivity slide. I certainly don't have to explain to this morning's audience that the interest rate environment changed dramatically over the past year. But maybe just as a reminder, in 2022, U.S. rates were raised by 425 basis points from a zero rate starting point; and euro and Swiss franc rates by 250 and 170 basis points, respectively, from a starting point of negative rates. In the first half of 2023, rates went up further still, with the ECB raising its deposit facility rate by another 150 basis points and the U.S. Federal Reserve and the Swiss National Bank each by another 75 basis points.
Last year, in May and again in July, we started guiding in more detail for our P&L sensitivity in gross margin terms to these rate hikes. And in February, I was able to conclude that the realized margin uplift in H2 '22 ended up largely in line with our guidance, not only in terms of the estimated benefit to NII and swap income, but also in terms of the partial offset from clients shifting cash from current accounts into call and time deposits.
In February, as part of our full year results presentation, we also updated our guidance. And in summary, we indicated that we believed that the gross margin had more or less reached peak rate hike benefit in H2 as the benefits of higher rates to NII and quasi NII would be balanced by higher deposit costs due to further terming out at higher rates. As we saw in the previous slide, where we discussed the gross margin development, that's indeed also how it largely played out in H1. With the total interest-driven gross margin component going up by just 1 additional basis point from where we were in H2 '22.
Looking at H2 '23 from where we are today in terms of balance sheet size, balance sheet structure and AUM levels, we believe again that the total interest-driven gross margin component is likely to remain stable from what it was in H1. In the graph on the left, we show, as we did before, the expected further benefits of further 100 basis point rate hikes in the key currencies, assuming the terming out continues to develop as we expect it will in such scenarios. And to reiterate, our current assessment is that, there would be little to no further gross margin benefit from here.
For the outlook for 2024 and beyond, we will have to start considering the possibility of rate cuts, as well as obviously, the further development of the current account volumes and the overall deposit base, which is why on the left-hand side, we now have also included an estimate of what happens when rates go down by 100 basis points. We assume that for the first 100 basis point rate decline, there will be no shift out of term and call deposits. Based on that assumption, our current best estimate under the customary ceteris paribus conditions, is that for a 100 basis point decline in dollar rates, we would see a 2 basis point negative gross margin impact. And for a 100 basis point decline in euro and Swiss franc rates, the estimated gross margin impact would be 1 basis point.
Let's turn to OpEx on Slide 13. The successful reset in cost efficiency in the 2020-2022 strategic cycle has created room to fund growth investments for the current cycle. As we outlined in the May 2022 strategy update, as we confirmed in February, we will place an increased focus on attracting top talent to further scale our presence in our key markets and our targeted investments in technology and innovation.
In H1, adjusted operating expenses grew to just below CHF1.4 billion, an increase of 5% year-on-year, well below the 9% increase in operating income. And as a result, the cost-to-income ratio improved to 65.3%. Personnel costs rose by 5% to almost CHF881 million. Payroll costs were up broadly in line with the year-on-year rise in the average number of staff. Performance-based remuneration went up as well, and these increases were partly offset by somewhat lower pension fund-related costs.
General expenses rose by 2% to CHF396 million. Excluding legal provisions and operational losses, which declined to CHF59 million, general expenses were up 7% year-on-year, mainly due to IT-related projects and software expenses, as well as an increase in costs related to travel and client events following the further relaxation of COVID-related restrictions, especially in Asia, with the opening up in Hong Kong earlier this year. Depreciation and amortization went up by 14% to CHF108 million following the rise in IT-related investments in recent years.
Putting it all together in terms of profit development, with a 14% increase in adjusted net profit, the business has made an excellent start into the new strategic cycle as our operating jaws widened year-on-year with operating income up 9% and operating expenses up 5%.
Adjusted profit before tax actually grew even faster by 19%, but the tax rate increased from 12% to 16% due to a higher profit contribution from relatively high tax jurisdictions. The pre-tax margin rose by 6 basis points to 30 basis points. And thanks to the buyback completed earlier this year, the increase in adjusted earnings per share was 16%. And finally, the return on CET1 capital increased by 4 percentage points to 34%, underlining our highly capital-generative wealth management-focused business model.
Our guidance for the adjusted tax rate has changed somewhat as we now foresee higher tax jurisdictions contributing relatively more to overall profit. So for 2023, we're currently expecting an effective tax rate in the 15% to 16% range. And for next year, when the OECD minimum tax rates kick in, potentially somewhat higher than 16%.
Moving on to the balance sheet on Slide 15. Our solid strong balance sheet remains highly liquid with 12% of assets in cash, a loan-to-deposit ratio of 62% and a liquidity coverage ratio of over 300%. Impacted by the weakening of the U.S. dollar and other key currencies, deposits decreased to CHF69 billion. And as I described earlier, the shift from current accounts and the term and call deposits continued with the latter now making up 56% of the overall due to customer's position compared to 43% six months ago. The loan book decreased to CHF43 billion as client deleveraging shrank the Lombard loan book with the mortgage book remaining stable. The treasury portfolio saw a slight decrease to CHF16 billion and cash stayed at CHF12 billion.
Turning to the capital development on Slide 16, and starting with the CET1 ratio on the left-hand side. Above the graph on the left, you see the RWA declining somewhat by CHF0.3 billion or 1%, mainly following a decrease in credit and market risk positions. You can find the details as always in the appendix. CET1 capital rose by CHF0.3 billion or 9%, mainly driven by strong net profit generation, 2.5% in CET1 ratio terms, and to a much smaller extent by the initial pull-to-par reversal of last year's decline in the value of bonds held in the group's treasury portfolio. This capital benefit clearly outstripped the impacts of the dividend accrual and the completion of the share buyback program at the end of February, which together cost 2% in CET1 ratio terms. Putting it all together, this resulted in a CET1 capital ratio of 15.5% at the end of June.
On the right-hand side, we show the updated pull-to-par estimate. We saw a CHF54 million OCI reversal benefit in H1 and of the remaining CHF525 million amount, we would currently estimate under stable market conditions that approximately 19% will reverse in H2 '22, around a third in '24, around a quarter in '25 and the remaining balance in '26 and beyond. Finally, our risk density guidance remains unchanged at 21% to 23% for the next three years.
Before handing it over to Philipp, a quick review of the improvement in the Tier 1 leverage ratio on Slide 17. As a result of the CET1 capital development and additionally helped by the successful placement of CHF400 million of new AT1 securities in February, Tier 1 capital increased by CHF0.6 billion, or 13%, to CHF5.2 billion. The leverage exposure fell by 4%, broadly in line with a 5% decline in the size of the balance sheet. As a consequence, the Tier 1 leverage ratio increased to 5.1%, very comfortably above the regulatory floor of 3%.
And with that, I now hand back to Philipp for the latest update on our strategic progress.
Thank you very much, Evie, for the in-depth view into our results. Let me now provide a strategic perspective on what has happened in the first half of the year, as well as a quick outlook for the second half of 2023.
In May last year, we presented our new strategic cycle: focus, scale and innovate. We are focusing on our clients on wealth management, but also focusing on further developing the value proposition for our clients, the quality of our business and the quality of our revenues. We are scaling the business in our key markets, driving growth, giving us the right critical mass in all the key geographies where we choose to be active. This is where we made the greatest inroads so far this year. And we have continued innovating wealth management through digital advancement of our operating model and upgrading the client experience.
We started 2023 with a very strong focus on organic growth, hiring and people development. We first showed a pickup in hiring figures in the Interim Management Statement. I'm glad to report that Julius Baer hired net 57 relationship managers in the first six months of 2023. On a gross basis, this corresponds to a triple-digit intake of relationship managers over this period. And even more impressive, this means an increase in the number of RMs year-on-year of more than 8%.
Our new hires come from a variety of international wealth management champions. And this has been the result of relationship and network building over the long term and underlines our appeal as an employer of choice. True to our strategy, new hires are particularly geared towards the geographies where we want to grow to scale.
We only hire relationship managers with a strategic client base fit, both geographically and segment-wise, who match and enrich our corporate culture, who share our views on risk appetite and risk management, and who are capable to scale their books in line with our aspirations, with our support, of course. To this last point, let me remind that our AUM per RM increased by 20% over the last three years alone.
Our compensation model for RMs introduced in 2020 has continued to prove its success in rewarding and incentivizing top performers, not only through our transition phase over the last three years, but also in our current phase of accelerated hiring. Over the course of last year, through the first six months of 2023 and looking further ahead, even as the talent market heats up, we continue to firmly and strictly apply the highest standards of quality in the industry to all our hires as introduced over the past years. And looking ahead, I can confirm that we continue to have an attractive pipeline for hiring in all our focus markets throughout the rest of this year and further into this cycle.
Alongside the hiring of top talent, we want to ensure that we are close to our clients in the markets in which we operate. This is why we are constantly investing in our global footprint. Judging by the distribution of our assets under management by client domicile, for Julius Baer, this means we have a strong position in our home market in Switzerland, but then an almost equal share in Western Europe, in Asia and in other growth markets. And along these same geographic lines, we have also been investing.
Starting from East to West, we have moved our Hong Kong office into new premises at Two Taikoo Place opened this year. That new office space brought together for the first time, everyone in Julius Baer Hong Kong and flagged a key commitment to Hong Kong as a financial center and hub for our Greater China business, and it provides us with future opportunities to grow.
We have expansion plans in Singapore, already our second largest group location by employees, that will provide us with additional possibilities to further drive our technology and operations platforms. This will happen at the latest early next year.
In India, where we have been present since 2015, longer and more consistently than any other international bank, we have just opened our seventh office in Pune. We will also move to new premises in Mumbai later this year and are currently relocating our Delhi office to bigger and smarter premises with longer-term plans to grow up to 10 locations in the country.
Last year, we reported the opening of our new Qatar office, the first office opened after the pandemic, and we continue to expand there.
But we are also investing here in Western Europe. For example, in the U.K., we have also just moved our London activities to new, highly attractive and sustainable premises and are planning a new office location in Northern U.K. in the second half of the year.
And last but not least, we have increased capacity in our Brazil office in line with our growth ambitions for this exciting country.
These are a few examples of how we continue to develop our global footprint in line with our local and global hiring efforts in our growth markets.
We have talked about hiring about our local presence, but equally important is the development of our own in-house talent. As you remember, from our May '22 strategy presentation, our future growth will not solely hinge on attracting the best talent, but also our ability to develop our own talent internally. I am glad to report on our progress in this area.
First, our graduate program. It helps us attract top caliber university students globally, thanks in part to its appealing four-month international rotation. This year, we hired more than 30 graduates, a part of them in client-facing roles. This global program adds to our cultural and educational diversity.
The key pillar of future RM development lies with our associate relationship manager program. Recently launched, it is being ramped up to full capacity by '24. We launched a pilot for 20 associates in '23 and are targeting an intake of 30 people next year, bringing the total cumulative number of participants by then to 50.
The associate RM program provides a multiyear on-the-job training program for in-house talent to become our next generation of relationship managers. On-the-job training in front teams is combined with modern classroom learning, and in some cases, external certification to provide the best possible and broadest education in the industry. Associate RMs will not only establish a pool of top educated bankers for the future, they will also help us drive the generational change within our front teams at scale and across the globe.
We don't stop there. So far this year, more than 350 employees globally have successfully completed either the assistant RM or the account manager training programs. These roles are critical in ensuring flawless service to our clients and in managing direct client contact and account relationships consistently and smoothly. Employees in turn, have the chance to further upgrade their profiles and increase their client-facing experience. This also increases the attractiveness of their roles and our appeal as an employer.
Last but not least, we enjoy one of the best benches of seasoned relationship managers across the globe. However, this also means we have to address continuity. This is why we have long established a proactive and structured succession progress. We want to allow our top talent to stay on as long as possible while at the same time, ensure a frictionless succession and transition to the next generation.
On a final note, let me highlight that we are committed to grow talent across the firm, not just in client-facing roles. It is crucial for our future operating model to ensure a healthy balance between external hires and internal growth. And hence, we are supporting internal development of mobility across all functions from front to middle and back office.
Following people and scale, let me now touch on our value proposition. As part of focus, we continue to develop our offering in line with client needs, with market trends and with an eye on the long-term evolution of our industry. This includes specific product launches, but also investments in scalable platforms and tools. Let me list some relevant examples from the first half of 2023.
We have launched a series of in-house funds that reflect our convictions and capabilities. It is crucial to highlight that this remains firmly within the context of our managed open architecture, where we give clients access to the best solutions in the market. But at the same time, are proud to promote our own distinctive capabilities. Part of this category is the JB Global Income Opportunities Fund, with which we raised approximately CHF230 million of ceding capital from clients just in the first two months. Overall, total net flows into our in-house funds up to June year-to-date amounted to more than CHF1 billion.
We also added further to our private equity offering, recognizing the important role of private markets for our clients. Within this context, our flagship Vintage program has just held its second closing. Private markets are becoming an important contributor of recurring revenues in the future.
On the platform side, I want to mention the developments in markets and our ability to deliver highly-customized investment solutions, adding new sophisticated payoffs to the toolbox is almost becoming routine as is arming our clients with even more powerful algorithms and access to substantial computation power, for example, to optimize structured products on the fly, [EG] (ph) towards a specific target yield.
Our efforts and progress are getting recognized, and we are proud that Julius Baer funds created for our private clients are of institutional quality. Some 50% of the assets in these funds are in strategies with top five- or four-star Morningstar ratings. This is a ratio that many asset managers would envy. This is, again, a testament to us focusing on where we can truly deliver distinctive performance to our clients.
An important part of our value proposition today is what we do for sustainability. This is an integral part of how Julius Baer operates. And let me quickly run through some of the recent developments.
Overall, we continue with our result-oriented approach to sustainability. We are determined to provide our clients with the best possible choices available to implement their convictions in the E, S and G space. At the same time, we are also committed to being responsible citizens. We want to walk the talk alongside our clients. This is why we've been pushing forward and progressing with our climate strategy.
We are convinced that stewardship plays an important role, and we are actively involving our clients to achieve this. We believe that data and transparency must be at the basis of every action and decision. That is why we've been both leading and pioneering as a large private bank with our ESG client reporting.
Our approach to this based on proprietary methodology has earned us the award for Best Private Bank for Technology for ESG Reporting globally at PWM's Wealth Tech Awards this year. First time distribution of these reports happened in '22 for clients booked in Switzerland and Luxembourg, with the ambition for a global rollout by 2025.
Our efforts have also been recognized by rating agencies, with a recent upgrade by MSCI in their ESG rating of Julius Baer to AA and Morningstar's Sustainalytics risk classification reduced from medium to low risk. Also noteworthy, our inclusion in the Bloomberg Gender-Equality Index. And we do not rest on our laurels. We continue to foster in-house expertise through our dedicated Sustainability Front Ambassador Club, which now comprises 250 senior client-facing employees globally.
Let me conclude by looking at our innovation efforts. I will be brief on this as we will provide a more comprehensive update with our full year '23 results. Innovation still plays a key role for Julius Baer, and we have established our ambitions for this in our strategy presentation of 2022. We also increased our planned spending on business transformation and technology across the '23 to '25 cycle to CHF1 billion in total. We are progressing in our various transformation topics and technology agendas, as previously laid out on this slide. Today, I'd like to take a step back and focus on the overall design work for our business transformation agenda.
We have progressed in this thorough design phase in the first half of this year to prepare carefully for the rest of our strategic cycle and the years to come and maximize our effectiveness. Julius Baer has, for a long time, followed three strategic priorities: to create a highly scalable back end, supporting us in our growth ambitions towards 2030 and beyond; to create operating leverage in our business model by offering the best technology support to our relationship managers and staff, making the human factor scalable; and to digitally enable our clients and ensure state-of-the-art delivery of our value proposition. Underpinning these three priorities is our ambition to harmonize our global operating model, allowing us to deliver a consistent client experience and maximize synergies in our wealth management model.
In the first half of 2023, we have formulated the aspirations and principles underpinning our operating model of the future with a look far into the 2030s. We are developing a specific target design and transformation roadmap for our business to support the realization of our goals. And we will provide you with more information when we present our full year results. At the same time, we are cautiously ramping up additional investments, as already announced, and expect to move towards an acceleration of delivery mode in 2024. I look forward to reporting back to you at our next meeting.
To conclude, let me shift to what lies ahead in the next half year. In the second half of 2023, we will continue to deliver on our strategy of focus, scale and innovate. We will maintain hiring momentum and drive further growth in our focus markets. We will continue to strengthen our offering and drive recurring revenues; many of the solutions I've outlined earlier today will support this. And we will finalize the design of our key future operating model and the related transformational investments, as I just reported. Across all of this, we will continue to maintain a firm grasp on risk, which has served us well in the last years. Last but not least, true to our purpose, we will continue to create value beyond wealth, keeping our eyes firmly focused on the needs of our clients, but also on the needs of all stakeholders.
Thank you very much, indeed. This concludes my remarks, and we are now ready to hand over to the floor and the phone lines for our Q&A.
We will now begin the question-and-answer session. [Operator Instructions] First question is from Hubert Lam from Bank of America. Please go ahead.
Hi. Good morning. I've got three questions. Firstly, flows. In May, June, they accelerated to 5% annualized growth. How much of the net new money during those two months came from new hires? And how much of it came from your legacy RMs? And is the growth over those two months could be across the second half of the year, just given the strong hiring tailwinds you've had? That's the first question.
The second question is also on the hiring opportunity for new RMs. What's your target for the year? Do you expect at least to double your first half run rate, or is it more front-end loaded? And can you also talk about the competitive environment for RMs? Is the cost of hiring RMs more expensive now just given more intense competition?
And lastly, on cost/income, should we expect a higher cost/income this year and maybe even next year due to hiring? Any guidance you can give in terms of the cost/income, just given the typical lag between hiring and inflows? Thank you.
Thanks a lot for the questions, Hubert. Let me start with the first one on flows. I don't have the breakdown for you for the two months of May and June in terms of seasoned RMs, what we define as RMs that have been on the platform for more than three years versus newer RMs, but I do have it for you for the first half of the year. So about 45% of the net new money number came from seasoned RMs and 55% from new RMs.
Now, with respect to the full year, as you know, it takes some time for these RMs we hired to start producing net new money and bringing net new money onto our platform. We believe that we should get about CHF2 billion to CHF3 billion of net new money from the RMs we've hired in the last few months for the year. That's question number one.
Question number two, with respect to our expectation, because it's definitely not a target, you will recall, after the full year results in February, I guided towards 175 gross hires in terms of RMs and 100 net hires. I think we're reasonably confident from where we sit today to say that we will likely exceed that on a gross basis and possibly even on a net basis as well.
And finally, on the cost-to-income ratio after the full year results, I also guided to a cost-to-income ratio that is closer to where we ended last year. I think that still holds true. That said, I want to reiterate that our cost-to-income ratio targets for 2025 of less than 64% remain firmly in place. And the glide path towards achieving those is going to be a little bit more back-ended.
Great. Thanks for that. Sorry, just a follow-up. In terms of the RM hiring environment, is it more -- it's obviously probably more competitive now. Have you seen the cost of hiring increasing?
This is a competitive environment, yes, indeed. And I think we still have the situation that many players want to be active in wealth management in the current environment. On the other side, I don't think that the cost of hiring has fundamentally moved. We have a very attractive compensation model that has now played an important role in retaining and attracting talent over the last three years within the same set of parameters. And we're sure that we can operate under that in the years to come.
Great. Thank you.
Next question comes from Vishal Shah from Morgan Stanley. Please go ahead.
Hi. Thank you so much for the presentation. Can I -- I have three questions as well. Can I first touch upon the gross margin trends? And then specifically, how do the last two months exit margin sort of rates look like for NII, advisory fees and brokerage fees? So that's one.
Then in terms of flows, what kind of products are clients investing in right now? And what has changed really in terms of how clients are thinking about positioning their sort of wealth now versus how they were thinking in December '22?
And then the last one is on capital, you're clearly at a much higher CET1 ratio versus your 14% buyback threshold. And earlier, you have mentioned that capital deployment will sort of be firstly focused on organic growth followed by M&A opportunities. And then, if those things don't materialize, then you might return in form of buybacks or something else. So, do you have a certain timeline in mind for this, i.e., if there is a cutoff date by when you think that, okay, if M&A does not materialize, then we decide to return the capital to shareholders? So that's three of them.
Let me start with number two, and I'll hand one and three to Evie. In terms of the flows, I think, obviously, what we have seen in the last year or so since the re-event of positive interest rate is a keener interest of clients to benefit from that, also through deposits and then through the different associated term solutions. I think the basic -- the fundamental appetite of clients to be active in capital markets, either in the equity field or in the fixed income field, today is still a bit mask and muted by the uncertainties in the market, the economic uncertainties about inflation/recession. I think even though now I think we should have more clarity, especially already in the U.S. and then also the geopolitic situation that does not increase the general propensity of clients to trade. And you see that also in the muted stock exchange volatilities. So, I would say, today, we have a situation that we have an equity bull market actually with a lot of clients still on the sideline. We all know that this can relatively quickly change as soon as confidence returns. But so far, I think clients will hold on to their savings products for the time being.
And Vishal, your first question on the exit margin. So, I'll give you the breakdown for May and June. Recurring gross margin was 37 basis points. Interest rate driven gross margin was 37 basis points, 21 basis points came from NII, 16 basis points came from FX treasury swap income. And then the last bucket, activity-driven was 22 basis points, 8 basis points of which came from other commission and fee income, and 13 basis points from non-FX swap trading income.
With respect to capital, I will reiterate here our capital distribution policy, which we updated in the Strategy Day last year in May. That remains unchanged. At the end of the year, when our books are closed, the Board of Directors will make a decision on whether to do buybacks above the threshold of 14% CET1 ratio. Thank you.
Thank you so much. And can I quickly follow up on that 37 bps fee margin that you mentioned, exit margin? What is the breakdown if you could provide between advisory and the brokerage/transactional fees?
The 37 basis points refers to the recurring gross margin impact. I don't have the breakdown within components of that off the top of my head.
Okay. Thank you so much.
The next question is from Mate Nemes from UBS. Please go ahead.
Yes. Good morning, and thank you for the presentation. I have three questions, please. The first one is on the treasury swap income, which you mentioned like quasi NII. Could you give us a sense what is your expectation specifically on that side of things? I know that you expect a stable interest-driven margin component in the second half. But I'm just wondering if the U.S. dollar, Swiss differential remains around current levels. Is that something that you also expect to be largely stable?
Then, the second question is on internal talent development versus hiring that Philipp, you talked about. Could you give us a sense how you think about these two channels of RM development? Would you expect a clear shift towards promoting associate RMs and then cultivating your own talent in-house versus external hires in certain areas? And if so, does that also expected to come with some cost benefits?
And the last question is on in-house funds. On Slide 41, you show that about 29% of the assets under management is in investment funds. Could you tell us how much of that is Julius Baer in-house funds? That would be the third question. Thank you.
Let me start with your question number two on the talent side. I said in the strategy presentation, I recall in May '22 when we laid out, let's say, a very long-term vision for the bank and without setting a clear target, but just stating what is possible, that it would not surprise me if we were able somewhere in the 2030s to generate 50% of our new relationship managers from in-house talent development. I think that lays out pretty well how we think about it.
I believe the two routes of hiring and internal talent development are highly complementary. We will always go out there in the market and tap into the best talent pools for rejuvenation, for skill addition, also to bring in external challenge. On the other side, I think we have an enormous opportunity now with the scale that we have to drive our own talent and especially through the talent route, the generational transition in the front teams. I think these two elements are completely complementary.
Will it have a cost impact? Maybe to some extent, I think, obviously, for in-house talent, you pay less for recruiting. On the other side, we will become also a creator of talent and suffer from some attrition moving forward. That's pretty clear. So at the end of the day, the cost side may be a bit more balanced. But I think it's a fantastic way again to rejuvenate, to create a new skill base and a culturally homogeneous group that we can deploy across the globe.
Mate, first of all, congratulations on your new role. Let me try and tackle question one and three on treasury swap income and our expectation for the second half of the year. As you correctly pointed out, it's mostly dependent on, a, the volume of FX swaps and, b, the rate differential between predominantly the dollar and the Swiss franc. So, of course, how that develops in the second half will play a role here. I can tell you that our current expectation is that, it's going to be -- the level we'll experience in the second half is more or less what we experienced in the first half of the year is around 14 to 15 basis points.
Then with respect to in-house funds, currently, we manage around CHF13 billion of in-house funds. But, of course, we also have our ManCo platform in Ireland, where we manage third-party funds and provide ManCo services as well.
Great. Thank you very much.
The next question is from Nicholas Herman from Citi. Please go ahead.
Yes, good morning. Thank you for the presentation. Hopefully, you can hear me okay.
Yes.
Very good. Yes. Three questions from my side as well, please. One on net new money, one on NII, and one on the recurring margin. So, on NII -- sorry, on net new money, excuse me, how are you thinking about the flow profile over time from here? Clearly, it does take time for a relationship manager to bring in money once they've joined the platform. So, are you comfortable based on the typical time it takes to them -- for an RM to bring in money, you will start to pick up at the back end of this year building into next year? Or do you also need to see market conditions improve? And, I guess, you also bank entrepreneurs, too. So, do you see more deal-making, more exits and so on, just to see like the inflection point? That's the first one.
On NII, you previously [indiscernible], I think, if I remember well, 35 basis points for this year on total NII, now 36 basis points. So, given there has been a fair amount of deleveraging this year, one might have thought, just ceteris paribus you might be a little bit lower than that. So, what's driven the better outturn on NII for this year?
And then finally, on the recurring margin, you've done a lot to enhance the value proposition. Now, I appreciate the plan to deliver 39 to 40 basis points is back-ended, but the recurring margin has also been pretty flat over the past year-and-a-half despite growth in own funds, private equity solutions and the like. So, what needs to happen to start getting that to tick up? Thank you.
Thank you, Nicholas. I'll start with the first one on net new money. I think the basic flow pattern for new hired RMs has not fundamentally changed from previous times. I think we still see timelines of, say, three to four years for a relationship manager to build his or her portfolio. I believe that is unchanged. I think where we have additional opportunity, obviously, is from existing relationship managers where we've seen our efforts to drive referrals, to drive share of wallet, to yield more instant results. And with the balance that Evie has mentioned before, I think it's important that we always work on both vectors.
Obviously, market conditions are important. I think they're important to instill a general level of confidence to clients, to change banking relationships as this often involves a rather complex processes for large and structured monies. The other element is, where market conditions play a role is on the wealth generation in certain markets. I've mentioned the IPO machinery, for example, in Hong Kong, but you could also look at it here in Europe, that obviously has been in the past, an important driver of liquid wealth generation and should also be moving forward again.
Nicholas, let me try and talk about the NII question, if I understood you correctly. So, for the first half of the year, interest-driven income was slightly above 36 basis points, and that was comprised of around 15 basis points in swaps and the rest NII. Now, as I look towards the outlook for the rest of the year, and you've seen our guidance in the interest rate sensitivity slide on Page 12, we don't expect that to change much. But, of course, things could happen. Yield curves could steepen again. Clients could re-leveraging -- could re-leverage. We could see an increase in loan growth that we currently don't necessarily foresee. So, it's hard to say. I think the base case is what we guided you towards in the interest rate sensitivity slide.
With recurring margin -- with respect to recurring margin, I would say, I'm heartened by the exit margin in May and June for recurring revenues, which was 37 basis points. We've always said that this is going to be a slow grind. For me, what's very pleasing to see is discretionary mandate penetration has ticked up year-on-year. You can see that it's in the decimal points, but it's a little bit higher than it was last year. That only comprises a third of our recurring revenues. There's all kinds of other products and service models that are recurring in nature. What gives me optimism is the fact that six months into the new strategy cycle, we've started to see the whole organization living and breathing recurring revenues, which I think is great.
That's very helpful. Thank you. If I could have a quick follow-up just on the NII. So NII, I think, does include quite a notable pickup in interest income from banks and from securities financing. So, is that level of interest income sustainable? Or is it just going to -- is there going to be some kind of mix shift going on to get to that 36 basis points in the second half?
I mean, it's -- one of the hardest things to do is to forecast the structure of the balance sheet. So, I think your guess is probably as good as mine.
Fair enough. Okay. Thank you.
The next question is from Anke Reingen from RBC. Please go ahead.
Thank you very much for taking my question. The first is on the balance sheet, given the deleveraging, the loan decline and the deposits in the first half. Can you talk a bit about the deleveraging trends you saw towards the end of the first half and in terms of deposit momentum?
And then, secondly, on the cost outlook into the second half, yes, you comment on the cost-income ratio. Can you talk a bit about absolute cost levels? Should we see similar growth in personnel and general expenses in the second half, second half as we have seen in the first half?
And then, on the net new money, I'm just curious, I guess, like a number of ways you can cut it, but how does it sort of like break down into net new money from new clients or gaining market share? Thank you.
Okay. On the balance sheet and on the deleveraging trend, what I can say is that, we were also impacted -- we have seen deleveraging, it's clear. But the number is not quite as acute as the headline figure suggests. I think the headline figure was 4%. And if you adjust for the developments in the dollar versus the Swiss franc on an FX-neutral basis, we're talking about 2% for deleveraging. What I can see when I look at our credit pipeline is that, it is healthy, and we are bringing new deals onto the platform. Beyond that, I cannot say much more at this point with respect to the lending book.
Now with respect to deposits, there as well we also saw the effect of the dollar weakening versus the strengthening Swiss franc. So, I think there, the minus 9%, if you adjust on an FX-neutral basis year-to-date, it's 7%. I will also point you to Slide 40 in the half year results presentation in the appendix where we show the AUM breakdown. And there, you will see that looking at it on a year-on-year basis, money market instruments have gone from 2% to 5%. So deposits, yes, have termed out or left the balance sheet, but when leaving the balance sheet, they're invested typically in money market accounts or similar type instruments.
On the cost outlook for the second half of the year, again, typically, we see in the second half of the year, a slight pickup in costs, and we'll see some of the RM hiring that we've done come through the numbers. That said, we did guide you last year in May in terms of cost takeout. We said that we were going to do CHF40 million a year to reach the CHF120 million run rate basis by 2025. What I can say is that based on measures we've taken so far this year, we've taken out about CHF50 million on a run rate basis, 50% of which will materialize this year, one-third is already in the numbers for the first half, and the other two-thirds will show up in the numbers for the second half of the year.
And can you repeat the question on net new money, Anke? Apologies.
[Technical Difficulty]
Okay. So we covered the point on credit. So let me go back to deposits. So deposits were down, I think, 9% year-to-date, 7% on an FX-neutral basis. We saw some deposit outflows in the first quarter when they were trouble elsewhere. But that stabilized to a great extent in the second quarter of the second half of the year.
With respect to the cost outlook, what I can say is that typically in the second half of the year, we seasonally see some cost uptick. We're going to see some of the effects of the ramp-up in RM hiring flow through our numbers. But we've also been consistent and consequent in what we've said in terms of cost takeout. You'll remember, last May, we talked about CHF120 million run rate cost savings by 2025. So far, we've done around CHF50 million on a run rate basis this year, of which 50% will materialize this year, a third you've already seen in the first half of the year, two-thirds will come -- of that 50% will come in the second half of the year, and we've taken one-off restructuring costs about CHF10 million with respect to that.
And then with respect to your third question on net new money, I would say, if you just take my reference to seasoned RM net new money versus newer RMs, it's around half-half.
Thank you very much.
The next question is from Kian Abouhossein from JPMorgan. Please go ahead.
Yes, thanks for taking my question. A few questions. The first one is on page -- Slide 12 -- first of all, thanks for the additional disclosure on the rate decline. [indiscernible] very theoretical exercise and 100 basis points parallel shift, no change in current versus time deposit balance or call versus time. Can you talk a little bit more about the real world, i.e., what the forward curves are showing us, which would be more of a deepening of the curve? And from your experience, historically, how the shift would be between current -- or call and time deposits, the way you call it, rather than the zero and the impact of the fair value book from that shift, assuming more of a deepening of the curve, which is kind of consensus expectations?
The second question I have is coming back to RM hires. Can you talk a little bit about 2024? And should we expect net new hires in that period and also around breakeven levels and how you measure? I think there was a mention of three to four years until we are fully seasoned. But I'm wondering, breakeven is it still 12 to 18 months. And how over that period, do you measure your new RM hires? Thank you.
Sorry, and last question. Just on activity levels, the U.S. both managers/brokers, not fully comparable, have indicated much more uptick over the last month as well as exit rate currently in terms of activity levels. It seems to be less of a discussion on your call or maybe I interpreted incorrectly. Can you talk about activity pick up very recently? Thank you.
Okay, Kian. Let me try and answer the first question. First of all, I think the forward curve is trending down and not up on the long end. The fair value OCI has no impact on interest rate sensitivity. It's not going through the P&L.
Sorry, just to correct you, the forward curve [is even] (ph). I'm not saying it's not going down, I'm saying if you look forward, the short rates are coming down faster than the long rate [indiscernible]
Okay, fair enough. Be that as it may, our best guess estimate of where gross margin will be related to interest rates or interest rate-driven income in the second half of the year is around the same levels that we've seen in the first half of the year. That means gross margin guidance of around 93 basis points for the year in total.
Sorry, maybe I didn't correctly express myself. On Page 12, your sensitivity on interest rate, I'm not really interested in the second half, just more -- what would happen in a scenario where the curve steepens, which is the expectation consensus? Both rates are going down, but the short rate is clearly going down faster, i.e., forward curve indicates a steepening of the curve from current levels, which is inverted. I'm trying to understand how you think the call and time deposits would change based on history, and clearly, how your fair value will change.
Okay. So on the liability side, most of our deposits are very short term in nature. So, call and term deposits, the vast majority is less than three months. So of course, if the short end of the curve comes down, we're going to see a decrease in interest rate costs associated with those deposits.
Now, on the asset side, the vast majority of our Lombard book rolls over every 30 days. And therefore, as rates come down on the short end, we'll also see interest income come down. The treasury portfolio, as you know, has an average duration of around two years. So that will hold up a little bit better.
Now, with respect to volumes, typically a steepening yield curve will be associated with re-leveraging, and therefore, we might start to see again volume growth on the credit side, which, of course, would help the NII in that regard.
Let me pick quickly on the RM hiring and on the activity level. I think I would clearly expect us to be a net new hiring territory also when we go into '24. Even though, again, we will not give any specific targets, I think this will hinge upon the opportunity set of hiring in the market. It will depend on the talent velocity in the different geographies. But I think looking at our hiring in '22 and now in the first half of '23, again, which has come from a broad array of sources, I think we are very well set up for that.
I don't say that -- I wouldn't say that the fundamental logic of breakeven point has changed in the past, even though we tend not to look at it like that. Obviously, we are transitioning RMs in over three or four years from a first very much input factor driven type of work and net new money gathering and top-line generation to more and more bottom-line generation. And at the end of that three- to four-year period, RMs will have to be self-sustaining on the new compensation model, which is very much oriented towards bottom line. And the -- we do not wait there for, let's say, 12, 18 or 24 months to intervene. We actually are very close to the new RM cases already in the first few months, accompany them along the pathway as their input factors start to develop. And so, we typically have a pretty strong picture of where an RM will end already within the first year.
In terms of activity level, I would distinguish a bit, let's say, the global pattern from the U.S. pattern here. And I think there's some idiosyncratic U.S. market element to what the U.S. players reported. I don't see that in the same way all across the globe right now.
Thank you very much, and thanks again for the additional disclosure.
The next question is from Jeremy Sigee from BNP Paribas. Please go ahead.
Hi, there. Thank you. Two questions on capital, please. The first is a clarification on Slide 16, where you show the walk of capital, there's a 50 bp improvement from other. And I just wondered if you could talk a bit more about what's in there and sort of how that rolls forward. Do we get more of it in the second half? Does any of it reverse? But first of foremost, what is it?
And then, my other question on capital was really about AT1s and just whether there's any change in your thinking around AT1s after what happened with Credit Suisse in the first half after the movements in spreads for that instrument? Is there any change in how you think about it and how much of it you're going to run with, et cetera, et cetera?
Okay. Thanks for the question, Jeremy. On capital, the 50 basis points that you see in the category other is associated primarily with a one-off sale in the treasury portfolio that was reclassified from fair value through OCI to retained earnings. So that's a one-off and won't be repeated. So I wouldn't roll that over for the second half of the year.
And the second question was on AT1.
I believe that the use of loss-absorbing capital instruments will be relevant for many balance sheets moving forward. I think, yes, we've seen the displacements around the events on Credit Suisse. I think it's a bit early to call where the vector is going. I think once the dust has settled in the early '24, first, all the participants and the key geographies relevant for the AT1 market will have to come together to discuss on what terms and specific covenants this market should be conducted moving forward. CHF300 billion market is just too small to operate under in a fragmented setting. But I don't think this will happen throughout this year, those conversations will happen next year. And the first players have already started to test timely that market. I think I wouldn't call it that at all. We'll see where the journey goes. I think, a healthy, let's say, availability of additional, let's say, capital instruments will be important for the entire industry moving forward, and everyone has an interest to get that together.
That's very helpful. Thank you.
The next question is from Nicolas Payen from Kepler Cheuvreux. Please go ahead.
Yes, good morning. Thanks for taking my question. Just three of them. First on the treasury book, you can see it has slightly decreased in H1. I was wondering if you have any room to actually increase it going forward?
The second question is on deleveraging. I was wondering if the deleveraging that we have seen in May and June were coming from the same geographies and for the first four months of the year.
And finally, on M&A, I was wondering with the current market condition, if you have seen an increase in opportunities, and if yes, in what kind of geographies? Thank you.
Let me start with the third question. No, we have not seen an increase in opportunities in the current environment.
And as to your second question, the deleveraging, yes, I think there has been quite some congruency, obviously, across all the geographies where we had seen deleveraging in the last 12, 18 months, we've seen this further progress. This was also where the Lombard positions were held.
On the treasury book, Nicolas, I mean, it was a small CHF1 billion decrease. Whether the treasury book increases or not depends on the size of our balance sheet, but the treasury book is primarily there to hedge our deposit base.
The next question is from Stefan Stalmann from Autonomous Research. Please go ahead.
Hi, good morning. Thank you very much for taking my questions. I have the first question, please, on your Lombard lending. I was generally curious whether you can give us a sense of how much of this Lombard loan book is actually really used to fund leverage investment strategies and how much is actually [indiscernible] relatively convenient way to raise collateralized funds for other purposes like buying a house or boat?
And the second question, liquidity regulation. I was wondering if after what has happened over the last, let's say, nine months, are you sensing any appetite by regulators, in particular Swiss regulators, to change the way they're looking at liquidity and funding requirements, in particular, LCR and NSFR? Thank you very much.
Okay. Thank you, Stefan, for the questions. With respect to your first question -- can you hear me?
Yes. No, I can hear you again.
Apologies. Okay with respect to your first question, I would say around 80% of the Lombard book is used for reinvestment purposes, and only the remainder for other purposes.
And with respect to your second question, currently, we have no information on changes on liquidity requirements to be globally imposed by the Basel Committee or in Switzerland by the relevant authorities. But I think it would be reasonable to expect to see some reforms taking into account what has happened in the U.S. and the situation at Credit Suisse and also the -- considering the digitalization of the banking industry.
I think in Switzerland, what we can say is the following. There's been a first, let's say, academic document that's mandated by the Swiss government around further developing too big to fail regulations. And this centers around three topics: first of all, it's better access to the Swiss National Bank as a lender of last resort in terms of liquidity; the second is higher capital requirements; and the third is temporary state ownership as an alternative resolution.
What I can say also is that modeling three-month deposit outflows is a requirement for Swiss too-big-to-fail banks and that has been applicable since the first of January of 2023. We, at Julius Baer are not a too-big-to-fail bank and therefore, do not fall under the auspices of this regulation. However, we are required by Swiss liquidity regulations to perform our own liquidity stress tests. And in that respect, we apply much more conservative in and outflow assumptions than what is stipulated by the LCR framework. And you've seen that our LCR number is upwards of 300%.
Great. Very helpful. Thank you.
The next question is from Adam Terelak from Mediobanca. Please go ahead.
Good morning. Thanks for taking the questions. I just wanted to push you on the gross margin outlook midterm. You're telling us that NII can be relatively stable-ish from here. You're talking fee margins up, and we've got cyclical low in some of the transactional revenue lines. So, is it right to say that the kind of the gross margin outlook is materially better than when you first set your plan? So, just a bit more color around that would be great.
Secondly, just a question on FX. Clearly, Swiss franc has appreciated significantly in recent weeks. Can you just give a bit more color about how that should impact the business?
And then finally, just a technical point on your LCR. Is the reason that strengthened so much the shift to term deposits because the deposit assumptions and outflow assumptions change because you've got the increasing shift to term deposits that you've been flagging well to us? Thank you.
Thanks a lot for the questions. Okay. On the gross margin, the outlook, I think, if I look at my crystal ball, is around 93 basis points for this year and maybe for next year as well. But of course, this is only as good as what my crystal ball tells me. With respect to how that has changed compared to the assumptions we had last year, I would say it certainly has some down. We were not expecting deleveraging to continue for the better half of the last 12 months, and we were expecting rates to taper off a lot sooner than they actually appear to be tapering off. So that's with respect to the gross margin.
On FX, as you know, a big chunk of our cost base is denominated in Swiss francs. And a big chunk of our assets under management is dollar-dependent. So of course, strengthening of the Swiss franc against the dollar hurts our bottom line.
And then, with respect to the liquidity coverage ratio, I think the cash outflow from the client deposits has reduced as a combined result of lower positive volume and clients moving to longer maturity fixed term deposits. This has contributed to roughly around CHF2.9 billion of lower cash outflows. And at the same time, there's less cash inflow mainly because of the reduced trading activity in derivatives, and that has reduced inflows by CHF1.5 billion while QLA has increased by CHF2.5 billion despite the fact that we've had some outflows in client deposits.
Okay. Just coming back on the gross margin point, you said it's come down. So that's versus -- so I think the original plan had mid-80%-s, or flat or mid-80%-s.
No. It was higher than mid-90%-s, yes.
Okay, thank you.
The next question is from Andrew Lim from Societe Generale. Please go ahead.
Hi, good morning. Thanks for taking my questions. So, the first one is on the efficiency ratio and your target there of less 64%, you said that it will be more back ended towards 2025. I was just wondering how you think about -- how you're going to achieve that into 2025. You talked a bit about the cost run rate with CHF120 million being taken out. But how about the other components of that? Obviously, NII seems to be topping out. Are you talking about an expansion of gross margins? And if not, perhaps more of that absolute growth in your recurring revenues and activity-driven revenues? And if so, what kind of growth rates are you assuming? So that's my first question.
And then my second question more on capital. I think you talked with respect to Jeremy's question about the reclassification of assets from fair value to OCI. I think you said that was a one-off in nature, but you did say before there was a bit of a stack of assets that could be reclassified. Is that definitely one-off now and that we shouldn't expect anything going forward? And then together with that, what could be the expected impact in your view from the final Basel III rules? Many thanks.
Okay, let me try and tackle first the gross margin. I think the way we think about the gross margin, it comprises three larger components. So first of all, is the recurring fees and it is our explicit aim to improve the recurring fee margin from 36 basis points for the first half of this year to 39 to 40 basis points in 2025. And I will note here, as I said before, that we had an exit margin for May and June of 37 basis points with respect to that component. This is likely to be a slow grind. But like I said, I think we're making significant progress towards moving that up in the next 18 to 24 months.
Secondly, we have the contribution from NII and quasi NII, so NII and treasury swap income. And as we already indicated, after full year results, we've reached, we believe peak rate benefit. So I would say from today's standpoint, I wouldn't expect much change in combined contribution of these interest rate-driven components in H2. Then you have, of course, the activity-driven bucket, which comprises the non-recurring component within commissioning fee income as well as the non-treasury swap-related component within income from financial instruments at fair value through profit and loss. And this I mean, combined component is, to be fair, the hardest, if not impossible to forecast. I think if we have a glass half full attitude, we could say that it is hard to see activity levels decrease further from the currently rather low levels. If we have a glass half empty attitude, I would say, I said the same thing in February, although I was a little bit vindicated because I think we did see a small uptick of 2 basis points in from the half -- second half of last year to the first half of this year.
And with respect to capital, first of all, with respect to the effects of the Basel III finalization, our risk density guidance remains unchanged, 21% to 23%. And I think with respect to -- there's some elements here. One is the pool to power of the bonds, and that was around CHF54 million. And then there's that 50 basis points of other income which was primarily comprised of a sale of a treasury portfolio position on the equity side, which was -- went from OCI to retained earnings and therefore, gave us more or less 50 basis point uptick.
Great. Sorry. Okay. So, some follow-on questions. So on the Lombard side, looks like you're aiming for at least 95 basis points for 2025, if I read you correctly, and perhaps even a bit more if activity levels pick up. And then, on the Basel III side, final end game here, you're seeing no impact for market risk-weighted assets and for other components we shouldn't be worried about any inflation there?
Let me start with the second question. We do expect some inflation on the market-related RWA, but that's already taken into account within our 21% to 23% risk density guidance.
And then with respect to your first question, I did not necessarily imply that we expect a gross margin of 95 basis points for next year. I said as far as I can see, that 93 basis points is looks like a reasonable assumption from where we sit today.
Okay, that's great. Thanks for clarifying that. Thank you.
The next question is from Amit Goel from Barclays. Please go ahead.
Hi. Thank you. So, I've just got some follow-ups just on the gross margin and a quick question on Kairos. But on the gross margin, just to understand, so to the guidance of 93 basis points for the year, obviously, compared to the kind of 96 bps that you outlined for the exit rate in the first half. I just wanted to check where that kind of comes down as such? Because I guess the reoccurring of 37 is still in direction of where you're aiming to. Is it that you're thinking about activity closer to kind of 20 bps and interest rates at 35? Or just trying to understand how you get back from the exit rate to that kind of average first half rate?
And then secondly, just curious if there is any update on Kairos given some of the press reporting in the last month. Thank you.
Let me start with the second question. I think nothing new to add. We've been setting Kairos on a new strategy and new management since 2020 and the transformation has been going on. And otherwise, we do not comment on anything in the press.
Again, on the gross margin, I mean, 93 basis points, 94 basis points, somewhere in that range for the full year as far as we can see where we are today, right? Of course, the swing factor here is activity-driven income. We're being somewhat conservative in -- I believe, in our forecast. We're not factoring in a significant pickup in client activity-driven gross margin income, and that could have an impact on the final number. But it's very hard to forecast.
Today's last question is from Michael Klien from ZKB. Please go ahead.
Well, thank you very much. Thank you also for the honor. I have hopefully three short questions. Firstly, on the relationship manager hiring. Can you provide some color in terms of the hiring in terms of regional breakdown?
And secondly, some curiosity. I saw on Slide 37, you give a split of that instruments by rating classes and you have got CHF481 million that is unrated. What is that exactly? Can you give us some more information on that?
And my final curiosity question is on the legal risk provisions, you increased it by CHF55.7 million. Can you give us some more color here as well? Thank you.
Quickly on the first and on the third, regional breakdown of relationship manager hiring. I think we've been able this year to hire from all key geographies, Europe, Switzerland, Asia, Middle East, including South America. Obviously, with the nine focused markets in which we're operating in where we concentrate the majority of our growth efforts, we always have a chance to adjust ourselves to the velocity that we see in the respective markets. So hard to project where we will hire exactly next and how much, but expect us to stay true to the guidelines set by the nine focused markets also as we go into '24.
With respect to the legal provisions, I think, as you know, we constantly update the level of provisions that we're making. We're also very transparent about all the cases that are outstanding. I think provisions at the end of last year were at an all-time low. When it comes to Julius Baer, we always prudently reassess those cases, and it has been an adjustment in this context.
And on the other question on the CHF480 million, it's just paper without any rating.
There seem to be no more questions. And with this, I will gladly conclude today's conference call.
Thank you much all of you for listening in, and thank you for your questions, and thank you for your patience with technology, which even three years after a pandemic sometimes can fail us. But we have shown you very clearly that the Julius Baer business model has demonstrated its strength in a complex environment. We are clearly determined to grow. We are well positioned for it. In the second half of this year, we'll continue on that push for growth in line with our strategy. We will further drive the quality of our business, and we will complete design and the roadmap for our business transformation and investments.
I'm very much looking forward to speaking to you all again very soon and share how we have continued to progress, and I'm excited about what we are achieving for our clients and our shareholders.
I wish you all a great day. Look forward to seeing you or speaking to you soon. Thank you very much.