Conference call: Danske Bank s financial results for the first quarter of 2004 by CFO Tonny Thierry Andersen Introduction Welcome to the conference call on our Q1 financial results at Danske Bank. First I will quickly run through the highlights before drilling down into the numbers for the Group and the individual business units. Finally, I will address our expectations for the full year. I will be using the presentation from our IR Web site. Afterwards you will have the opportunity to ask questions of me and Senior IR Officer Henrik Andersen. Slide 3 This is a good result we are presenting today. In fact it is the highest core earnings we have ever had in a single quarter, with an 8 per cent improvement from an already high level. So our business is developing well, but we are facing a stiff headwind from low interest rates that puts pressure on the deposit margin and the return on shareholders equity. We continue to take market shares in Denmark, Sweden and Norway in our banking book, where lending to private individuals shows double-digit growth. Corporate lending has been flattish. Revenues are down 4 per cent, but remember that we have seen short-term interest rates decline by 78 basis points in conjunction with an appreciating Danish krone. These two factors alone cost us 320 million kroner on the top line in Q1. On the cost side, things are developing according to plan.
We kept loan losses at a low level, and the macroeconomic outlook now seems more encouraging. Investment earnings are showing a strong improvement because of favourable capital markets positioning and the fact that last year we deferred the risk allowance in our life and pensions business. Slide 4 All our key ratios profitability, cost efficiency, capital management are moving in the right direction. If I were to include investment earnings in core income, the C/I ratio would have been 48 instead of the reported 52. On the capital side, we have bought back shares worth roughly 700 million kroner out of the total of 3 billion that we are committed to buying back during the first half of this year. EPS rose 13 per cent because of earnings growth and, to a lesser extent, the share buyback. Slide 5 As you all know, we continue to contend with low interest rates. That is the main headwind we are facing right now and the primary reason for the 8 per cent decline in net interest income YOY. The 78 bp. decline YOY in the money market rate cost us roughly 270 million kroner in lost revenue. In addition, remortgaging activity was roughly 40 per cent lower this quarter, which meant less interest income on the haircut we can make when people refinance. This is roughly 30 million kroner.
So if you look at the underlying fundamentals in lending growth in the retail book, the essential factor is that we are taking market share. We are seeing double-digit growth in Sweden and Norway as well as in the retail book in Denmark. Corporate lending, in contrast, has been subdued. Slide 6 Fees and commissions are up 6 per cent, as the stronger capital markets more than compensated for the expected decline in remortgaging activity. One should remember, however, that Danish investors generally prefer bonds to equities. This means that, as expected, our income is less volatile than that of some of our Nordic peers. Slide 7 Costs are in line with expectations, even adjusted for performance-related bonuses and lower severance payments. The cost/income ratio improved to 51.6. For the year, we are maintaining our guidance for total costs at around 14.6 billion kroner excluding accounting changes. Slide 8 We held loan losses to the low level of 11 bp of loans and guarantees. For the first time, we are breaking down loan losses across the various business units. I am sure that some of you will spend time digging into these numbers to figure out a trend. But please remember that we make anticipatory provisions and do not wait until default before provisioning. For the year, we still estimate loan losses of around 14-16bp. We expect the macroeconomic environment to be better than we have seen in a few years because of low interest rates and the fiscal stimulus package that was put in place this past March.
We expect GDP growth to be around 2.3 per cent in 2004 and consumer spending to be around 3.6 per cent, which would be the highest level in many years. In the past three months, we have seen a small decline in unemployment, and we expect the trend to continue during the rest of the year. Our accumulated provisions show that we still have a healthy coverage ratio. Slide 9 For our Danish banking operations, we are showing you separate results for Danske Bank and BG Bank for the first time. Let s begin with Danske Bank. It maintained last year s level of core earnings before provisions despite the effect of lower interest rates. Lending growth to the retail segment was quite strong, primarily because of our open-plan product called Danske Prioritet. In this quarter alone, it grew 5 per cent. For the ninth consecutive month, the market share of retail customers improved. On the corporate side, lending declined because of generally low investment. In the latest quarter, however, loans to corporates grew 3 per cent, reflecting our strong relationship with top-tier Danish companies. To convey the positive underlying fundamentals, I have played with numbers to show you what the change in earnings would have been if interest rates had not changed since Q1 2003 (see the bottom, left-hand chart). The 6 per cent increase in earnings shown here is a better indicator of our actual business development.
Slide 10 At BG Bank, earnings rose 7 per cent. Allow me a retrospective comparison: on a like-for-like basis, this quarterly result is as large as BG Bank s annual result before it was acquired by Danske Bank in 2000. That tells you something about the pay-off from the merger. And earnings would have improved even more if we had had the same interest rate environment as last year (again, as shown in the bottom, left-hand chart). Lending to retail customers rose 13 per cent, while lending to corporates declined 2 per cent. Our open-plan product sold well and continues to do so. Market shares remained stable. Slide 11 Banking Norway is facing a dilemma. Its volume growth and market share gains are indisputable. But Norway is also facing stiff headwind from a sharp decline in interest rates, and the result is not inflated with interest-hedging revenues. In addition, we have expansion costs for new branches and marketing campaigns. The performance should be evaluated in light of these factors. Obviously, a ROE of 9.4 per cent after loan losses does not meet our cost of capital of 13 per cent pre-tax. But with no changes in interest rates and the foreign exchange rate, ROE would have been 16 per cent. Our challenge in Norway is to take full commercial advantage of the ongoing domestic merger. Our broad product range, the local management team and the backing of Danske Bank Group give us the necessary arsenal to do so. In summary, we can see that things are moving in the right direction, and the result is actually close to our expectations.
Slide 12 With 17 per cent lending growth, Banking Activities Sweden is increasing its market share, although this is not very evident from the P/L because of declining interest rates. Adjusted for interest rate changes, the top line would have grown by 20 per cent. Given the fact that the unit is in an expansion phase, we find the return acceptable. The growth in fees and commissions was 31 per cent and actually exceeded that of most of our Swedish peers. Costs were as expected as we opened three new branches in Stockholm and hired more people. Slide 13 Other banking activities are showing the same level of earnings, with some variation among the units. All units are producing satisfactory returns. Slide 14 This has been a good quarter for our mortgage business, exceeding our own expectations. Remember that Q1 2003 was the peak of the remortgaging frenzy. Since then, remortgaging activity in the Denmark as a whole is down almost 40 per cent YOY, as you can see from the middle chart. That decline would have been even greater if we had not seen a continuation of strong sales of our interest-only products, whose disbursements now amount to 35 billion kroner. This constitutes roughly 11 per cent of our retail mortgage stock, just six months after the product was introduced. It may well be that our initial forecast of a saturation point at 15 per cent of the retail loan stock for interest-only products was a little too conservative.
The market shares took a dip in Q1 as Q4 of last year included a large corporate deal. We can see that for every open plan product in the banking book, roughly 40 per cent of the proceeds are used to repay traditional mortgages. But we don t mind this substitution in the banking book, as the banking product has three times the margin of a mortgage loan with the same first-lien collateral. It also probably builds better fences around our customers, fortifying the Group s overall customer position. With an outlook for rising interest rates, traditional remortgaging will continue to dwindle YOY. But we could see rising activity from borrowers wanting to migrate from floaters to fixed rate, and interest-only products continue to sell well. Last year the turnover in the retail mortgage stock was almost 40 per cent, and this year we expect it to be about 25-30 per cent. Slide 15 Danske Markets showed a good result in Q1. It maintained its market positions and benefited from the rebound in equities and CF, albeit at modest absolute levels. Slide 16 Our life and pensions business continued to do well, though we sense that the competition in the health and disability business is getting more intense. For the year, we should see premium growth of 8-10 per cent.
The investment return was 3.2 per cent for the quarter, which means that in contrast to Q1 2003 we can book the risk allowance. Let me give you some idea of the sensitivity of the investment return to the booking of the risk allowance. If the current interest rate environment does not change, we can sustain a 22 per cent drop in equity prices and still book the risk allowance for the year. Slide 17 Whenever you look at asset management in Denmark, you should remember that Danish individuals and institutional investors and pension funds especially prefer bonds to equities. The proportion of equities in AUM is thus only 18 per cent. Although this is a small improvement over last year, it is still far below our Swedish peers. In our asset management business, we saw a 46 per cent improvement in earnings, which reflects a combination of rising AUM and lower costs. Slide 18 Earnings from investment portfolios more than doubled, although we had a conservative risk profile. Besides the fact that last year s result was affected by the need to defer the risk allowance in our insurance business, our positioning in the bond and equity markets paid off well. But it would be fair to say that the markets in general behaved favourably. The increase in costs is related to performance-based compensation. Slide 19 In conclusion, we maintain the same guidance for core income, costs and loan losses as when we announced our full-year 2003 results. We therefore we expect core earnings to be slightly higher than they were last year.
Please keep in mind that we do not give guidance on investment earnings. To summarise, Danske Bank is doing well despite some heavy macro headwind. The retail book is growing nicely, and we continue to take market shares. Our risk/return profile in Markets and treasury is also acceptable. Costs as well as loan losses are under control, and we are showing progress in all key financial ratios. To the extent that the lending growth will not consume enough capital, we will keep returning excess capital to the shareholders in the form of share buybacks and dividends. Our current challenges are the adverse impact of the low interest rate environment and the relatively modest equity exposure among Danish investors. But they should not disturb the general state of affairs in which we continue to enjoy sound underlying business growth. This concludes my presentation. Thank you for your attention. I am now ready to take your questions.