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Edited Transcript of DNB.OL earnings conference call or presentation 30-Apr-20 11:30am GMT

Q1 2020 DNB ASA Earnings Call

Oslo May 14, 2020 (Thomson StreetEvents) -- Edited Transcript of DNB ASA earnings conference call or presentation Thursday, April 30, 2020 at 11:30:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Harald Serck-Hanssen

DNB ASA - Group EVP of Corporate Banking

* Ida Lerner

DNB Bank ASA - Group EVP of Risk Management

* Ingjerd Cecilie Hafsteen Blekeli Spiten

DNB ASA - Group EVP of Personal Banking

* Kjerstin Rasmussen Braathen

DNB ASA - Group CEO

* Ottar Ertzeid

DNB ASA - Group CFO

* Rune Helland

DNB ASA - Head of IR

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Conference Call Participants

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* Chris Hartley

Redburn (Europe) Limited, Research Division - Analyst

* Jacob Max Kruse

Autonomous Research LLP - Partner, Scandinavian Banks

* Johan Ekblom

UBS Investment Bank, Research Division - Equity Research Analyst of Benelux and Nordic Banks

* Joseph Dickerson

Jefferies LLC, Research Division - Head of European Banks Research & Equity Analyst

* Maria Semikhatova

Citigroup Inc, Research Division - VP and Analyst

* Martin Leitgeb

Goldman Sachs Group Inc., Research Division - Analyst

* Riccardo Rovere

Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst

* Sofie Caroline Elisabet Peterzens

JP Morgan Chase & Co, Research Division - Analyst

* Thomas Svendsen

Nordea Markets, Research Division - Director of Financials

* Ulrik Årdal Zürcher

Danske Bank A/S, Research Division - Analyst

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Presentation

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Operator [1]

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Good afternoon, and welcome to the DNB Quarter 1 Presentation 2020. My name is Anna. I will be your coordinator for today's conference.

(Operator Instructions)

I will now hand you over to Head of IR, Rune Helland, your host for this call. Thank you.

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Rune Helland, DNB ASA - Head of IR [2]

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Hello, everyone, and welcome. We hope you are all well and are comfortable where you are. Here in Oslo, we have the CEO, Kjerstin Braathen; CFO, Ottar Ertzeid; CRO, Ida Lerner; we have Head of Personal Banking, Ingjerd Hafsteen Spiten; and Head of Corporate Banking, Harald Serck-Hanssen.

Ottar will start with a brief introduction before we go over to the Q&A. So please, Ottar?

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Ottar Ertzeid, DNB ASA - Group CFO [3]

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Thank you, Rune. The first quarter has been an unusual quarter, also in banking. We believe that the Norwegian economy is well equipped to handle this situation. At our Capital Markets Day in November, we have talked about Norway's strong fiscal and financial position, including the 3 built-in stabilizers in the economy, the fiscal policy with the strength of the Norwegian government, which has really been put to work during the last couple of months. And also the flexibility in monetary policy, where the key policy rate in Norway has been reduced by 125 basis points last month.

In our view, Norway and DNB is also operationally well equipped to handle this situation. We are a highly digitalized society and bank, having most of our contact with customers through the mobile bank, the Internet bank and the call centers, and have thus been able to continue running the banking operations almost as normal during these special times.

We also see that solid financial foundations we put in place before this situation is really paying off. We are one of the most solid and best capitalized banks in Europe. Liquidity is stronger than ever. Our credit ratings are really benefiting us in these times as we see in growth in deposits. And not least our high operating profit before provisions provide substantial loss absorbance capacity during these special times.

And this is also what we see in the first quarter with continued solid underlying operating performance, but the results affected by significant loan loss provisions due to COVID-19 during the quarter.

We see a 12% growth in net interest income from the first quarter last year and 0.5 percentage point from the fourth quarter, positively affected both by the repricing in 2019 and increased volume.

With regard to commission and fees, they are up 1% from the first quarter of last year, with a strong performance in January and February and somewhat softer in March due to the effects of COVID-19.

You also see a positive development in other operating income, contributing to a solid development in operating profit before impairment provisions.

The big number in the quarter is, of course, impairment provisions. According to IFRS 9, they are taken somewhat earlier in the credit cycle than would have been the case in the former accounting rules based on incurred losses. You see that 50 -- approximately half of the provisions we take in the quarter are related to stage 1 and stage 2 customers, performing customers and approximately half is related to stage 3.

Even with these significant provisions, we have a return on equity for the quarter of 6.5%. On top of that, we also note that the capital situation is highly satisfactory. Leverage ratio, 6.5%. A 50 basis point reduction is due to high deposits with certain banks, which, again, reflects our desire to build resilience in these uncertain times.

Common equity Tier 1, we have a bigger headroom towards the requirement than ever and very happy with the capital situation.

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Rune Helland, DNB ASA - Head of IR [4]

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Okay? Then we can go over to Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

And the first one is from Sofie Peterzens from JPMorgan.

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Sofie Caroline Elisabet Peterzens, JP Morgan Chase & Co, Research Division - Analyst [2]

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Here is Sofie from JPMorgan. I was just wondering if you could give a little bit more details around the macro scenarios and oil price assumptions behind your loan losses that you're taking this quarter.

You mentioned that it's the GDP growth around the levels we saw in 2008 and '09. But if you can give actual numbers for -- on the GDP, unemployment, house prices, that would be very helpful.

And my second question would be on payment holidays. What level of payment holidays are you seeing in your portfolios? And do you expect some of these payment holidays that -- to actually turn into NPLs? And if so, kind of what level -- when do you expect payment holidays to potentially become NPLs?

And the third question would be on the government guarantee schemes. How much have you taken off the government guarantee scheme? What is the pricing? And what kind of risk weight you use for the government side guarantee scheme?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [3]

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Thank you, Sofie, and I'll start, and then Harald can address the third one.

When talking about assumptions and what kind of a scenario we have built for the reserves we've taken, it's important to just be specific that these are related to the reserves we have taken in stage 1 and stage 2, which is approximately half of the reserves taken in the quarter.

Secondly, I would also like to point out that it's a series of factors that we include in our modeling. And in addition to these factors, we have also made specific consideration related to certain sectors that are too much reflected or not well enough reflected. So there's a number of factors that goes into the aggregate consideration, leading to the provision close to NOK 3 billion in stage 1 and 2.

As we've said, our scenario is more severe than the financial crisis. We have used the finance department as a reference. They do have an interval when it comes to the GDP growth for Norway, if we use that as an example. But obviously, a sharp decrease in the second quarter with a gradual opening up of the economy again towards the end of the quarter and a relatively -- end of the year with a slower pick-up in the economy in the third and fourth quarter.

We -- if you use the sensitivity, for instance, on the GDP, given the large uncertainty that we appreciate in there in the market, we have sensitized on an additional 5 percentage point decrease in the GDP. The point estimates currently in our assumption is minus 2%. If we scale this up and put an additional 5% decrease on the GDP, this would have led to an additional loss of NOK 300 million, everything else being equal.

Oil price, we've used an average for the year of $48.

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Harald Serck-Hanssen, DNB ASA - Group EVP of Corporate Banking [4]

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$43.

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [5]

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$43, sorry, a barrel, also reflecting the higher pricing level going into the year. Again, sensitizing -- with the sensitivity, if we reduce this to $30 a barrel, this would also lead to an additional NOK 300 million of losses.

So a manageable impact of these factors, and it's important to understand that it's a series of factors that impact the picture.

Payment holidays have been very actively sought from the personal customers. It's important to point out that

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installment release and no customers have asked nor are getting any holidays on interest rate payments.

The portfolio is very solid. We have approved in the range of 27,000 requests for payment relief, so this is not in any way meaningfully impacting the risk profile of the portfolio nor do we expect these to turn into NPLs over time.

And that situation, in a broader perspective, would be similar also for corporate clients, even though we have been active helping them with pushing installments somewhat out in time and also providing liquidity facilities.

As for the guarantee scheme, this is an important initiative, and I'll leave it to Harald to answer.

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Harald Serck-Hanssen, DNB ASA - Group EVP of Corporate Banking [6]

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Yes, thank you. I'll give you some key facts on that. DNB was the first bank in Norway to really launch these guarantees with a 90% -- no sorry, these loans with a 90% state guarantee, obviously affecting also our use of capital on these loans. It's fair to say we've been somewhat surprised by the moderate demand so far.

So far, we have approved approximately NOK 1 billion of these loans. The average size of the loan is as small as NOK 1.5 million. And it's somewhat difficult to give you exact figures as to the percentage approved, but it looks like it's in the area of 50% that we will be able to approve, based on the regulations of standards set by the government.

So in my mind, the cash compensation scheme that was launched after the state-guaranteed loans will have a much, much bigger impact on the Norwegian economy, and it will be a very important factor in reducing the knock-on effects to other industries from this downturn.

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Sofie Caroline Elisabet Peterzens, JP Morgan Chase & Co, Research Division - Analyst [7]

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Okay. If I may, could I just ask about the credit rating migration that you have seen on your portfolio. How much did you see -- how much negative rating migration did you see this quarter on your corporate portfolio, please?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [8]

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Negative credit migration is visible in the RWA inflation. That is showed in the bridge where approximately 30 basis points is related to negative credit migration in the quarter. So there is some migration, but the larger impact is from the macro factors.

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Operator [9]

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The next question comes from Johan Ekblom from UBS.

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Johan Ekblom, UBS Investment Bank, Research Division - Equity Research Analyst of Benelux and Nordic Banks [10]

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Just 2 questions for me, please. I mean, number one, can you talk a bit about the sensitivity and help us understand. I mean we've -- all of the Nordic banks have reported and -- so some banks are indicating multiple billions of higher expected credit loss by moving to a downturn scenario that tends to be kind of minus 5% to minus 7% GDP, and you were talking about a couple of hundred million.

So for us, a lot of these models are very opaque. So can you understand why your model seems to be so insensitive to worse macro outcomes, both in terms of GDP and I guess also in terms of oil price? And if they're so insensitive, why -- how do we explain the large provision charge in the first quarter? So that's the first question.

And then the second question, just if you can remind us in terms of interest rate sensitivity, is there any reason not to assume an unwind of what you guided to previously when rates were rising?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [11]

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Thank you for the question, Johan. I think it's an important one. I would not say that our models are not sensitive, but there is a series of factors that needs to be taken into account. And these models are quite complex, which is why I pointed out earlier on that you will not get visibility just from taking out a couple of reference points and trying to use that as a full basis for the picture.

Our model related to the future outcome is based on the economic outlook for the coming 3 years with a multitude of factors. And obviously, there's been a sharp, at least, I can only speak for our view, change in how we see the world and the uncertainty in the world in the coming 3-year period compared to where we were at the end of fourth quarter.

Furthermore, we have also taken a look at specific sectors. And now we are talking about the healthy portfolio, where we have made some additional reserves in the offshore sector, expecting a lower activity level in the oil -- on the oil investment side. And we have also shown some caution on the commercial real estate related to the fact that hotels are practically shut down and that shopping malls see a lower revenue activity and a lower revenue stream.

So in aggregate, there's a series of factors that have been taken in where we reflect the future uncertainty, which is why our numbers in overall turn out as they do for the first quarter.

The sensitivity that we referred to on GDP for Norway and oil price just reflects the fact that there is indeed a broad variety of factors and not just single estimates that comes into the picture.

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Johan Ekblom, UBS Investment Bank, Research Division - Equity Research Analyst of Benelux and Nordic Banks [12]

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Can I just follow-up on that then? I mean, so can you disclose what probability you assigned to your base case and downturn case today? And what the ECL impact would be of assuming 100% on the downturn case? I think that's pretty standard disclosure in the annual reports, and I think some of your peers have updated those numbers with Q1 results.

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [13]

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I'm afraid we can't. And I think it's important to keep in mind that that we appreciate that it's not necessarily easier to compare one bank to the other. We can talk to our consideration where a substantial degree of uncertainty towards the outcome is factored in into the numbers. What we know for sure is that it's not accounting principles that actually ends up impacting how high losses will or will not be.

And in today's world, I think we all have to acknowledge that how much will be actual losses from this situation is highly uncertain, and that's the fact we just all have to live with for a while. And we do our utmost to improve both the situation for the customers to sustain the period as well as work to limit impairments as much as possible.

You asked about interest rate sensitivity. I'll have -- Ottar, you can comment on that.

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Ottar Ertzeid, DNB ASA - Group CFO [14]

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Yes. We have reduced customer rates by up to 85 basis points following the cut in the rates by the Central Bank.

And as you correctly hinted to, when we increased rates last year, we said that each 25 basis points hike increased net interest income by approximately NOK 1 billion annually. So when we now reduce rates, you should expect an approximate proportionate opposite effects on the way down.

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Operator [15]

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The next questions come from Riccardo Rovere from Mediobanca.

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Riccardo Rovere, Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst [16]

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I just want to get back one second to the assumptions plugged into the almost [NOK 6 billion] -- you have taken NOK 6 billion -- almost NOK 6 billion. And you're telling us that if the GDP in Norway falls to 7%, so an additional 5% on top of the 2% that you have already plugged, and if the oil price remains at $30 per barrel for the rest of the year, you will be charging an additional NOK 600 million, give or take, of provisions.

Now I don't know what else can go worse than that. Maybe GDP could go to a decline of 10%. But in any case, implicitly, and correct me if I'm wrong, you are basically saying or signaling that you have taken the majority of the provisions in this quarter. Because even if I double the NOK 600 million, but even if I triple the NOK 600 million, implicitly, if the GDP decline adding another 5% is kind of correct, I would need -- I could need -- I don't even think what I could -- should plug to have similar quarters in the 3 quarters, the last for the year. Is there anything wrong in what I'm saying?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [17]

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What I think is important to highlight

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when it comes

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well, there are different number of macro factors that are inserted into the

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in looking at

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how it impacts the economy as such, it is a lag effect.

So a lower GDP this year has a negative effect next year as well. But I think it's important to say that what we're saying here is that we are also, in terms of the guidance given by the regulators is also that you should take into account, government initiatives and what -- how they are expected to dampen the effect. And I think it's fair to say that the government initiatives we've seen in Norway have been extraordinary.

And that's also one of the reasons why you might see that it hasn't that severe effect even if you push it further down. And the government has also been very clear saying that they will do its upmost to support the Norwegian economy.

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Riccardo Rovere, Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst [18]

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But again, I'm sorry -- but again, from what you're saying, this is like saying that, again, it sounds like that you have taken a very good part of the provisions in this quarter, if the situation remains more or less what it is today from what the visibility you have today, agreed?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [19]

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And this is right, Riccardo. This is also our understanding of the IFRS 9 framework that losses should be taken early on in the cycle. Then obviously, in a situation with substantial uncertainty, this is reflected. It's also fair to say that it's a higher sensitivity with a GDP level moving from plus 2% to minus 2% versus from minus 2% to minus 7%.

But you need to keep in mind that this is a 3-year view we're taking into account, so also the development beyond this year will be important for future considerations. This is the situation for stage 1 and 2.

In stage 3, there will always be the risk of company-specific situations. This can go both ways. But we're not giving a guidance specifically on losses, but we are saying that we expect most of the losses to be taken in first and second quarter.

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Riccardo Rovere, Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst [20]

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Okay. Okay. Very, very, very clear.

Second question, if I may. Can you update with the recent -- your recent thinking around dividend, the buyback and then capital return? Where do we stand, is everything frozen?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [21]

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Well, the proposed dividend for the year -- or the decision on dividend has been pushed out by the Board, and they have announced they will take a view on this no later than December this year.

So we will schedule an extraordinary general assembly during the third quarter. We have, due to the uncertainty, also suspended our activity in terms of share buyback. And have said that the next time we will consider to apply for a proxy on share buyback is at the same time as we make -- or the Board makes a recommendation to the general assembly on the dividend.

This seems like, in our view, a wise consideration by the Board, given the uncertainty in the economic outlook. It is important to say that the considerations then at that time, in our view, will be based on the robustness of both the capital structure and the buffers at the time as well as how the economic outlook appears then in the fourth quarter this year, where, hopefully, we have much more visibility on how this is going to turn out than we have today.

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Riccardo Rovere, Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst [22]

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So let's say, everything is kind of suspended, hoping for better times, then. Fair?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [23]

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There will be no further considerations relating the dividend for '19 until the fourth quarter of this year. I think that is what you -- what we can say.

But we can also -- to reiterate what our CFO pointed out in his introduction, we are very comfortable with our capital position. We have a larger buffer towards the required level of capital than ever before, substantial capacity to withstand the downturn we're in, while, at the same time, supporting customers and maintain our dividend strategy intact.

But obviously, the Board will have to take into account the economic outlook and the situation when they make their considerations in the fourth quarter.

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Operator [24]

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(Operator Instructions)

Next question come from Ulrik Zurcher from Danske Bank.

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Ulrik Årdal Zürcher, Danske Bank A/S, Research Division - Analyst [25]

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I have 2. First one is a bit technical. But does the change in the macroeconomic forecast affect the migration of loans into stage 3 or is that company-specific? What I mean is that if you say, okay, we think the economy is and oil price is going to develop this way, okay, then maybe some oil exposures need to be moved into stage 3? Or does it only affect the provisioning rate?

Second question is that just want to make sure I understood this correctly because it's -- you hinted to it at the presentation that losses might stay a bit elevated in Q2 under your current assumption. But then will we see a more normalized rate in the second half of the year, like loan loss rates, under your current assumption? I know it's a lot of uncertainty.

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Ida Lerner, DNB Bank ASA - Group EVP of Risk Management [26]

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Well, first of all, if we start with the -- what happens when the company moves from stage 2 and stage -- into stage 3, that's based on individual assessments. And that's the similar process that we always had when it comes to the individual impairments, where the customer is thoroughly analyzed and then we make a decision based also on different factors affecting that specific customer. So that's not model-based in the sense -- in that sense.

When it comes to -- sorry, your second question was more...

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [27]

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Second question was on second quarter losses. I think we addressed them earlier on. Given the uncertainty, I think it's difficult to say more than we previously said. We expect the losses to be highest in first and second quarter.

We also reiterate that we have taken in the future uncertainty in the first quarter, but there may be changes to the scenario as illustrated by the sensitivities given as the situation develops. And there will be company-specific situations that can even, in this situation, move in both directions. So I think that's what we can say.

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Operator [28]

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The next questions come from Jacob Kruse from Autonomous.

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Jacob Max Kruse, Autonomous Research LLP - Partner, Scandinavian Banks [29]

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So first question was just on the mortgages and the pipeline that you have there. How do you think about the -- if the lockdown restrictions start to open up a bit or given the lockdown restrictions that you have, how do you see that developing in Q2? And how do you -- does it change when the lock down restrictions ease up at the latter half -- or latter end of Q2, if that's what happens?

And then my second question was just on asset quality. You used to give some detail on kind of breaches of covenants and where you are in discussions with clients. Could you just talk a bit about what you're seeing specifically in terms of corporate clients in those more vulnerable sectors, either already breaching covenants or asking for extensions or asking for some types of restructurings? Just to give an idea what you're actually anecdotally seeing, more specifically with those exposures.

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [30]

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Thank you, Jacob. Ingjerd will answer the first question, and then Harald can assist on the second one.

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Ingjerd Cecilie Hafsteen Blekeli Spiten, DNB ASA - Group EVP of Personal Banking [31]

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Yes. On your first question, Jacob. We see -- we experienced a quite normal situation now when it comes to mortgages, both in demand and also for the real estate brokering. They have -- they will deliver about 80% -- more than 80% of the budget we set in 2019, actually, on the real estate.

When it comes to mortgages, we have had really -- we have had many, many customer conversations, and we have a lot of demand for -- regarding an application, regarding mortgage installment postponements, around 27,000, actually.

But as we have previously commented, that is not holiday -- payment holiday as you have -- as you call it globally. It's no postponement of -- it's only postponement of paying...

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Harald Serck-Hanssen, DNB ASA - Group EVP of Corporate Banking [32]

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Installments.

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Ingjerd Cecilie Hafsteen Blekeli Spiten, DNB ASA - Group EVP of Personal Banking [33]

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So for us in -- and we just got the Norwegian figures for expected -- for mortgages -- mortgage growth in March, and that was still 4.7% for March. We expect it to decrease a bit probably as it -- but we still see a well-functioning market, actually, both for mortgages and in the real estate market, and increased demand for our deposits.

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [34]

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Good. Harald?

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Harald Serck-Hanssen, DNB ASA - Group EVP of Corporate Banking [35]

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Yes. Well, first of all, it's been gratifying to see that a fairly large share of our corporate banking portfolio is pretty insulated from this downturn. So I think there are 2 key industries to focus on. One is the maritime industry and oil and gas, where we see limited impact on shipping. There have been no new distressed cases there. And also on oil and gas, we are very comfortable with our E&P portfolio.

So it's the offshore portfolio where we have the challenge. We already have 1/3 of the portfolio there in restructuring. And obviously, the second round of restructuring that we are in the midst of will become more challenging, and that is reflected in the increased provision levels that you see in the first quarter.

When it comes to the retail sector, it's been an interesting development because we have expected this to be worse. We see that, again, about half of the portfolio has been insulated. We saw a 37% increase in online purchases in March. And we have had one bankruptcy among our clients on the retail side since mid-March.

But on the other hand, we actually had 10 challenging situations, all ending up with the sponsors putting in more equity. So all in all, we have not seen a strong increase in the number of companies where we will see and need to provision from what we see today. Again, keeping -- emphasizing the uncertainty on the offshore side.

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Jacob Max Kruse, Autonomous Research LLP - Partner, Scandinavian Banks [36]

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Okay. And just could you say -- I don't know if you still give this disclosure, but how big a portion of your offshore portfolio going into this was already in breach of covenants?

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Harald Serck-Hanssen, DNB ASA - Group EVP of Corporate Banking [37]

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We don't have the exact number in breach of covenant, but we had 1/3 in stage 3, and -- yes. So those are the -- there might be some minor brief covenant breaches also in the other 2/3 of the portfolio, but it's basically 1/3 that has been challenging.

And again, the loan loss provisions we take are mainly on the existing names where we've already taken provisions. Just again to specify, that's the stage 3 provisions.

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Operator [38]

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The next question comes from Martin Leitgeb from Goldman Sachs.

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Martin Leitgeb, Goldman Sachs Group Inc., Research Division - Analyst [39]

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My first question is again back to provisioning, and then -- I think it's the first time we see the application of IFRS 9 and how it works in practice and there's just differences in the sectors.

So just trying to better understand what the message you see here. But -- so if we look at the first quarter provision, which is large, if you compare to a loan loss rate as implied by stress test and if you compare it across the sector. Is the message here that from here for the rest of the year, if that the economic outlook stays unchanged, we should revert back to some form of normalized loan loss rates, maybe similar to what we had in '19, maybe much higher given how things evolve?

But the message very clearly, obviously, you don't annualize the first quarter, and we are having to do some more normalizations here.

And the second question, I was just wondering if you could help us quantify what the impact on revenues arising from COVID-19-related disruptions. Obviously, you have flagged the impact of lower interest rates and the sensitivity to lower interest rates.

I was just wondering if there's other major elements within revenues worth flagging.

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [40]

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To address your first question, we are now in then stage 1 and 2 portfolio consideration when it comes to losses. It's important to bear in mind that there are 2 categories impacting the reserves on this portfolio. One is the series of macro factors and the economic outlook. Secondly, it's the grade and the risk of each and every customer in the portfolio.

So firstly, just take the assumption that there are no changes to our view on the future economy and the various parameters that we've set aside for in -- for the future in the coming quarter, then the only additional potential reserves would be from increase in exposure.

There would be no additional losses then in view of the macro factors.

Second -- the second factor to keep in mind would be to watch the credit migration in that portfolio. If there is a negative credit migration, that would lead to some additional reserve. If it's a positive, it would lead to the opposite. I'll leave it to Ottar to answer the...

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Ottar Ertzeid, DNB ASA - Group CFO [41]

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On the COVID-19 income effects. Besides the net interest income, there will be effects on commission and fees and mainly two-folded.

The first effect is on transaction-based income, mainly investment banking that we will see a slow March and going into April in debt capital markets -- equity capital markets and M&A which we'll expect to pick up again, particularly in the ECM area.

Then we have the second area, it's the money transfer and banking services, where we see less cash withdrawals from ATMs and also less use of credit cards internationally. So there will be an impact on money transfer and banking services.

And thirdly, there will be some effect on the real estate and broking, even though activity in April has not been affected as much as expected as the Head of Retail just commented.

So that's with regard to transaction-based income. And then we have what's based on market values. Of course, equity prices are lower now. As you know, that will have a fee income on then revenues from asset management and defined contribution pension. The sensitivities in those areas combined is that 1 percentage point in equity value amounts to NOK 10 million annually in fees.

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Operator [42]

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The next question comes from Joseph Dickerson from Jefferies.

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Joseph Dickerson, Jefferies LLC, Research Division - Head of European Banks Research & Equity Analyst [43]

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So I just have a couple of questions on the oil price movements. At what price -- can you just

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your exploration and

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loans

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a linear relationship of those

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given the commentary that at $30 a barrel, the additional impairment

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Operator [44]

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We are so sorry, Joseph. Your phone is really poorly, and you are not -- we can't hear half of the words you are saying. I don't know if you can just try to dial back again and we transfer you back into the question area when you dial up again. Can you please do this? And we can do the next person.

And the next question comes from Maria Semikhatova from Citi.

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Maria Semikhatova, Citigroup Inc, Research Division - VP and Analyst [45]

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I have a couple of questions. First of all, on asset quality. Could you please provide a bit more color on the increase in stage 3 loans over the quarter? You mentioned that you had one bankruptcy in retail, and I think oil-related increase in stage 3 is not surprising. But you've also seen some, according to your disclosure, pick-up in services and also financial companies. So maybe you could just talk about whether that was driven by some specific cases or you already saw a deterioration because of the COVID-19 situation?

And the second question, on your cost outlook, how confident are you with the ambition to have a cost-to-income ratio below 40%, given that you provided this target in a very different traveling environment. So maybe you can talk about is there any actions you can take on the cost side to actually deliver on your ambitions?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [46]

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So should I start perhaps and then Harald can still add if there's anything that he thinks should be added to my comments.

When we look at stage 3, as you can see from the disclosure also in the presentation, NOK 1.5 billion of the impairments we took in stage 3 are related to oil, gas and offshore. So the rest is related to other parts of the sectors or the other parts of the portfolio. And I would say that, that's still -- and that's also then reflected in the presentation where we've seen some of the most affected sectors. But yes, we have had a few customer cases in service, and we've also had other customer-specific cases in other sectors as well.

I wouldn't say that that's -- it's no -- not a single large exposure in that sense that has opened up, but it's more of a multiple of different customers in the different sectors, as you can also see, in terms of the increase in stage 3.

What's important to highlight in terms of the impairments in stage 3 as well as, of course, that, that has a -- as Ottar pointed out in the Q&A and during the presentation, is some exchange rate effect there as well.

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Ottar Ertzeid, DNB ASA - Group CFO [47]

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And I think it's fair to say when it comes to service, Ramira (sic) [Maria] that the biggest challenges are related to travel and leisure. That's where we see the biggest challenge.

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Harald Serck-Hanssen, DNB ASA - Group EVP of Corporate Banking [48]

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On the cost side, there will be some negative effects from foreign exchange we estimated equal to NOK 35 million in March due to the Norwegian kroner. But as you see from the numbers, overall costs are down from the fourth quarter.

Going forward, we have said that it might -- may be challenging or perhaps also unlikely to meet all the financial ambitions this year. And that's more related to the income side of the cost income ratio, reflecting the earlier comments on the second quarter effects on NII and commission and fees due to the effects of the lockdown in this period.

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [49]

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So just to add one point maybe. When it comes to cost efficiency, I'm sure you -- for those of you who have followed us for a while, you know that we work consistently and systematically on cost efficiency, which also means that we have ambitious plans and targets when it comes to increasing efficiency and impacting costs going forward.

The key focus will be to continue that and deliver on that. But we do expect revenue impacts, as Ottar is saying. And we will, of course, also look for opportunities to increase cost efficiency given the new environment we're in.

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Maria Semikhatova, Citigroup Inc, Research Division - VP and Analyst [50]

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I understand. And just maybe a small question on exposure to vulnerable sectors. Thank you so much for this additional disclosure, specific industries. You provided the total share in your portfolio based on net exposure. Do you have a number? How much provisions do you have against these vulnerable sectors?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [51]

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Well, I don't have that number in my head in terms of accumulated impairments we've got in the vulnerable sectors that we've identified. I'll need to come back to that.

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Ida Lerner, DNB Bank ASA - Group EVP of Risk Management [52]

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But you get guidance in the fact book where we show the table per industry, where you can see the reserves made against the various sectors that are defined. That's the level of disclosure we have per industry.

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [53]

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And in the fact book, it also states clearly what -- how that's spread as well on...

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Harald Serck-Hanssen, DNB ASA - Group EVP of Corporate Banking [54]

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Page 23.

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Ida Lerner, DNB Bank ASA - Group EVP of Risk Management [55]

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Page 23.

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Operator [56]

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And we do have Joseph back again in the room. So Joseph Dickerson from Jefferies.

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Joseph Dickerson, Jefferies LLC, Research Division - Head of European Banks Research & Equity Analyst [57]

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Just wanted to know [what is] breakeven for your exploration and production loans? And then if you can discuss the relationship between the oil prices provisioning because as you went from

(technical difficulty)

to about $43 assumption for this year, that drove up to NOK 6 billion of provisioning more or less based on your disclosures today. And then you said on the $30 and it's

(technical difficulty)

So if you could just discuss the relationship there, that would be helpful. Presumably, if the average was also at $20, would that be a larger impact or less? It sounds like the broader impact has been from the move [from $30]down to $43 than $43 to something else.

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Harald Serck-Hanssen, DNB ASA - Group EVP of Corporate Banking [58]

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It's Harald. I'll try to answer your questions. We didn't hear you clearly, so -- but hopefully, I'll be able to answer your main questions.

I think we need to split our oil-related exposure into 2 areas. One is where we have a direct correlation with oil price, and that's on the exploration and production side. If you look at that portfolio, 2/3 of the exposure is related to the North Sea, either U.K. or Norwegian sector. And there was actually a study by an independent analyst called [Rud Mek] that said that 95% of the production in the North Sea is cash breakeven at below $10 per barrel. So that's one reference point.

We do have some reserve-based lending. It's less than 20% of the E&P portfolio with very robust structures for the senior lenders and where the borrowing base is reset periodically.

So then we have the more challenging part to explain, is oil service and offshore, where you have a derived demand, which is not directly dependent on the oil price, but depending on the activity level, especially on the offshore drilling side. And that is where we have taken the provisions on the offshore side, not much on oil service because historically, the oil service companies have been very good at adjusting their cost base based on the activity level.

Today, we received news from the Norwegian government that they are introducing measures to stimulate the Norwegian oil industry, which will impact the oil service and offshore industry positively. So we still need some time to digest the effects. But they will clearly be positive in terms of the activity level for the next 2 to 3 years, which are the most critical in those sectors.

But again, we have recognized the increased challenges on the offshore side. We have pushed out in time the expected recovery. We have reduced our estimates on both the rates and utilization, and that is reflected in the provision levels made in the first quarter.

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Operator [59]

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And I'm so sorry, I do think that Joseph had a really poor phone line. He dropped in the middle of your explanation and hopefully he will call back again. We do have 3 more questions. Actually, I see that Joseph actually called back so I will transfer him straight back to your question.

Joseph, your line is now open again.

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Joseph Dickerson, Jefferies LLC, Research Division - Head of European Banks Research & Equity Analyst [60]

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(technical difficulty)

I'll circle back.

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [61]

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I think this is the third time we're not hearing. So operator, I think we just have to move on. I'm sorry.

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Operator [62]

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We've gone to the next questionnaire, and that is Chris Hartley from Redburn.

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Chris Hartley, Redburn (Europe) Limited, Research Division - Analyst [63]

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I actually think you covered almost everything I was going to ask. I just want to be really clear on that sensitivity, that -- the numbers you've given, not -- sorry to labor the points. But those numbers you've given, are they very much all else being equal numbers? So whilst oil down to $30 would have a NOK 300 million impact, the reality is that if oil averaged [$30,] then it's also quite likely that unemployment will rise, and therefore, house prices will fall, and so there is more of an impact than just that single sensitivity. Is that the right message?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [64]

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The sensitivities are given everything else being equal. That's right.

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Operator [65]

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And the next question is another question from Riccardo Rovere from Mediobanca.

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Riccardo Rovere, Mediobanca - Banca di credito finanziario S.p.A., Research Division - Research Analyst [66]

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Getting back my second on provisions. Is it fair to say that in using IFRS 9 in this quarter, you have not adopted any kind of relaxation? So you have calculated 12-month expected losses and lifetime expected losses as normal with no kind of relaxation, so plugging anything into the models normally, like you have done in everything without this current situation? This is the first question.

The second question I have -- sorry, is it possible for you to give a ballpark on what percent you think of stage 2 exposures might eventually migrate to stage 3 with the current visibility that you have at the moment?

And finally -- and before you mentioned that there are some part of your exposures in the oil sector that are related to the activity levels. When I look at the website of all the [sector assets], they clearly say that the activity level on the shelves is expected to remain at fairly stable levels over the next foreseeable years. Also thanks to Johan Sverdrup. So is that -- does this mean that those sectors should not eventually suffer more than they have done so far? Or there is nothing -- there is no relationship between the 2 things?

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [67]

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Thank you, Riccardo. On your question number one, you are quite right. We have deployed IFRS 9 and without making any meaningful adjustments to the framework. We have noted regulatory authorities in other jurisdictions encouraging banks to consider how they would like to deploy it. We have deployed it to reflect the uncertainty and the estimated loss as you describe it.

As for the ballpark of exposure moving from 2 to 3, I apologize, we won't be able to help you on that. I think, again, all need to factor in the uncertainty in the outlook that we do experience in the situation. When we refer to activity level, it's more specifically the new investment activity that leads to additional activity for the offshore sector. So the ongoing fields are not expecting -- expected to be shut down. It's more related to the future exploration and drilling and search projects.

And oil majors have come out after the virus outbreak and the turbulence in the oil price, stating that they will reduce their planned investments considerably in the area of 20% to 25% across the industry.

However, as Harald pointed out earlier today, we've received news of material changes to the tax regulation for old investments, for new investments, which means that investments taken this year and next year can be written off in the same year as they are taken.

These are forceful stimulus to the companies in order to make further investments. And we expect the revisions on the upside to be meaningful compared to how we saw the picture before this news came out.

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Operator [68]

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And there is one question left, and that's from -- another question from Jacob Kruse from Autonomous.

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Jacob Max Kruse, Autonomous Research LLP - Partner, Scandinavian Banks [69]

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Just 2 quick questions on the oil side. Could -- you mentioned the breakeven price on the Norwegian shelf. Could you just give any indication of how your offshore book is split up geographically? How much of it is Norway and how much of it is, say, U.S. or other areas?

And my second question was just, and excuse me if you have answered this, but you gave a sensitivity of oil going back to $30, or being at $30. Do you have some idea what happens if oil stays, let's say, $20 persistently? So it's not a recovery, but just a flat oil price, $20, from here on out. What that would be to your losses?

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Ottar Ertzeid, DNB ASA - Group CFO [70]

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I'll answer you on the geographic split. I don't have it actually calculated on the offshore side because offshore market, remember, is very much a global market. So if you're a Norwegian operator, you can operate in in other markets and vice versa. So we have a number of international operators, so it doesn't really make that much sense. But the majority of our exposure is in the Norwegian market on the offshore side, more than 50%.

When it comes to E&P, it makes much more sense to look at it geographically. And there, it is 1/3 in the U.S. and 2/3 in the North Sea.

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [71]

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As for the future oil price, we gave a sensitivity all being -- all else being equal for this year. When it comes to a future longer-term oil price of $20, it is difficult to see such a level without a fundamental change in the structure of energy demand in the world.

I mean we've had a substantial drop in demand from 100 million barrels a day to now the area of 70 barrels a day, and the airline traffic is just a smaller part of that. A much bigger part of it is related to people's cars, for instance. And when everybody is staying at home, not a people -- not a lot of people are driving around.

But we do expect over time, demand to pick up again. This is bound to happen when economies start to open up and people start driving their cars again. And with the price of $20 a barrel, there just isn't enough supply that would stay open over time in order to service the necessary demand.

An interesting data point, I believe, is to look to China, who is nowhere near in normal operations to put it that way. But gradually, they have started to reopen. One of the findings is that if you look at the traffic pattern, it's above what you would see as a normal level. And the reason for this is that nobody -- or very few would like to take public communications, so everybody is jumping in their car when they need to go anywhere. A car overall represents approximately 30 barrels a day, whereas the airline traffic is somewhere in the range of 5 to 9 barrels a day, which means that we can get that back to very, in this sense, decent increases in demand without having the airlines back into any type of normal operations.

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Operator [72]

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We did get in one last question, and that's from Thomas Svendsen from Nordea Markets.

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Thomas Svendsen, Nordea Markets, Research Division - Director of Financials [73]

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Could you say something about the cost level so far in Q2 versus the pre-crisis level, whether the decline is material? And also on the number of full-time employees, it was down around 2% Q-o-Q. Is that a coincidence? Or do you think this is a trend that will continue throughout the year?

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Ottar Ertzeid, DNB ASA - Group CFO [74]

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If you look at the Q1 numbers, you saw there was a NOK 634 million decrease in costs in the first quarter. NOK 300 million of those were pension costs, which we -- and a part of that was pension cost, which we expect to be around NOK 300 million higher going forward. So I really think you should take a look at the first quarter numbers, and just for the provision for [the lead] claim of NOK 169 million, add back to around NOK 300 million in pension costs and also part of the variable pay, we said reduced personnel expenses. So that is as close as we can say something at the present time with regard to costs.

FTEs, I think, I mean if you're not only look at FTEs number. We will gradually -- have gradually converted, for example, consultants to full-time employees. I think it's more relevant to look at the cost numbers as such then only the number of FTEs. But taking in mind, as the CEO mentioned already, of course, we have ambitions with regard to the cost efficiency, which we pointed to at the Capital Markets Day in November, and we are still working on that topic definitely.

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Rune Helland, DNB ASA - Head of IR [75]

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All right, everybody. Thank you so much for your participation. Stay safe out there, and I hope you all have a nice day. Thank you very much.

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Kjerstin Rasmussen Braathen, DNB ASA - Group CEO [76]

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Thank you.