Swedbank AB (publ) (OTCPK:SWDBF) Q2 2022 Earnings Conference Call July 19, 2022 3:00 AM ET
Company Participants
Annie Ho – Head of Investor Relations
Jens Henriksson – President and Chief Executive Officer
Anders Karlsson – Chief Financial Officer
Rolf Marquardt – Chief Risk Officer
Conference Call Participants
Maths Liljedahl – SEB
Magnus Andersson – ABG
Andreas Hakansson – Danske Bank
Sofie Peterzens – JPMorgan
Namita Samtani – Barclays
Rickard Strand – Nordea
Omar Keenan – Credit Suisse
Riccardo Rovere – Mediobanca
Martin Leitgeb – Goldman Sachs
Annie Ho
Good morning, everybody. It’s a bright and sunny morning here in Stockholm. So I wish everybody a very warm welcome to Swedbank Second Quarter 2022 Results Presentation. I’m Annie Ho, Investor Relations, and in the room with me today is Jens Henriksson, our CEO, Anders Karlsson, our CFO and Rolf Marquardt, our CRO. As per usual, we’ll start with the presentation, and then have Q&A. So without further ado, Jens, please.
Jens Henriksson
Thank you, Annie. And let me also wish everybody a warm welcome to this presentation of our result for the second quarter 2022, a quarter where we once again deliver a strong result in turbulent times. You all know that our four major events that are shaping our time, the war, the pandemic, inflation and climate change, and they are all interconnected.
The quarter was dominated by high and rising inflation, turbulence on the financial markets with increasing rates and falling stock markets, and a weaker economic development, Estonia, Latvia, Lithuania, and Sweden, all our home markets are affected by the situation with lower growth and rising inflation.
But low public debts, public finances in world class, high household savings and profitable companies creates a strong resilience. Looking forward, we see continued rate hikes by Federal Reserve and the Riksbank. The European Central Bank is expected to follow suit later this month.
And then this sends a clear signal to households and corporates that the central banks will act forcefully to bring back inflation to sustainable levels. Economic growth is expected to slow down during the fall and then stabilize on lower levels coming years. The rate raising cycle is expected to be aggressive, but not long lasting.
The Riksbank forecast their own policy rate to peak at around 2%. In this situation, we are supporting our customers and contributing to do the transition as they adapt their business models, energy sourcing and household budgets. In this time, I feel confidence from the fact that we for a long time have had a conservative credit origination standards and prepared our customers for higher rates.
The new rate environment affects the bank’s business and is positive for net interest income, for quite some time with lost money on the large inflow of deposits. Now, it turned into earnings. A part of this is shared with our customers, as we have reinstated interest in all savings accounts in Sweden. We see a good and stable growth in lending in the segments where we are strong and where we want to grow and that goes for both corporates and mortgages.
Swedbank’s profit increased during the quarter to SEK 4.7 billion, net interest income was SEK 7.1 billion, which is the second highest in the history of the bank. Commission income remains stable and declining income from asset management fees is being offset by higher card income [ph]
Net gains and losses are down due to one-off sale of Danish mortgages, but the underlying level is on par with last quarter’s low level due to the continued turbulence in the debt markets. Expenses were according to plan and the cost cap for the current year of SEK 20.5 billion and SEK 500 million for the US investigations remain unchanged.
Credit quality is strong, which is reflected in low credit impairments slightly lower than the previous quarter. And that our exposure to Swedish property management companies is in line with our strategy and risk appetite. The equity markets valuation of these companies have dropped as interest rates have risen. But we are confident in our conservative credit origination standards that during a long time as focused on our customer’s cash flow, debt-service tolerance, business models and good collateral.
Our liquidity position is strong and we have a significant buffer of 4.6 percentage points relative To the Swedish Financial Supervisory Authorities capital requirement. Return on equity increased in the quarter to 12%. And, as I have announced previously, I will before the year end host an Investor Day to present our plan on how we can reach 15% return on equity.
The focus on internal controls and governance during the last three years is continuously producing results. Fitch upgraded our rating to AA minus noting that we have addressed our historical shortcomings and implemented broad based changes in our corporate culture, compliance, organization and risk control.
And we continue to invest in infrastructure and availability for our customers was good in the second quarter. Nevertheless, we did have a serious IT incident in Sweden that affected our customers. To make sure this does not happen again, we are improving our IT change management.
The geopolitical situation has raised the cyber threat level in all our four home markets. We are cooperating with relevant authorities and are allocating extensive resources to keep our systems resilient and resistant. We shall be there for our customers 24 hours a day, seven days a week.
The mortgage business remained strong, and we are the market leader in all our four home markets. We had the conservative and thorough credit process and the group grew by SEK 11.9 billion in the quarter.
But with higher interest rate and increased uncertainty in the housing market, it takes longer for buyers and sellers to agree on the market price. House prices in the Swedish market have dropped during the quarter from high levels with around 2% between March and May. And we expect a continued slowdown during the year and the Baltic house prices have continued to rise.
As a leading digital bank with physical presence, we continue step-by-step to adopt secure and established cloud solutions where we are building flexible services that makes our customers financial life easier. This quarter the first functionalities in our new savings platform are being run as a pilot with a group of customers in Sweden. And we continue to develop a comprehensive offering.
In Sweden, expense control has been launched for joint [ph] customers, in the Baltics children can now be on-boarded digitally. And so far this year, we have on-boarded more than 30,000 customers digitally, and more than 70% of digital bank visits are now made through the app and customers rating in the App Store kept us on top. The National debt office in Sweden has once again entrusted Swedbank to manage a large share of the Swedish states payment through an effective and proven solution.
Our green asset portfolio grew by 14% during the quarter and now holds SEK 53 billion including new and existing loans that have been reclassified. And ahead of the new sustainability regulation that take effect in August, we have trained 3900 advisors to help our customers to understand how their personal choice of investments impacts and contributes to sustainable society.
And our focus on sustainability is noted by both our customers and stakeholders at large, fair finance guides, policy report ranked Swedbank as number one among the large banks in Sweden and Swedbank has reached the highest level, Diamond in the national Sustainability Index of Latvia, and Standard & Poor raised our sustainability rating based on an updated evaluation of the anti-money laundering governance in Swedbank.
In Estonia, Latvia and Lithuania, both inflation and activity remained high in the quarter. A transition is underway to adapt to high energy prices, commodity shortages and broken supply chains. And we are supporting this transition by financing the liquefied gas to replace deliveries from Russia. At the same time, we’re seeing individuals invest in renovations and solar panels to growing extent.
In the Baltic countries, lending for solar panels was three times higher in May than the same month in 2021. And also we see that demand for insurance and fund savings is going up.
We are proud to be the leading bank in all our four home markets, Estonia, Latvia, Lithuania, and Sweden, and we are focusing. During the quarter, we have entered into a strategic partnership in Norway with the largest savings banks as their bond bank. And with this change, we can give a sharper imprint at a lower cost and a stronger comprehensive offering to our corporate customers. Our focus is our home markets.
And with that, I give the floor to our CFO, Anders. The floor is yours.
Anders Karlsson
Thank you, Jens. And now let’s go into the details of the quarterly result beginning with lending and deposits. The total loan portfolio increased by SEK 33 billion this quarter, excluding a positive FX impact of SEK 10 billion.
Corporate lending performed well, having contributed with SEK 19 billion to this increase. This was mainly driven by higher volumes in the property management and food retail sectors. SEK 5 billion of this were revolving credit facility drawdowns and the rest were in the form of traditional lending.
Swedish mortgages grew by SEK 11 billion, where we continue to be the market leader. Baltic banking lending volumes grew by SEK 3.5 billion supported by robust new business in private mortgages.
Customer deposits were stable overall, having decreased this quarter by SEK 6 billion, excluding a positive FX effect of SEK 14 billion. Private deposits increased by SEK 9 billion, while corporate deposits decreased by SEK 15 billion.
Now looking at the revenue lines, starting off with net interest income, which increased substantially and was the second highest quarterly NII ever. The increase was driven by higher volumes and higher deposit margins, which more than mitigated the impact from decreased lending margins and higher funding costs.
As I mentioned last quarter, when it comes to NII sensitivity to interest rate movements, we benefit from higher rates over time. The magnitude of the positive NII impact is dependent on the level of pass through to administratively priced lending, and deposit.
And here, we will strive to achieve the right balance between business opportunities, given the economic outlook, and the overall impact on profitability, given our balance sheet composition.
When it comes to business dynamics, we have seen a slight decrease in the Swedish housing prices and in the number of transactions. We remain confident that there will be continued growth in Swedish mortgage volumes, but most likely at a lower pace, as there are elements of the underlying housing market dynamics that are still supported.
Over to net commission income which was stable. Card commissions were higher from a COVID restriction free quarter, along with an increase in travel expenditure and higher volume per transactions due to inflation. This, along with increases in corporate finance and securities business helped to offset the negative impact in asset management from continued adverse market conditions.
Turning to net gains and losses, which had another challenging quarter. Sales and trading in both fixed income and FX contributed positively, as did Group Treasury’s covered bond buyback activity. However, market rates increased and the – we saw continued widening of credit spreads negatively impacting the bond inventory in large corporate and institutions and treasuries liquidity portfolio, reminding you that treasury’s liquidity portfolio will pull to par. And there was a one-off of SEK 54 million from the sale of the Danish mortgage portfolio during the quarter. Other income decreased by SEK 100 million. But please note that Q1 included a provision release of SEK 115 million in the insurance business.
A few words on expenses before I hand over to Rolf. Expenses were higher quarter-on-quarter due to seasonality. Higher number of FTE’s and the impact of the annual salary review in the Baltics. AML investigation costs for the quarter was SEK 92 million.
Our SEK 20.5 billion cost cap and an estimate of SEK 0.5 billion AML investigation costs for 2022 still stands. Any excess FX volatility over the year would not cause us to deviate from our business and investment strategy, as a weakening Swedish krona is positive for our net profit bottom line.
I will now hand over to Rolf to talk about asset quality and credit impairments.
Rolf Marquardt
Thank, Anders. During the second quarter we have seen continued growth in all four home markets. We have also seen signs of a slowdown and adjusted macro forecasts on the back of the recent development that Jens highlighted. Despite this the base case expectation is still continued economic growth, but at a lower level than we had previously anticipated. In this situation, we conclude that our credit quality remains strong, as demonstrated by the SEK 40 million in credit impairments for this quarter.
Before I go into the details about credit impairments, I wanted to briefly describe Swedbank’s approach to property management and mortgage lending. To start with property management. Swedbank’s origination standards and lending strategy has for a long time being focusing on cash flows and on collateral.
The main factor is debt service tolerance or what is often referred to as debt yield requirement, which is to make sure that our customers are able to withstand significantly increased interest rates and vacancy rates, and still be able to service debt [ph] and amortizations.
Our criterion is that the customer should have a debt service tolerance of 6% to 8% depending on the property, or the type of property. This kind of stress of the net operating income is part of the normal approval process, as well as the annual review of each customer.
The average debt service tolerance ratio for our 15 largest property management customers is close to 8%. On top of that, we have collateral with low LTV levels. For the total portfolio LTV ranges from 39% to 54% in the different countries. The average LTV for commercial real estate is 52% and 55% for residential real estate. These principles are applied across the bank and in the Baltic countries the debt service tolerance requirements are even stricter.
We are also active in low risk segments in geographical areas with a growing population and stable demand. Our portfolio is well diversified, focused on residential office and logistic properties. We have for many years been more cautious with retail and hotel properties.
A very significant part of the credit risk exposure is collateralized through pledge from property. So Against this background, the bank is well positioned also on distressed conditions.
Then on to mortgage lending, where the approach is similar, when granting mortgages the approach is based on the household affordability, taking into account a stressed interest rate of 6%. We review the stress interest rates level and the cost levels included in the affordability calculation on an annual basis. This makes sure that the private mortgage customers have margins to cope with increasing interest rates and the increasing costs.
The average LTV ratio is 51%. And as you can see from the distribution the resilience to price corrections is strong. Regulatory requirements of maximum LTV of 85% since 2010, and amortization requirements are also supportive. As you know, the historical loss levels have been very low in this portfolio also in stressed periods. Our assessment is therefore that the credit quality is strong.
Let’s now turn to asset quality and credit impairments in the second quarter. Credit risk indicators like past EU [ph] loans for different sectors and geographies, credit migrations and impairments continue to be at low and stable levels.
Total credit impairments ended at SEK 40 million of which SEK 147 in Swedish banking and with recoveries in large corporates and institutions of SEK 115 and SEK 2 million in Baltic banking.
Going into the details, updated macroeconomic forecasts increased provisions by SEK 252 million. Rating and stage migrations increased provisions by 150. A majority of this is related to the customers we mentioned last quarter, which are directly impacted by the geopolitical crisis. Some of these customers have now been downgraded increasing stage two provisions. At the same time, a corresponding release has been made of the export portfolio adjustment.
A small recovery has also been made related to the off – oil and offshore portfolio which totals to release of SEK 101 million. The total export portfolio adjustment now amounts to SEL 1.7 billion.
Individual assessments improved by SEK 105 million on the back of divestments and revaluations in the oil and offshore portfolio. Other factors contributed with the release of SEK 156 million, mainly explained by amortizations on loans with increased level of risk.
So with that, I toss the ball back to you, Anders.
Anders Karlsson
Thank you, Rolf. Let’s now turn to Capital. Our capital position remains strong, with the CET1 capital ratio 18.3%, meaning a buffer of 460 basis points above the minimum regulatory requirements. The capital target range of 100 to 300 basis point still stands and risk exposure amount increased by SEK 19 billion to SEK 744 billion.
Regarding expected future capital requirements in the near term the counter cyclical buffer will be raised to 1% next quarter, and 2% in the second quarter of 2023. We are still awaiting approvals for our updated IRB models from our regulators.
With that, I hand over to you Jens to conclude.
Jens Henriksson
Thank you, Anders. Let me now summarize. During the quarter our profit increased to SEK 4.7 billion and with the second highest net interest income in the history of the bank. We have the stable lending growth to both corporates and households. And we are well positioned for coming interest rate increases.
Costs are under control, credit quality is strong, and we have low provisions. Return on equity increased to 12%. We have a strong capital and liquidity position. We have conservative credit origination standards and we are there for our customers with advice and lending.
The economic outlook in our home markets have deteriorated during the quarter with rising inflation and in this environment Swedbank stands strong. Our customer’s future that is our focus.
Thank you for is stunning. And with that I give the floor back to you, Annie.
Annie Ho
Thank you very much. AND I’ll pass it on to the operator, could you please open the lines?
Question-and-Answer Session
Operator
Thank you. And we will now begin the question-and-answer session. [Operator Instructions] So the first question comes from the line of Maths Liljedahl from SEB. Please go ahead.
Maths Liljedahl
Yes, good morning. And thank you. First on NII sensitivity, and then if there’s been any changes to your sensitivity, if you could disclose a number, especially as we see the ECB being more positive. And I noticed a huge increase in derivatives in the balance sheet. Is that affecting the NII sensitivity in any way? That is the first question.
And the second on commercial real estate, if you could comment on the loan growth on LC&I how big share that is commercial real estate, because I haven’t really heard the same comments from the other banks, do you believe you increase your market share in the in the commercial real estate segment? Thank you.
Anders Karlsson
Thank you. And on your first question, there is a slight uptick on the sensitivity from – on the 50 basis point from 3 to 3.3, approximately. But I view that as a fairly theoretical number. And if you look at what has happened in the quarter, that will probably give you more of a sense of what’s coming in the future. But let’s come back to that, on the commercial real estate, I hand over to Jens.
Jens Henriksson
Thank you, Anders. We have the property management exposure in the lending book of SEK 230 billion in Sweden. And that is the lowest among the three large banks to Sweden, and our exposure to the sector is in line with our strategy and our risk appetite. And we are confident that we for a long time have had good credit origination standards and a focus on our customer’s debt service tolerance and cash flow.
And as Rolf said in his introduction, the average debt service tolerance ratio for our 15 largest property management customers is over 7%. And on top of this, we have collateral. So looking forward, we are ready to support our core customers further if it is in line with our strategy, risk appetite and leads to well balanced growth.
Maths Liljedahl
Okay, thank you. And the increase in derivatives in the balance sheet, should I read anything into that?
Anders Karlsson
No, you shouldn’t.
Maths Liljedahl
Okay, okay. Thank you.
Operator
And the next question comes from the line of Magnus Andersson from ABG. Please go ahead.
Magnus Andersson
Yes, good morning. Just continuing on NII, there and as you said Anders [ph] this sort of – the corporate lending growth was primarily driven by property management and food and retail, just wondering if you could say anything about the sustainability of this given bond maturities that they have in 2023, ’24? For example, how you look at that. And secondly, where do you think the spread widening in the bond market could have an impact on your corporate lending margins within that that segment?
And finally, perhaps if you could say anything on the competitive potential future competitive situation on the deposit side? How high do you think rates can go before you have to pay an interest on your transaction accounts? Thanks.
Anders Karlsson
Thank you, Magnus for those three questions. I probably forgot some, the first one. But if you look at the sort of more – the margin, potential for increased margins on corporates, especially where you have seen that the credit spreads have widening dramatically in the corporate bond market.
Logically, it should be there. We haven’t seen much of that expansion in the margins yet. On the new lending, it has picked up a little bit. But if you remember the some – most of the RCFs has been sort of negotiated before the invasion of Ukraine and the inflation and hikes. So I think it is a little bit too early to say on that and competition is actually quite high in the in the corporate segment.
Coming back to Jens answer, when there is a bond maturity coming up, if it fits our risk appetite, and our strategy, and it’s a core customer and good business, we will definitely be there for – for our customers.
On your question on the savings or the deposit side, I think that there is a distinct difference between transaction accounts and savings accounts, as you have seen in the quarter. It has turned in – it has always been an important funding source for us. It is now very attractive. What I do foresee is if rate hikes continue from the Riksbank, that there will be a certain amount of competition and that is something that we are following on a daily basis.
It’s about a balancing act between net interest margin expansion and outflows. And that is what we are following. As far as the transaction accounts come, the price elasticity is quite low. I will not give you a level, as one of the competitors did, but the rates need to increase further, definitely before that is even something we will consider.
Jens Henriksson
Could I follow up on you Anders, sort of look from the customer side, from the customer side now we have now reinstated interest rates on all savings account in Sweden. And that’s something that when I meet customers stay late – like a lot. And if they want to have higher rates, they’re welcome to come into us and they can make on a fixed and locked terms and we can deliver a competitive offering.
Magnus Andersson
Okay, thank you, May I just – just follow up on the corporate lending there on a more detail note, is it still the case that the part of the book with administratively set rates is around SEK 60 billion, SEK 70 billion?
Anders Karlsson
That – yes, but that also includes consumer loans. So the sum of corporate and consumer credits that are set at administrative rates is around SEK 70 billion, if I remember it correctly, Magnus.
Magnus Andersson
Okay, thank you.
Operator
The next question comes from the line of Andreas Hakansson from Danske Bank. Please go ahead.
Andreas Hakansson
Thanks. And good morning, everyone. I’m afraid I’ve going have to go back to the net interest income. If we just look in the mortgage side, and you’ve seen a SEK 66 billion reduction in your outstanding covered bonds in the quarter. And you’re now down to only 34% of your mortgages funded with covered bonds, so huge deposit funding there.
You have been increasing your prices in line with everyone else in the market. But given that the funding structure has changed, can we really say that mortgage margins are expanding at the moment? Or what’s your view on that?
Anders Karlsson
Thank you, Andreas. I think it is – you’re right. We are funding our retail mortgages with more deposits than usual, than in the past. On your second observation, yes, we have done five increases this year. And we have done that along the curve. And we have – we did it in – the large changes was made in end April, May June and early July.
So the margin development I think this will be sort of rolled into the book during this quarter. So the full repricing effect from mortgages will not be seen until September. So I think it is – there is – as far as I know, and see since we are sort of raising rates after market rates have been moving, there has been a certain margin compression on one hand, on the other hand, the repricing of the three months in particular is coming during the quarter.
Andreas Hakansson
But another way of looking at it, if you take deposits that were previously unutilized, that clearly is zero and all of a sudden you get a rate of – I don’t know the margin. Exactly, let’s say 140 Bps, right? That’s a very meaningful pick up, right?
Anders Karlsson
Correct. And that’s what I meant with the focusing on net interest margin expansion in my answer to Magnus.
Andreas Hakansson
And on that covered bonds, I mean, you down to the lowest level I’ve seen in a very long time. I don’t have all the history here. But would you expect that the covered bonds to continue to shrink? Or will it start to issue more in the second half?
Anders Karlsson
I would say that it will be on the same level, we don’t need it as you know. But on the other hand, you need to serve your investors to certain extent to keep up a liquid curve. But we are using the covered bonds as sort of the mechanism between deposits and senior. And as you know, the latter we need to issue on the back of regulation.
Andreas Hakansson
Thanks. And then finally, just in the Baltic NII, you arrived [ph] where has of course moved up by head over potentially to be [indiscernible]. Can we see – did we see any benefit for the Baltic NII some higher rates, they start to come in Q3 and Q4?
Anders Karlsson
I would say that the majority of the effect will come in the coming quarters.
Andreas Hakansson
Okay, that’s all for me. Thank you.
Anders Karlsson
Thank you.
Operator
And the next question comes from the line of Sofie Peterzens from JPMorgan. Please go ahead.
Sofie Peterzens
Yes, thank you very much. It’s Sofie from JPMorgan here. Just a quick follow up on the presentation. Could you just elaborate a little bit more what do you mean with the debt service tolerance? Is it – they got a stress interest rate or borrowing cost, or kind of how the debt service tolerance goes for the three – for the property management companies is calculated. And related to that you also have the 6% interest rate stressed level for private mortgages in Sweden. Today there is headlines in the local press that is the – Swedish mortgage rates could potentially go the 5% of retirement, Sweden, Swedish mortgage rates go to 5%. That would mean that the stress interest rates will increase by 5% or – and so basically is it on top of the current mortgage rate? Or is it fixed kind of 6%? So that would be my first question.
And then my second question would be around the cost, in New York [ph] kind of reiterating your SEK 21 billion, of course, including AML cost, but how should we think about the potential cost pick up that we have seen in recent years in the fourth quarter, should we expect this year to be less, of course, inflation in the fourth quarter? And what makes you so confident that you will deliver on the SEK 21 billion of cost. Thank you.
Rolf Marquardt
Thank you, Sofie. It’s Rolf here. So regarding debt service tolerance, what we do then is to – we really – we look at net operating income, and how much that could carry on service in terms of interest rates, payments and amortization payments. And so, if you have, as we have the average for the 15 [ph] largest companies, the debt service tolerance ratio, which also is often referred to as debt yield, that is close to 8%. So if you have 8%, to pay interest rates and amortize for then – and then you have funding costs today that is on average, like 2%, or something, you realize that you have a quite decent margin before you start to get close to what you could – what you could manage as a property management company. But that’s the way it’s been done.
So it’s a kind of an affordability calculation, if you will, and it contains margins, why we’re now. And I also think that when you look at this and the development you’ve seen for property management companies when it comes to credit spreads and bond funding and so on, you also need to take into account first of all that they have managed their interest rate risk, so they will have time to adjust, it will take time before this starts to, to feed into to their net operating income. And also when – before it starts to impact them. And the bond maturities are also being spread out over time, so they will have to – time to adjust.
Sofie Peterzens
Sorry, just to clarify. So in your example, then if the debt yield is close to 8% and the finding of is 2% does it mean that it has a 6% buffer, or does it mean that it’s 8% above the 2%?
Rolf Marquardt
No, it means that there is a buffer between the two.
Sofie Peterzens
Okay…
Rolf Marquardt
And then move on to your second question about the 6% stress rate, interest rate for mortgages. So today we apply a 6% stress rate. But that is something we review on an annual basis. And when interest rates are moving upwards, that is something we review and stand ready to adjust if we come to that point. So – and that’s the way we’re also have done it in the past. So that’s the method we apply. Okay?
Sofie Peterzens
Great. And what about the cost?
Anders Karlsson
Yes, Sofie. Hi, its Anders. On the cost side, first of all, the way you should view the second half of this year, is that it will be more similar to the second half of the year 2020, rather than the 2021. So that’s the first answer to your question.
When it comes to inflation, inflation creeping into our cost base, I think there are a couple of elements for you to know about. One is that the larger external contracts we have our fixed price during this year and in many cases during the next year. The salary review has already been done both in Sweden and the Baltics. So from that perspective, I think the combination of those two things is the reason why we are reiterating the cost cap of 20.5. And then please remember that any excess FX volatility will not be taken into consideration as far as I am concerned, since it’s positive for net profit bottom line.
Sofie Peterzens
That’s very clear. Thank you.
Operator
And the next question comes from the line of Namita Samtani from Barclays. Please go ahead.
Namita Samtani
Hi, I’ve just got one question. So it looks like mortgage market share grew in the quarter in Sweden. So I’m just wondering where did Swedbank pick up this market share within Sweden, like is it the larger cities? Or is it the suburbs? Thanks.
Rolf Marquardt
It’s Rolf, here. It is actually spread across the country. So no specific out of the ordinary location as with.
Namita Samtani
Thanks very much.
Operator
The next question comes from the line of Rickard Strand from Nordea. Please go ahead.
Rickard Strand
Hi, good morning. Two questions on costs from my side, starting with the FTE growth, that continues to be up 2% year-over-year and also growing sequentially. Just want to hear how you see that developing going forward for the second half of the year, but also into next year.
Anders Karlsson
Thank you. I think that I’ll say, that you get the same answers I gave in the – in this – in the previous quarter. We are investing in competence, but at a much, much slower pace than you have seen in the in the previous years. And on top of that, and you will expect that to be on a lower level going forward.
And secondly, which is actually not helping anyone the attrition rate is coming up to much higher levels than you saw during the COVID.
Rickard Strand
Okay, thank you. And then also on – I noticed Baltic inflation is around 20% currently in the [indiscernible] numbers, just want to hear if you – how is that impacting your cost basis that’s taking into account for the rest of the year, right. I think that will sort of impact the cost – cost development for next year rather?
Anders Karlsson
Thank you. No, as I said, and most of our contracts with external suppliers of any magnitude are fixed for this year. And the salary review has already taken place in the Baltic countries. When it comes to the next year, I will not guide on that, it’s too early, we will come back on that.
Rickard Strand
Okay, thank you.
Operator
And the next question comes from the line of Omar Keenan from Credit Suisse. Please go ahead.
Omar Keenan
Good morning, everybody. Thank you for taking the questions. I had a question on the net interest income outlook. And then a second question on the IRB overhaul. So firstly, on the NII outlook, you know, the rate sensitivity is clearly very attractive, especially with the growth in the deposit base over the past couple of years.
I just wanted to understand some of the possible headwinds. So I can size the net benefit to NII going forward. I just wondered if you could perhaps comment on the mortgages and where you see the front versus back book on the fixed and variable books, you know, once the current pricing changes are fully loaded.
And just on the Treasury NII. Is there any outlook you can give us there? Because it does look like it went backwards in the quarter. I know that there were certain positions there in the past that dumped in the year on rate sensitivity. So wonder if you could perhaps comment on treasury and maybe NGL there?
And then secondly, just on the IRB overhaul, noted your comment that it’s likely to be delayed. Is there any ballpark figure for the size of the potential impact? Or could you perhaps point us in the right direction of where to look, where risk weights might go up? Thank you.
Anders Karlsson
Thank you, Omar. You are a master in combining four questions into two. I will try to see if I can manage all of them. When it comes to the headwind on NII, as you asked about, I mean, the headwind, we know about is the necessity to issue senior preferred and senior non-preferred, that has become a more expensive, but that’s something we have to do. Other than that, I don’t see any specifics on that part.
When it comes to – you are correct that the balance sheet composition of the bank is attractive in an increasing rate environment and that is why I talked about focusing on the net interest margin expansion.
Secondly, when it comes to treasury, you shouldn’t read too much into that, as you know, treasury are in between the business areas on the liability on the asset side. And when we change the FTP it immediate transforms into the deposit side, while it takes a time to roll in on the asset side.
As far as the NGL and treasury comes, it’s in the quarter primarily coming from the fact that we are holding a liquidity reserve in government bonds or covered bonds that is something we need to have. From an NII perspective it’s positive, but since it is valued at fair value, we have the NGL volatility. The important thing to remember when it comes to treasury is that it will pull to par. It’s not something we are trading.
And on your last question on mortgages, I think the back book has a 35% floating, 65% fixed, but what we have seen lately, if we include the rollovers it’s 75% used in [ph] floating at this point.
Rolf Marquardt
Hi, Omar. Rolf, here. And then to comment on IRB overall. So, the plan – the Swedish if say [ph] plan is to, to finish this work during 2022. We filed the first application two years ago, last application a year ago. And that’s the plan and then it will take some time before it’s implemented technically. But if that time plan holds, it should be in the figures the first half of next year.
And when it comes to the impact of that exercise, we haven’t communicated that and we need to get further in the approval process before we can really know about the impact. But it means increased capital requirements at certain degree, but more stable ones. That’s as far as we can go at this point.
Omar Keenan
Okay. Thank you very much.
Operator
And the next question comes from the line of Riccardo Rovere from Mediobanca. Please go ahead.
Riccardo Rovere
Thank you for taking my questions. Two, if I may, just to make two other clarification on what you stated before with regard to deposit beta [ph] you stated that with the inflows you have seen over the past months and years, and given the level of liquidity in the system, without giving a number stands to the correct [ph] you stated that you do not expect any particular deposit beta on your one rate to go up. So clients at least at the beginning will not or should not get much on transaction accounts, if I understand it correctly, without giving a number doesn’t matter.
The second question, the second question I have is on asset quality. Today, you’re telling us that the LTV on the mortgage and commercial real estate is about 50% or so. So you would need a collapse in real estate prices to see any impact on LTVs. And you’re also telling us that you’re stressing – stressing, using stress in the portfolio with 6%, 7%, 8% rate for the debt. It’s also the PD should not dramatically increase unless unemployment goes to the roof which doesn’t seem to be the case.
What would you need to see a sharp deterioration of credit quality in the group? Could have the wrong end kind of sensitivity if gas [ph] had to stop flowing to Germany from Russia. Thanks.
Jens Henriksson
Okay. Thank you, Riccardo. If we start off with your first question. Again, there is a clear distinction when it comes to price elasticity between transaction accounts and savings accounts. And that has been a fact. As long as I can remember, what I said is that on the transaction accounts that the rates needs to move higher than they are today in order for us to consider paying on the transaction accounts.
On the savings accounts, it’s much more of a balancing act. It’s a very attractive funding source. And that’s why I said it is a balancing act between net interest margin expansion and flows in the books.
If you look at the quarter, the pass through on savings is 7%. If rates increases, I think it will be more difficult to keep a pass through at that very, very low level but that is what it’s all about.
Rolf Marquardt
Okay, Riccardo, Rolf here. So about the LTV and PD related question you asked. So yes, it will take – it would actually take a quiet significant change – drop in asset values or property management – property values to really make a change when it comes to RWA inflation. And that’s for a couple of reasons.
So first when it comes to LGT [ph] those would gradually improve, but then we have the risk-weight floors that for commercial and residential real estate and also mortgages that – that sort of impacts here. So, it takes a significant drop. And in the new models we are discussing with the Swedish [ph] to say, they will be more stable, meaning that and calibrated across the cycle, meaning that PDs will also be stable across the cycle.
So, it takes a quiet significant drop and to understand why, or to what it really take, to start to see changes. That is something we can’t sort of exactly guide. But when you look at the different kinds of stress tests that we communicate externally also, and when you look at our LTV distribution that we also publish, you can realize that and see that sort of the first 30% will actually – or prior change will not lead to any significant changes. It’s when you’re past that point, where you start naturally to see – to see changes.
Riccardo Rovere
And with regard to Russia?
Jens Henriksson
Well, I could say a few words, a few words on that. So what I said today was that we expect growth to slow down but we do not expect a recession. And of course, if we would see dramatic changes in the gas distribution to Germany, that will of course lead to worsening economic development.
But we feel confident that we stand strong. We have as Rolf clearly demonstrated it today, good credit origination standards and good collateral if something would happen.
Riccardo Rovere
Okay, thanks. Thank you.
Operator
And we have time for one more question. So the last question will be from Martin Leitgeb from Goldman Sachs. Please go ahead.
Martin Leitgeb
Yes, good morning. Could I have two question please, on commercial real estate. And the first one, I was just wondering if you could clarify how indexation works, or the majority of leases in the commercial real estate book in Sweden indexed and would they expect this indexation to hold so the ability of borrowers to pass on higher rent to their tenants?
And secondly, I was just wondering, I mean, the loan books it is really helpful on slide 18 in terms of commercial real estate, I was just wondering what percentage of it would you call is, is speculative, but we know in a form or development loans in a way where it says speculative risk in terms of tenancies or leases. Thank you.
Anders Karlsson
So about indexation, when it comes to commercial real estate normal agreement includes indexation related to inflation. So, meaning – and that – the period that you’re looking at is from October to September, and then it starts to apply the following year. So that’s meaning that inflation could be passed on to customers.
When it comes to residential real estate in Sweden, that is being regulated. So there – and negotiation needs to take place, expectation is, of course, that it will at least partly be passed on, but it depends on the outcome of that kind of negotiation. And then could you please repeat your second question, I couldn’t hear it clearly.
Martin Leitgeb
Yeah, no, no worries. I was just wondering, in terms of the commercial real estate book, how much is if development finance, so whether that’s, you know, classical development of buildings, and then the borrower needs to find a tenant or whether there’s some speculative risk in terms of tenancies that, you know, there might be vacancies of staff [ph]
Anders Karlsson
Okay, well, that’s very, very limited in that part of the book.
Martin Leitgeb
Perfect, okay. Thank you very much.
Jens Henriksson
Well, then I take the chance to say thank you to everybody for calling in and asking us always difficult and informed questions. We at Swedbank are very proud that we once again delivered a strong result in turbulent times. And with that, I wish you all a great summer, not too warm I hope. Look to forward seeing you again. Take care. Bye-bye.
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