Nordic Banking Sector Insights Q2/2022: Boring but good!

Soaring inflation, raising interest rates, war in Ukraine, sanctions on Russia, covid-19… The second quarter of 2022 was full of major events challenging the operations and business of the whole European banking sector. And despite this, the large Nordic banks delivered solid results in the quarter.

In this article we share our perspectives on the financial performance and strategic position of the six largest banks in the Nordic region after they announced their Q2/2022 financial results. As mentioned above, the banks fared well in a very difficult economic environment delivering an average return on equity (ROE) of 10.8%. Their operational efficiency also remained strong illustrated by an average cost-to-income ratio (C/I) of 49%.

Chart 1: Key financial figures Q2/2022. Source: Sample banks’ Q2/2022 interim reports.
FX rates as of 30 June 2022. Source: https://www.ecb.europa.eu/stats/policy_and_exchange_rates/html/index.en.html

All the banks in our sample group were challenged during the quarter and that was most visible in their capital markets related income which decreased significantly compared to the previous quarter and Q2/2021. On the other hand, the banks are beginning to benefit from the raising interest rates and saw a noteworthy increase in their net interest income. As interest rates are expected to increase further in the near future this will provide the banks with a robust financial tailwind also in the coming quarters.
 

Nordea and DNB lead the way

We are very impressed with the performance of Nordea and DNB that were able to increase both their top and bottom lines in the quarter while most of the other banks saw a drop in their performance quarter-over-quarter (Q/Q). They are currently also on top of the group with ROEs of 13.3%, up both Q/Q and year-over-year (Y/Y). We will note that during the quarter DNB included the figures of Sbanken⁴ into its income statement and that provided a boost to its volumes. However, even without those numbers DNB’s financial performance was very strong in the quarter.

SEB and Swedbank are great examples of our headline statement: Boring but good. While both saw declines in their operating profits and ROEs Y/Y they delivered great results and remain very profitable with ROEs north of 12%.

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1. Nordea Bank, Danske Bank, SEB, Handelsbanken (SHB), Swedbank, DNB
2. Excluding regulatory costs, e.g. the Swedish bank tax and resolution fees
3. Figures include SHB’s total operation i.e. also Denmark and Finland
4. DNB’s acquisition of Sbanken was finalised in Q1/2021.

SHB finally sells its Danish business. But what about Finland?

During the quarter SHB finally found a buyer to its Danish business that has been on sale since October 2021. The buyer is the third largest Danish bank, Jyske Bank, and the deal was announced by the parties in June⁵. According to the terms of the deal Jyske Bank will pay a premium of DKK⁶ bn 3.0 (~EURm 400) to SHB at the time of deal closing. This is good news for SHB as it is now one step closer to focusing solely on its core markets: Sweden, Norway, the Netherlands and the UK. However, the final step in this process i.e., the sale of its Finnish business has yet to be finalised at the date of this article and will require management attention also during the latter half of the year.

We see four main scenarios for the sale of SHB’s Finnish business and we’ll shortly explain those below. Scenario 1 is that one of the big players in the market i.e., the OP Group, Nordea or Danske buys the whole business. However, due to the high market shares of the OP Group and Nordea this might expose them to a long and thorough competition law scrutiny and neither probably has any appetite for that. Meanwhile, as we’ll explain below, Danske is dealing with other challenges that consumes their attention and hence, it is unlikely that they will have capacity to consider such a transaction – even if that might be good for them.

Scenario 2, which we consider the most probably one, is that SHB’s Finnish business will be split into smaller portfolios and sold to multiple buyers⁷. This would enable some of the smaller Finnish banks, such as Aktia and the Savings Banks Group, to take part in the transaction. Scenarios 3 and 4 would entail either a large international bank or a smaller fintech-type player to emerge as the buyer. Santander is an example of the previous and Lunar Bank of the latter category. However, these are wildcard scenarios which we do not consider too likely.

Whatever shape and form the transaction takes we truly hope that it will fall into place as soon as possible as then SHB can really focus on its core business, and we’ll be able to see its true performance under its new legal set-up.

One keeps falling deeper and deeper…

Danske Bank’s compliance struggles are well documented⁸ and the resolution of their Estonian branch’s money-laundering scandal still awaits the final decisions of the relevant authorities in Europe and the US. We are saddened to see that Danske’s challenges are now spreading even wider with their trading income landing in negative territory during the quarter⁹. This reflects the higher risk profile of Danske’s trading activities compared to its main competitors, Nordea and SEB. Nordea and SEB also experienced major challenges in their capital markets businesses during the quarter due to subdued customer activity levels but were still able to report positive results in these business lines.

The one positive thing we can highlight in Danske’s Q2/2022 activities is the split of its former Personal & Business Customers division into Personal Customers and Business Customers. We believe that this will enable Danske to focus much better on these customer segments and hopefully, over time, also improve its financial performance. Danske’s ROE of 4.0% in the quarter is simply not sustainable and they have to find a way to improve their profitability.

Our perception is that currently too much organisational focus and energy is directed at resolving Danske’s compliance issues – which obviously must be addressed appropriately – and too little on their business performance. We think that this needs to change as strong business performance and good profitability is the first risk buffer of any bank and Danske is no exception. This also the reason why we think Danske should not rule out buying at least a part of SHB’s Finnish business as that would provide a much-needed positive boost to its business momentum.

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5 https://www.handelsbanken.dk/tron/dkpu/info/contents/v1/document/70-145861
6 DKK = Danish kronor
7 E.g. SHB Finland’s corporate and private customers could be split into two separate portfolios and among the private customers e.g. the high-affluent and mass market segments could form two additional sub-categories.
8 https://danskebank.com/about-us/corporate-governance/investigations-on-money-laundering
9 Danske reported a loss of DKKm 390 on its trading income.

Different strategies for capital management

On face value, the strong capital management positions for the Swedish domiciled banks (SEB, SHB and Swedbank) seem to indicate that capital optimisation opportunities exist. The banks are operating with significant capital surpluses (460–480 basis-points (bps) above current regulatory minimums) and yet do not seem to take major actions to move closer to their stated capital targets which are 100–300 bps above the regulatory minimums. The management of the banks have to take into account guidance from the local financial supervisory authority, the Finansinspektion (Swedish FSA), which could require they maintain a conservative capital policy for the time being, even if that has not been explicitly communicated by any of the banks.

We recognise that the Swedish FSA will raise the countercyclical capital buffer in Sweden by 200 bps by Q2/2023 and the forthcoming Basel 3.1 changes, plus economic uncertainty, may be driving management behaviours and decisions. However, if the Swedish banks continue their strong capital generation trend, management may start to explore opportunities to become more capital efficient.

An opposite strategy is being pursued by Nordea that announced yet another share buy-back programme in connection with releasing its Q2/2022 interim report. This one amounts to EURbn 1.5 and comes on top of the previous programmes of EURbn 2.0 and 1.0, announced in September 2021 and February 2022, respectively. Similarly, DNB takes constant action to maintain efficient capital levels with a 1.5% share buy-back mandate obtained in the quarter¹⁰. While their current capital level seems at first glance very high it is only 30 bps above their long-term capital requirement¹¹.
 

Looking ahead

These are unprecedented times in the Western societies and the banking sector is in many ways at the center of most of the current major events that are shaking the foundations of our economies. In the Nordics we can be glad to have extremely resilient large banks that are able to continue their operations largely uninterrupted even in these turbulent times. This allows the individuals, companies, and public sector entities in the region to get access to their needed financial solutions and to continue investing in promising business opportunities.

The future is filled with uncertainties and there are several sources of risk. The most significant downside risk for the Nordic banking sector would be a long-term recession, triggered by persistent inflation and rising interest rates, leading to large-scale loan defaults. This would require bank management to shift attention to enhancing their processes to manage non-performing exposures, a focus of European regulators, as well as ensuring that their capital positions remain strong.

These risks could be exacerbated by climate related stresses on particular parts of their credit portfolios (e.g. transition risks for oil & gas companies and valuation uncertainty for loans secured by collateral in areas of increased flood risk). Stress testing analysis completed by banks, for management and regulators, provide the appropriate tools to understand and assess these risks. Although these tools will need to evolve, given our uncertain future, the risks are unlikely to look like anything the Nordic banks have experienced in the past 25 years.

Under any future economic scenario, we urge the banks to continue executing on their current business development agendas, modernise their operations and improve their digital offerings. This is the only way for them to stay competitive and meet the constantly changing customer needs and requirements of regulators and other business constituents.

For example, the ongoing green transition of various industries will require the banks to take decisive actions to support the companies that embark on this journey and that should continue even amidst an economic downturn. We believe that this will not only benefit the companies and societies in which they operate in but also the banks themselves as they will have loyal future-proof customers at the end of this transition.

To conclude, the large Nordic banks are currently in great shape and delivered very good results in Q2/2022. They can expect headwinds in the latter half of the year due to the prevailing economic challenges but are well positioned to navigate through any macro scenarios and come out even stronger on the other side.

We will keep following the Nordic banking sector and share our perspectives with you every quarter.
 

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[10] Of the 1.5% mandate given by the local financial supervisory authority, Finanstilsynet (Norwegian FSA), 0.5% can only be used for hedging purposes. The DNB’s Annual General Meeting gave the DNB’s Board a mandate of 4.0% in Q2/2022, of which 0.5% is for hedging purposes.
[11] DNB’s current and future capital requirements and the Norwegian FSA’s expectations are very clearly and transparently explained in DNB’s Q2/2022 interim report presentation, slide 15.