Svenska Handelsbanken AB

STO:SHB A

Earnings Call Transcript

[Rolf Marquardt, Chief Financial Officer]

Good morning everyone and welcome to this conference call for the first quarter of 2018. Joining me today, I have Lars Hoglund, Head of Investor Relations and Annika Engler, Head of Group Accounting. The slides used in my presentation are, as usual, available at handelsbanken.com.I will start off by making some comments to an article in the Swedish paper Dagens Industri today. Dagens Industri is quoting a letter sent to Handelsbanken U.K. from U.K. FCA in August last year regarding our U.K. anti-money laundering prevention procedures. Where they point to areas where we need to improve.Already before this letter was sent to us, the bank intensified further our work in improving systems and routines in this respect and that work is continuing. We take this matter very seriously and we have ongoing dialog with FCA and we have committed substantial resources to further improve our processes to prevent financial crime. The requirements from regulators, in general, in this area have increased a lot over the last years, as you know. As this matter is subject to confidentiality, this is all I can say about this process for now.The increased efforts in this area is also a part of the additional resources we commit to control functions which we also comment in the report.Let's start with Slide #2, during the first quarter the stable value creation continued with an average growth rate of 15% in equity per share and dividends. Much of the Q1 report is about growth. We could continue to see good growth in our business operations across the bank. This momentum we used to invest in creating an improved offering to our customers, increased operating efficiency in preparing for the next step in the U.K. and further adopting to regulatory requirements.So now, please turn to Slide 5 on the income statement for the first quarter compared with the fourth quarter 2017. Net interest income decreased by 2%, but adjusted for the increased Resolution Fund fee, it increased by 1%. This is mainly explained by increased business volumes and increased deposit margins outside Sweden. Net fee and commission income decreased by 2%, mainly due to seasonally lower payment commission. The net result of financial transactions is as you know relatively small revenue item for the bank compared to our peers. This quarter the result was partly affected by negative effects in the valuation of derivatives used for hedging the banks' fund. Other income during Q4 included the dividend from VISA Sweden of SEK 576 million, which explains the difference.In total, revenues fell by 7%, but adjusted for the dividend from VISA Sweden and increased Resolution Fund fee, the decrease was 1%. Staff cost increased by 3%, when adjusted for the quarter's higher allocation to Oktogonen and the changed pension plan in the U.K. The explanation is found in an increased number of employees in our growth markets and within our IT operations as well as exchange rate effects, but also annual salary review.Other expenses including amortizations and depreciations followed relatively normal seasonal pattern and decreased by 5%. As we have explained before, we have increased our IT development capacity in order to support our growing business and to improve efficiency to make preparations for the subsidiarization in the U.K. and to continue adapting to new regulations. These various investments are reflected in our cost level this year.Loan losses amounted to SEK 153 million, corresponding to a loan loss level of the 0.03% according to the new IFRS 9 standard. The underlying credit quality remained stable. In total, operating profit increased by 3% between the quarters. Adjusted for non-recurring items related to the VISA dividend in the previous quarter and revised pension plan in the U.K, the increase was 14%.Adjusted also for the increased Resolution Fund fee and the increased Oktogonen allocation, the increase was 20% between the quarters.Now, moving to Slide 24 and net interest income developments. During the quarter, net interest income decreased by SEK 129 million or 2%. The main drivers were the fee to the Swedish Resolution Funds that increased this year to 12.5 basis points from 9 basis points in 2017. This led to an increase in government fees of SEK 191 million. Increased lending and deposit volumes in our home markets which together added SEK 77 million. Increased margins that added SEK 49 million, mainly driven by higher deposit margins in the U.K. Currency effects, which added SEK 46 million, 2 days less in the quarter reduced net interest income by SEK 69 million. And finally, other impacts amounted to minus SEK 47 million including a negative benchmark effect of SEK 28 million.Sweden, the mortgage margin was unchanged at 106 basis points. The overall lending margin development was slightly positive for corporate customers and slightly negative for retail customers in most countries outside Sweden.Moving to Slide 7, when we take a closer look at the net interest income development over the last years, we can once again conclude that when adjusting for the increase in government fees, that the bank reports the highest level so far. The Resolution Fund fee in Q1 amounted to SEK 617 million. We have seen a very positive trend the last 2 years, compared to Q1 2016, the reported net interest income has increased by SEK 853 million or 13%. Adjusted for government fees, the increase was SEK 1.2 billion or 17%. The growth in our home markets outside Sweden has been very strong, when we look back and the contribution to the Group's net interest income has been increasing steadily. Today home markets outside Sweden accounts for 40% of the Group's net interest income compared to only a very marginal share a few years back. After few years weak development in Sweden, the trend changed in early 2016.Now to Slide 9, when we look at an aggregate net interest margin in the Group, expressed as net interest income in relation to total asset, we see a significant recovery since Q2 2016. The seasonal pattern that started to occur in 2015 is explained by the shrinking balance sheet at year-end, which has the positive impact on the margin, as well few days in the first quarter, which adversely affects the margin. Nevertheless, the net interest margin trend that has been positive since Q1 2015, when we compare the net interest margin in Q1 '18 to Q1 '17, we see an increasing by 5 basis points and that's the level is the highest for a first quarter since 2013.The positive trend is mainly a result of the continued good volume development in our growth markets, where margins are generally higher as well as low funding costs.Please turn to Slide 10, improvement in net interest income in Sweden is largely driven by increasing lending volumes, for example in the mortgage market. As you can see in this slide, the smaller institutions had taken larger share of new lending over the past 2 years and new players have announced their presence in recent months. There has been a further tightening of competition, but this has been going on for quite a while already. Looking at the market shares of new lending, we can conclude that Handelsbanken's share in recent quarters has been more or less in line with our share of total outstanding volume around 23%. In the first 2 months in 2018, the share of new lending was slightly higher at 24%. We're obviously a leading player in the Swedish mortgage market and we intend to keep it that way. We have a high degree of efficiency in mortgage administration. The Swedish mortgage book is over SEK 750 billion and this is managed [ in staff to protect ] by 80 employees.And we also have more than 400 branches in Sweden that takes care of mortgage advice and distribution to a cost of more than SEK 500 million. In the distribution of mortgages, we have a potential to become more efficient through digitalization and other process related improvements which will reduce costs over time.Slide #11, our development in the Swedish mortgage market shows that our business model is appreciated by our customers. This is particularly obvious today when the number of alternatives in the market increase, both in the form of new players and new types of mortgage offerings. At the same time new regulations regarding amortization requirements and the debt to income ratios are really complicated and often difficult for customers to understand. This increased the need for advice. It is still clear though, that there is a need to improve and streamline mortgage services -- the mortgage process and the mortgage distribution. This is a development that is ongoing and that involves both an increased level of digitalization and other process improvements. Over time, the mortgage process will most likely become fully digitalized, not only in Handelsbanken but also for the market as a whole. But a differentiating factor in our case is that we will continue to offer personal meeting and personal advice.Much of the investments that we are currently making in the mortgage loan process will release significant time and capacity into branches. [ Time that instead ] can be devoted to customer meetings and advice as well as reducing cost. This is what we have done in the savings business and what we aim to do also in the mortgage business.Please go to Slide 12, our solid development in the Swedish fund market continues. During the first quarter, the bank got 54% of net inflows into market, which should be compared with a 11% market share we have, of the total outstanding fund volume. This suggests that there is good potential for continued growth. Since 2010, the bank has taken 23% of total net inflows into Swedish market and has been the largest player. It should be noted that this has been done in a market that has undergone major changes over the past 20 years. Many new players have entered and the level of competition has increased.Slide 13, it is not only Sweden that is growing in this area, the asset management business in our other markets has also had a strong development. Since Q1 2017, net inflows in mutual funds outside Sweden were almost SEK 10 billion, which accounts for around the third of the total increase in the Group.In Heartwood, in U.K. we have seen a further increase in net inflows, which is a consequence of us reaching out to an increasing number of customers around the U.K. with our wealth management offering.Net inflows in Q1 increased by 38% compared to Q1 last year. We are working to achieve the same in Netherlands where we are increasing the level of integration between Optimix and the branch operation. In all markets, fund volumes reached an all-time high level in the quarter.Now to Slide 14. The strong development in the savings area is an outcome of a few improvements over the last years. In particular, the advisory service process has undergone major improvements with the aim to offer a holistic advisory service. Our own funds have also had a strong performance and strong ratings. The focus into branches on asset management advice has also increased. This is also why the number of advisory meetings has been growing rapidly during the last year. In the first 14 weeks 2018, the number of advisory meetings increased by 45% compared to last year.Now to Slide 16. 2 years ago, we initiated a change into Swedish operations and made a provision of SEK 700 million to enable structural changes. Significant changes have been made during this process. Many branches have moved from street level premises to the second floor, some have left high street location and changed office space to better support advisory business.A number of branch offices in particular in the major cities have been merged and the number of staff has been reduced, this has improved productivity. Going back to 2013, we can see a sharp improved trend in Sweden since 2016.Revenues per employee has increased strongly, as well as profit per employee. At the same time, we have increased our level of investments in the bank and with this higher level we get more business and revenues per employee today compared to 2 years ago. The investments we make now are expected to generate continued productivity developments throughout the bank.Please go to Slide 17. In the U.K., our good development continues. Business volumes are growing steadily, although we only open a few new branches in the past years. All branches still have small market shares and therefore have good growth potential. In local currency, net interest income increased by 16% during the year, while fees and commissions increased by 17%.In Heartwood, capital on the management increased by GBP 300 million since the first quarter 2017, of which [ GBP 350 million ] were net inflows. The funds in the management now amounts to GBP 3.4 billion. The average volume of household deposits has also increased by 32% compared to year ago. We now run at full speed in the creation of a U.K. subsidiary. The U.K. business has been growing significantly over the years and have the potential to become bigger. Creating a subsidiary represents the next step in the evolution of our U.K. business, that means that we are improving local U.K. capabilities.We are investing in new systems and processes that will streamline the branches' work and enable handling of more customers, improved customer on boarding processes, et cetera. The current efforts and investments in the U.K. come with increased costs, as we have previously communicated. But it improves the foundation for continued growth and value creation.Now to Slide 18. When we look at our youngest home market Netherlands, we also see a very satisfactory development. Operating profit rose by 35% in local currency compared with the first quarter 2017 and business volumes develop strongly, lending increased by 21% and deposits by 41%. Also in the Netherlands, the Bank has the most satisfied customers and the distance to competitors is high among both private and corporate customers.Optimix, our asset management arm, which we acquired in 2016, greatly contributes to the sharp increase in net fee and commission income. The return on equity in Netherlands was almost 14%.Now please turn to Slide 19 on the capital requirements. The CET1 ratio was 21.6% and we estimate the Swedish FSA requirement at the end of the first quarter to 19.5%. This means that we are just over 2% above the SREP requirement and that we are within our target range of being 1 to 3 percentage points above the SREP requirements.The decline from 22.7% in Q4 to 21.6% in Q1 2018 calls for some explanation. During 2017, the bank has had a risk weight floor on certain property management lending in the U.K. In 2017, this was applied in Pillar 2. This floor has now been moved to Pillar 1 and thus increased the risk exposure amount and reduced the capital requirement in Pillar 2. This reduces the CET1 ratio, but has no impact on the amount of required capital. This change explains 0.4 percentage points of the change since Q4 2017.Growing lending volumes reduce the ratio by another 0.4 percentage points and net pension assets reduce the ratio by 0.3 percentage points. Exchange rates improved the ratio by 0.2 percentage points. What should also be noted is that the level of accumulation of the quarterly profits in core equity is low, since a large part has to be deducted during the year. This is because of the regulatory requirements, which states that the dividend to be deducted is the higher of last year's total payout ratio and the average of the last 3 years' total payout ratios. This means that we are now deducting more than 90% of the profits that we generate during the year.Having said this, we want to underscore that this is not a forecast for future dividends, it is purely a mechanical calculation based on regulatory requirements. Right before Easter, Swedish FSA published a proposal that risk weight floor for mortgage loans in Pillar 2 shall be transferred to Pillar 1 starting December 31 this year. This is intended to create a level playing field as Nordea moves, its headquarters to Helsinki. The capital requirement in absolute terms is today SEK 106 billion and this will not change. What it does mean however is that our CET1 ratio all else equal would drop to 16.6% based on Q1 numbers from the current 21.6%. As a consequence, the required asset ratios will also drop, so the capital impact is neutral.So to summarize on Slide 20. When adding another quarter we see that a stable value creation continues with an average annual growth in equity per share, including dividends of 15%. The first quarter showed a strong business development and we continue to see good growth opportunities. The project of establishing a U.K. subsidiary continues according to plan, as well as the work with IT development. Loan losses were very low and asset quality is stable. The common equity Tier 1 ratio was 21.6% and the bank is within its target range.With that, I'll conclude my presentation and open up for questions. Thank you.

[Operator]

[Operator Instructions] Our first question is from the line of Jan Wolter of Credit Suisse.

[Jan W. Wolter, Head of European Banks Research]

Just couple of questions, follow-up from the press conference in Stockholm. So first on the cost side there, could you just tell us what are the major regulatory and IT projects which are still running in the bank apart from the U.K. subsidiarization, PSD2 and GDPR, so excluding those 3, which you highlighted previously will continue to run this year? Just curious about what the major project are still to be implemented in this year and perhaps next year? So that's the first question and then a detail there whether or not the cost for the subsidiarization of the U.K., is that now in full in the P&L in Q1, so the delta there of around [ SEK 80 million ], it means that the incremental cost in the coming quarters will be 0, we will stay at this level, so those are my 2 first questions.

[Rolf Marquardt, Chief Financial Officer]

So, first of all you mentioned the major projects PSD2 and GDPR, that's of course important to us -- be that also this year and some extent also next year and then we have projects ongoing to improve data quality. And that's something that I guess that most banks are involved in doing. So that's related to BCBS 239. Then we also have some remaining parts that all related to MiFID II, that is being reduced -- sharply reduced and will be finished this year. That is, at least what we anticipate now and then we have a project where we are changing our securities system and that is something we have been running for many years and that still goes on, but that will continue this year at a slower pace so. And I think those are the major ones and a part of course of the Brexit related things. What we have also mentioned in regard of U.K. is that previously, is that we are building loan ledger and we also are improving the customer onboarding services we have and support for that. So that's also important development that will have both a business impact because it will improve operating efficiency, it's really time consuming to onboard customers in the U.K. today and it's also good from a regulatory point of view of course. But those are the major ones that comes to mind. And then regarding Brexit cost, yes, so the [ SEK 300 million ], we communicated as an estimated cost for 2018 in Q4. That is the base we are running at now, so -- and we don't expect that to change. So you can expect a quite even development regarding that cost going forward during 2018 and then next year that is expected to go down slightly. But then in addition we do other things into U.K. as well. So for instance, the customer onboarding project that I just mentioned .So the Brexit cost, we have communicated is the cost that we -- that are tied to the preparations for creating a subsidiary.

[Jan W. Wolter, Head of European Banks Research]

Just another question if I may, different subject. In the quarter, we did have in the U.S. market, widening of the LIBOR spread -- LIBOR OIS spread and some changes there perhaps in the short-term funding market, to see PCB market. Did you see any impact in the P&L on the NII from either extra cost or extra gain from this volatility? And #2, related to that, have you changed your behavior in anyway in terms of how you issue CP subsidies in the U.S. market, you're going shorter or longer, so focusing more on Swedish or moving out of the U.S. market and issuing short term debt in other currencies?

[Rolf Marquardt, Chief Financial Officer]

So, the impact -- we have had some impact, but we estimate that the impact is approximately SEK 10 million and that is what shows us in the treasury line in the net interest income. So it's not the major impact, but we have had some impact and I -- when it comes to the funding strategy, we have not changed that, we have seen margins being changed to some extent, but I mean we have very low risk in that portfolio and we haven't changed behavior and strategy in that respect.

[Operator]

Our next question is from the line of Kim Bergoe, Deutsche Bank.

[Kim Bergoe, Research Analyst]

Just I think -- I think most of my questions have been answered, but just one question about, you previously -- you've been linking sort of the strength of the bank to being -- to having high customer satisfaction both absolute and relative to your peers. Can you talk a little bit about where that's moving? If there is any indications of that moving? Or is that still the case, so you are keeping that level?

[Rolf Marquardt, Chief Financial Officer]

Thank you, Kim. Yes, definitely. I mean that's really our key focus and I think it's good that you did bring this up because I think when we look at the value creation that we are able to make and what we see going forward -- the strategy we have, it is really to -- I mean we stick to be -- to run branch offices and to see that as a focal point of the bank, we are digitalizing and we have a good digital offering and we continue to develop that obviously, but we will keep our branch offices and that is because we think that customer satisfaction being close to customers and building relationship will become even more important in the future when as many banks become more purely digitalized and so the customer meeting in many cases will be real important and so we expect that this could overall be a differentiating factor in our case in the future. So, the ambition we have and some of the changes we have been making recently in the Swedish branch operations is, certainly moving in that direction where we, in some cases, have left the street level and moved to second-floor and so on so. We want to transform the business in the direction of a more complete advisory service where we take account of -- full economic picture of our customers, both corporate customers and private individuals and what is the differentiating factor in our case is that we will, if you're a Handelsbanken customer, you should be able to go to your branch when you want to, when you feel a need to and then you will meet a person in flesh and blood and that will be fully responsible for all of the business you have with the bank. So satisfied customers and keeping costs low and being efficient is really still core of business model and that will not change.

[Kim Bergoe, Research Analyst]

Just maybe a follow-up to that, do you see that -- so do you see a risk to I guess it's really the differential between you and the peers in terms of satisfaction. Do you see a risk of that differential reducing as more and more of the interaction with the customers goes online, goes mobile and less is physical or do you expect that you can keep the differential to your peers. Can you keep that? Will you be able to keep that in a more digital banking world?

[Rolf Marquardt, Chief Financial Officer]

No, on the contrary actually because -- so first of all the most satisfied customers we have is, the ones that use both. And I think it's really, really key to us to keep the closeness that we do to customers when we offer both. So, I don't see that's a contradiction, it's something that is working in our favor. And I think, when we look at the way we are giving advice now in the direction we are moving and I think one interesting example is what happens now in the Swedish mortgage market when we see new players entering the market and when they do, they, in some cases, at least they offer a slightly different mortgage product that differs from the normal standard mortgage products we have in Sweden and that have been offered historically by banks. And then in addition, we also have the newly introduced amortization requirements and we need to calculate debt to income ratios which we haven't done before and our customers haven't done it before, and that's really, really complicated. So that will increase the need for advice and we see that in our branch operations. So, we certainly think that this moves in our favor and that we even, in a more digitalized world, to offering this will benefit, in terms of customer satisfaction.

[Operator]

We go now over to line of Geoff Dawes at Societe Generale.

[Geoff Victor Charles Dawes, Equity Analyst]

And just couple of questions on the U.K. operations. I was expecting about that the operational costs and don't see a few things are changing as well by subsidiarization for your sales, but also a change in the government lend funding schemes, changes in the base rates and so on. Can you talk about your funding cost going forward with all that taken into account? Is it going to go up? Is it going to reduce the competitiveness of the bank and how are you going to manage that situation? So that's the first question and then a follow on from that. Do you see any similar processes required outside of Sweden and outside of the U.K., so setting up subsidiaries in any other operations?

[Rolf Marquardt, Chief Financial Officer]

So regarding operating costs in the U.K. and what we can see going forward, obviously that is impacted by the Brexit preparations and the subsidiarization and some other costs we do take in order to improve that business and to prepare. So, and that is something you have seen coming through the P&L now and that will continue during this year as we have communicated before. And this year, in general, when it comes to development needs in the bank in total, but also in the U.K. will be a peak here, I would say, certainly when it comes to preparations for creating a subsidiary. Regarding funding costs, we don't expect that to be impacted actually by us forming a subsidiary. So first of all, there is -- the funding strategy we have -- to have a really stronger, really centralized funding operation that will continue. So the responsibility for long-term funding and so on will still be seen by the head office and a coordinator here. So, and then short-term funding is, to some extent is being done in the U.K. already, apart from the deposit -- stable deposits in the U.K. then and that won't change, that will continue the same, but we will then start issuing short-term in this, but we don't expect that to have any, any impact on funding costs. And then the final question about subsidiarization in other countries? No, we have no plans at this point to make any changes. I mean running the operations through branches is something that is efficient and it has been working well also in the U.K. Now Brexit means that we -- it meant and sort of decided a point when we needed to make a change in the U.K. But, there are 2 things that make U.K. different compared to our other whole markets outside Sweden and the first one is that, we would have been forced to do this at some point anyway because of the rules in the U.K. about doing self banking, so for retail activities. At some point, we would have come to that point anyway. But more importantly on the way we see our business in the U.K. long term. Is that, I mean it is a business that has been growing at a very steady and a fairly high pace for long time. So, we see -- so we have become quite big actually. And we have no reason to think that the development will change in a significant way. So, we have the potential to become bigger in the U.K. And then it means something to have more capacity locally to deal with things. It also comes with a cost obviously, because we do have to put more emphasis on local governance and so on so. Many regulatory things that comes to play when it comes to forming a subsidiary, but it will also be beneficial to have a greater capacity locally in the U.K. and that's why we have taken the step there. But it's -- no plans to make any changes in other markets.

[Geoff Victor Charles Dawes, Equity Analyst]

So that's already clear and helpful.

[Rolf Marquardt, Chief Financial Officer]

Sorry, just to mention -- I forgot to mention the Funding for Lending Scheme, which is sending in the U.K. and the impact, we could expect that, that might have a margin and so on. And I can say that at this point we haven't seen any impact from that. If you look at the margin development in the U.K. it's a slightly positive trend when it comes to corporate lending, but still slightly negative trend when it comes to retail lending.

[Operator]

Our next question is from the line of Willis Palermo at Goldman Sachs.

[Willis Palermo, Equity Analyst]

I have 2 questions. The first one is on the volume growth in the quarter, especially on the mortgage side in Sweden. Should we expect the same pace over the coming months in the year? Or have you seen any change in momentum between the different months in the quarter, perhaps related to the new regulation introduced in March?

[Rolf Marquardt, Chief Financial Officer]

So, about volume growth in the mortgage market, we saw actually -- if you look at the numbers and I am sure you've seen it, that we had an increase that was slightly higher than we normally have each quarter -- this quarter. And so, I would say that development we have seen during this quarter has been slightly higher than we often see. And that also happened when the amortization requirement was introduced in 2016. So what happens is that, sometimes people try to get that loan before the new system enters into force. And so I think that is part of the development side. So I think what we conclude is that, that has been a stable development and then in addition some additional volumes coming in. So, and I think that's what you should have in mind when you move forward.

[Willis Palermo, Equity Analyst]

And outside of the mortgage market in Sweden, have you seen any stronger activity among SME outside of the property management sector?

[Rolf Marquardt, Chief Financial Officer]

I think, we can say -- and this is more anecdotally and what we see in terms of business inflow, it is looking good, I think. So the business momentum is good and what we hear anecdotally and also see that we get more and more business. So, times are good in that respect. So, it's not a dramatic change, but positive sign still. So, it's like it has been during the last quarter or 2, I would say.

[Willis Palermo, Equity Analyst]

And second question, just to come back on your comments, what competition in the Swedish mortgage market. How do you see the branch managers reacting to the other players reducing their prices? How are they -- what are they doing in order to maintain the market share?

[Rolf Marquardt, Chief Financial Officer]

So what we see is that, first of all we have seen that the Swedish mortgage margin has been stable during the quarters. So a very small change in that end and we also see when we look at the published margins -- average margins that each bank publish and have to publish, we see that we are still -- we have our 3-month rates, we have the highest margin and that is still the case. So quite small changes and also if you look at the market share we have been getting, that also tells you that we are getting our market share and they are able to do business and to defend stable. I also think that when you have a customer relationship, you want to defend that and we are competitive. I think so even though we have new players and we do not neglect that kind of competition, definitely not. But we are competitive and we can offer terms that are good and especially to the customers that also have offerings from other new players that are mainly targeting more wealthy customers and so on, then we are competitive and we can -- we also want to defend our customer relationship. I just want to add one thing there I think, so because I think the development that we see in the Swedish mortgage market is interesting and some players are alluring or using other funding sources, but I think what you should keep in mind when you look at this, is that we have a really strong foundation for meeting that kind of competition because the Swedish fund covered bond system is a real efficient funding system and we also have efficient operations in administering the mortgage loans we have. But some of these players have in their favor is that they are not facing the same kind of regulations, obviously and that -- but I think the total sum so far has been good for us.

[Operator]

We’ll now go over to Jacob Kruse at Autonomous.

[Jacob Max Kruse, Partner, Scandinavian Banks]

Just 2 questions, I guess. First, you may have commented on it earlier, but the discussion in the press today about the U.K. FCA and putting parts of the banks virtually, what's they call it under administration, could you just give me an update on what is we [ learn ] and what is the current state of that? And then secondly on the cost side, as I understand if your IT cost was mostly drove the increasing cost in this quarter, especially on a clean basis except pension issue. If I -- did I understand you correctly that you say, you expect these development cost to peak in 2018 or did you just mean that development cost including the Brexit expenses peak and so how should I think about that for 2019? Yes, I guess, those were my 2 questions.

[Rolf Marquardt, Chief Financial Officer]

So first of all, about the FCA investigation, and I want to firmly deny that we are under any kind of administration job to underscore that and get that right. So, that is completely wrong and then I think -- so FCA approached us and made an investigation in mid 2017 and they found some weaknesses in our financial crime prevention routine and we have taken significant action to correct those deficiencies and to improve our handling of that. We take this very seriously and we've also spent a lot of resources in this area. And I also -- when it comes to cost development and then slightly moving away from the FCA issue, but a more general comment on cost development and regulations and so on so. When it comes to development capacity we have developed now, as we communicated in Q4 and we have increased our capacity in that end and then in addition we have Brexit that's why we communicated it in Q4 and that is also what they have seen now and materializing in our cost numbers. And we had now reached the level of development capacity that we think we need going forward. And I -- and when you look at what we use that development capacity to do is to, of course, to improve the offering to customers and to improve operating efficiency, it is also to make preparations for subsidiarization in the U.K. but it is also to a significant degree, a question of continuing to adopt to regulation. And when it comes to regulations that is something that it doesn't only equate costs in terms of development and IT development, it also means that further development and build-up of the control functions and all different control functions that's both internal audits it's we control, it's compliances on. And also routines in across the bank and this is something that is -- we have in common with all banks. But what this has meant in our case is also that we have increased our resources in the control functions and that goes across the bank actually. So that is also one part of the cost development we've seen and the increase in number of employees in more -- in support units in the bank. And when it comes to the level of capacity we have built now both when it comes to development and also the control functions. I would say when it comes to control, we have reached the level where we want to be; when it comes to development and when it comes to control functions, we are nearly there, so not so much more to expect in that end, for everything we can know at this point. And I think -- and then when we look at about Brexit and what we can expect going forward, we expect to stay at this level when it comes to capacity and also when it comes to Brexit costs as we have seen in Q1 also the other quarters during 2018. And then when we look at the expectations for 2019, when it comes to development needs that are tied to regulations, we see that for everything we know now that this is a peak year when it comes to the regulatory related development that will go down next year. We will have to develop a lot related to regulations next year as well, but not at a level we are today. So that gives us some room next year. When it comes to Brexit cost next year, that is also supposed to be slightly reduced and even more so in 2020.

[Jacob Max Kruse, Partner, Scandinavian Banks]

Okay. And just in terms of, does that mean the declining cost from development cost, is that from a group cost point of view. That's certainly you can save more in line with PS, keeping cost flat or is that too much like a guidance or budget?

[Rolf Marquardt, Chief Financial Officer]

I think, we don't give that kind of guidance, as you know but I think the way you can think about that is that I mean if we have slightly less pressure to carry out regulatory related development, then we can choose and then we can choose to use that for business development and we can also choose to use that partly because to reduce cost. But what also comes into the cost calculation is that we are doing things now to become more efficient to increase operating efficiency. We are taking steps to improve efficiency in our mortgage process in Sweden in particular and that is a very time consuming exercise in our branch offices in Sweden. So that's an important point and we are using our [ rather ] techniques and so on to improve the efficiency, so we are taking many measures also to reduce cost becoming more efficient. So that is also something that takes time for that to feed through, but that's also part of the expectations for the future.

[Operator]

We're now over to Paulina Sokolova, Barclays.

[Paulina Sokolova, European Banks Analyst]

Most of my questions have been answered actually. But, may be just one small question on net gains and losses this quarter. So they've hit low if I look at the last 2 years. Could you may be give us some more color on what's behind this and if you would expect this revenue line to move back up in the coming quarters?

[Rolf Marquardt, Chief Financial Officer]

Paulina, I think, well, this is an item where -- which is always quite small in our case compared to our peers and that's because we have such a conservative view on market risks and related risk. So, and this -- and that also means that when we have some negative changes or positive ones they've become really obvious and this time we have some impact related to derivatives that we use to manage our risks when it comes to our funding and that where we do not supply hedge accounting. So, it's -- that's the answer and it is actually as simple as that and that's sort of a one-time effect or impact. So that's what the way it is and I think no reason to expect us to move away from the average we've had in the past.

[Operator]

We're now over to Nick Davey at Redburn.

[Nick Davey, Research Analyst]

Two questions, please. The first one on capital. A word from Slide 30, it looks like in the quarter retained profits where worth about 10 basis points, the capital lending growth took about 40 bps off. So you are running at around a 30 bps negative organic capital generation. If it carries on to the rest of the year, it will leave you slightly tight by the end of the year relative to your range. So could you just address that? And then whether your centralized business model, what can you do to prevent that being your capital trajectory? And then on the second question, please. Just coming back to this discussion around cost. Difficult for now, but then a rough estimate would be that you spend about 15% or 16% of your total costs on IT, both in maintenance and developments and personnel, which just looks like the low-end of the range relative to your P&P. So could you just talk to that and then if you recognize that 15%, 16% number. I understand you are more bronze led than some peers, but it does seem quite a big gap relative to some of your Swedish competitors. So and do you think that is a sort of steady run rate or is it a time that might need to dressed up?

[Rolf Marquardt, Chief Financial Officer]

So first of all the capital generation capacity and -- so in Q1, we fortunately -- I'd say that we had strong lending growth. So, it looks really positive and then you have the question of capital generation and to what extent that can balance the growth rate? And yes, of course, that could be the case, if we continue to grow at a very high pace and we don't have capital generation during the year to meet that it could mean something. But we are within our target range. So we are not at that point. In addition, we also have and that was announced yesterday that we have or intend to sell our share in, what is called the -- you see what's the credit information bureau that we co-owns with [ everybody ] and that will have a slightly positive impact on core equity Tier 1. When that happens, it expected to happen in Q1. What we could have also do, of course, is to -- the board could always announce a payout ratio strategy and that would also change things and I think what is the most important part of this is the capital generation we have. And then we have to follow the rules, so -- if the board has not made any formally decided payout ratio strategy, then we have to apply the rules and those are the ones we are applying now. But we are within the target range and we have the capacity to deal with the situation. And then when it comes to the cost ratio and the spending we make on IT. And I can't really answer about the levels, because then I would need to see the comparison and so I can't reply to those numbers exactly, but what I can tell is that we are -- as you have seen we are spending more on development and that is, of course, beneficial and necessary to improve our IT infrastructures and that is something we do step by step all the time. And then in addition, when we need to, we take bigger steps and some of those steps are the steps we have been communicating about. So, for instance, loan ledger in the U.K. is one of them and also the security system we have been investing in for a number of years and our capital market division is another example and so on so. So, we do what we have to. And I wouldn't say that, that we have the same needs as other banks when it comes to having or keeping a good infrastructure. So just -- the other fact that we have branch offices and that doesn't really change that picture. That is something that helps us to create value and to build strong relationships, but we are still need to and make sure that we have a good infrastructure.

[Operator]

We now go to Vivek Gautam at JP Morgan.

[Vivek Gautam, Analyst]

Two questions from me, please. Firstly, very small ones. Firstly, you mentioned earlier on the call about 3 month rates being higher than the rest of the market. In March it was 1.62%. Can you tell us what is the average rate for the low LTV customers, anything like below 50% LTV or below 60% LTV, that's the first one? And the second one is, what percentage of your lending -- mortgage lending is getting impacted by the new amortization requirements in March? And if you do some backward looking, data crunching what was it in January and February when the amortization requirements were not in place?

[Rolf Marquardt, Chief Financial Officer]

So about the low-LTV and the margins we [ charge ] that is not something we have disclosed. So I can't really answer that, I'm afraid. And when it comes to the number of customers or part of the customers that do are impacted by the new amortization requirements, I will pass the question on to Lars Hoglund if he knows.

[Lars Höglund, Head of Investor Relations]

I mean the number that Swedish FCA talked about earlier was around 14% of the borrowers that were affected. And our share is roughly the same ballpark.

[Vivek Gautam, Analyst]

That 14% was for 2016 as I believe. Is there any updated number that you can provide us or is that the right ballpark number?

[Lars Höglund, Head of Investor Relations]

No, but it's -- I mean this doesn't change dramatically between quarters. So, you can assume it's in that ballpark.

[Operator]

Okay, as that was the final question we have time for today. May I please pass it back to you for any closing comments?

[Rolf Marquardt, Chief Financial Officer]

Now, thank you everybody. Bye-bye.