SCANDINAVIAN_BANKS：HEAT_WAVES_IN_EUROPE’S_COOLEST_MARKETS？-2012-10-18.ppt

,european credit research financials scandinavian banks heat waves in europes coolest markets? 16 october 2012 anna schena,abc global research the scandinavian “safe haven” status could be challenged by a vulnerable real estate market and a more adverse eurozone slowdown however, strong sovereign backing and pro-active regulators could sustain investors confidence our top pick in the nordic region is seb (upgrade to ow). we reiterate our neutral recommendation on nordea and underweight on danske bank scandinavian banks benefit from strong sovereign backing as well as investors perception that they are somewhat isolated from the wider eurozone debt crisis. these factors have contributed to excessively tight spreads compared with european peers, in our opinion. notwithstanding the strength of scandinavian states, investors should pay more attention to several factors affecting the strength of their banks, in our opinion. in addition, the economies of the regions are mainly export driven and we find it difficult to expect that they will be immune to an economic downturn at their doorstep. moreover, scandinavian banks financing relies on market funds, especially covered bonds. should investors sentiment towards such instruments change, banks funding costs could rise. the characteristics of the real estate market are another cause for concern. as denmark already demonstrated, a thinner-than-average deposit base and,analyst hsbc bank plc +020 7991 5919,,high loan-to-deposit ratio expose the scandinavian banking sector to the risk of a cooling real estate market. exposures to the shipping industry and, in certain cases, to weaker economies are further causes for concern. however, the swedish and the danish regulators are taking a pro-active approach towards capital and liquidity requirements,view hsbc global research at: *employed by a non-us affiliate of hsbc securities (usa) inc, and is not registered/qualified pursuant to finra regulations,which should prove positive for the sector, offsetting our concerns for the moment.,issuer of report:,hsbc bank plc,we upgrade our fundamental recommendation on seb to,disclaimer & disclosures this report must be read with the disclosures and the analyst certifications in the disclosure appendix, and with the disclaimer, which forms part of it,overweight from neutral, and reiterate our neutral recommendation on nordea and our underweight recommendation on danske bank.,seb,neutral),european credit research financials 16 october 2012 fundamental view investment considerations,abc,recommendation,rationale,risks,danske bank,underweight,danske banks business model is in our opinion riskier than that of its scandinavian peers. we think that the banks exposure to ireland will continue to weigh on the banks profitability.,upside risks to our recommendation include a strong recovery of both irish and danish economies.,moreover, the subdued economic situation in denmark is unlikely to help danske to outperform its scandinavian peers. we remain nervous about the high loan-to-deposit ratio of the bank and the high reliance on covered bonds for its funding needs.,nordea,neutral,nordea benefits from a leading position in the scandinavian region. we think that its geographical footprint has worked in its favour during the unfolding of the eurozone crisis. however, the banks exposure to the struggling danish economy and shipping sector leave us unconvinced about its business model. moreover, its core tier 1 ratio under basel iii is the lowest among the four biggest banks in sweden, according to a study by the bank of sweden. we would like to see a further strengthening of its capital ratios as well as a reduction of its funding gap to turn,downside risks to our recommendation include a sharp fall in the swedish housing market, further deterioration in the danish economy and any unfavourable rating actions. upside risks to our recommendation include continued avoidance of the wider eurozone problems and strengthening of its capital base.,more positive on the name.,overweight (from,seb is another group that benefits from its geographical footprint in the scandinavian region. although the bank is, as its peers, reliant on market funds for its funding and remains exposed to the baltic region, we think it could outperform its scandinavian peers. the banks capital ratios appear solid even in a stressed basel iii,downside risks to our recommendation include a deterioration in the swedish economy as well as in the baltic region. the bank is likely to be affected by any negative development in capital market business and any unfavourable rating actions.,scenario (as published by the riksbank) and its asset quality has been improving since 2010 levels. source: hsbc 2,european credit research financials 16 october 2012 sector characteristics scandinavian banks benefit from strong sovereign backing and perceived “safe haven” status export led economies, such as those in scandinavia, are unlikely to be immune to an economic slowdown on their doorstep exposure to real estate also poses risk to some scandinavian banks,abc,strength/ opportunities stable political environment and pro-active approach from governments and central banks strong sovereign support perceived “safe haven” status among many of the investors low levels on npls, albeit rising challenges/weaknesses thin deposit base high reliance on market funds, especially covered bonds falling house prices in denmark exposure to real estate and shipping sector exposure to weaker geographies, namely ireland for danske banks and the baltic region for seb and nordea,economics overlook the distress experienced in the eurozone in the last two years has helped to consolidate the perception of nordic banks as a “safe haven” in the banking sector. the financial institutions in the region possess many positive aspects, including strong sovereigns, low level of npls and high capital ratios. in addition, holding little government paper of the more troubled countries in europe helped establish investors confidence in the sector. however, even if all of the countries in the region, other than finland, are outside the eurozone, they remain widely exposed to europe. denmark and sweden are members of the european union, while norway, even if not a member of the eu, is still closely linked to europe thanks to its membership in the eea. moreover, the export- driven scandinavian economies rely on europe as their main export market, as seen in chart 1. although a large portion of this european exposure is with other scandinavian countries, germany and uk, it is likely that the effects of a global slowdown will hit home, in a more adverse economic downturn.,3,90,70,50,30,european credit research financials 16 october 2012 chart 1: exports by region 100% 80% 60% 40% 20%,chart 2: unemployment rate (%) 15 10 5 0,abc,0%,2006,2007,2008,2009,2010,2011,2012,dk,sw,fi,no,denmark,finland,germ any,europe,africa,americ a,asia,ocenia,netherlands,n orw ay,sw eden,source: statistikbanken, scb, tulli, ssb however, the worse effects of a slowdown could be blunted by the true sovereign status of the regions countries, i.e. their ability to set interest rates and affect their currencies (again with the notable exception of finland.) in fact, many of the metrics of nordic economies,source: imf chart 3: general government gross debt as a % of gdp,compare well with continental peers, giving a,2006,2007,2008,2009,2010,2011,2012,degree of confidence that they will be able to support their banking system if needed. unemployment rates, as shown in chart 2, are,denmark netherlands source: imf,finland n orw ay,germ any sw eden,among the lowest in europe. however, it is in the gross debt to gdp ratio that the difference is most staggering, even compared with “virtuous” countries like germany and holland. this ratio is, in our view, very important as a low level of indebtedness gives the countries in the region a much wider space of manoeuvre if they had to intervene and support their economies and their financial sectors. it will also underpin investors confidence in the region. 4,300,250,200,150,100,50,20%,15%,10%,5%,european credit research financials 16 october 2012 loan book scandinavian banks tend to operate extensively across the region with some operations in other european countries. the banks in our coverage universe are no exception, with nordea in particular enjoying a dominant position in the scandinavian region. scandinavian banks also,chart 4: real house prices - index, 1q 95 = 100,abc,tend to have quite diversified portfolios, with,mar-95,mar-99,mar-03,m ar-07,m ar-11,some specialists lending, as in the case of shipping activities.,sw eden finland,denmark norway,we expect to see a mild reduction in the loan books in the region, especially in denmark. we think scandinavian banks will be affected by deleveraging households and by the slowdown that is likely to continue in europe. moreover, we expect banks to try rebalancing their loan-to- deposit ratio and narrow their funding gap by shrinking their loan books. the performance of their portfolio has been historically strong with one of the lowest levels of npls in our universe of coverage. however, the npl ratio has been deteriorating since 2010 levels, mainly owing the banks exposure to real estate and,source: riksbank we fear that the other countries could experience the same price evolution as denmark, causing spreads to widen. in particular, sweden and norway appear vulnerable to us. moreover, the fall in housing prices is relevant, in our opinion, considering how important the covered bond market is for the financing profile of scandinavian banks. as shown in chart 9, nordic banks have one of the thinnest deposit bases in our coverage universe and rely on market funds, especially covered bonds, to fill their funding gap.,increasing losses in their shipping loan books. chart 5:real estate related exposure as % of total credit,these exposures in particular make us more nervous about the soundness of the loan books of scandinavian banks. our more immediate concern is the exposure to real estate considering the recent evolution of prices in the region. if we take the case of denmark, we can see how real estate prices have been falling since their,exposure,2007 peak, as shown in chart 4. this rapid movement caused considerable distress in,0%,2010,danske,2011 nordea,seb,h1 2012,denmark with banks experiencing a sharp rise in,source: company data, hsbc calculations,npl levels and households seeing their capacity of remortgaging considerably reduced. 5,european credit research financials 16 october 2012 chart 6: real estate npls ratio (% of re credit exposure) 8% 6% 4% 2% 0%,chart 8: shipping npls ratio (% of shipping credit exposure) 8% 6% 4% 2% 0%,abc,2010,danske,2011 nordea,seb,h1 2012,2010,danske,2011 nordea,seb,q2 12,source: company data, hsbc calculations the second exposure we are nervous about regards the shipping industry. although not a big part of the banks lending book, as shown in chart 5, the performance of this particular part of the loan book has been deteriorating substantially since 2010 levels. given the low level of activity registered in the sector (the baltic dry index is slightly shy of its historically lows) and the slowdown in world economic activities we feel there is little space to think about a recovery of the sector, at last in the short to medium term. chart 7: shipping exposure as % of total credit exposure 5% 4% 3% 2% 1% 0%,source: company data, hsbc calculations in addition, some of the banks in our coverage universe have exposure to weaker economies that substantially increases the risk in their lending portfolio, namely ireland for danske bank and the baltic region for seb and nordea. we expand on this in the banks profiles which begin on page 14.,6,2010 danske source: company data, hsbc calculations,2011 nordea,seb,q2 12,depositsontotalassets,loantodepositratio,rbs,cbk,ingbank,san,lloy,bnp,ucg,bbva,rabo,seb,dnb,nda,sweda,shba,danske,80%,60%,40%,20%,0%,european credit research financials 16 october 2012 deposits and funding profile one of the weakest aspects of the scandinavian banking system is the low level of deposits that banks hold resulting in an extremely high loan-to- deposit ratio that they show. as demonstrated in chart 7, scandinavian banks compare poorly with continental peers, having one of the lowest deposits base in relation to total assets in our universe.,encumbered, with covered bond pools on total lending ratios ranging from 57% for danske bank (also considering realkredit danmark pool) to 35% for nordea and 36% for seb. while not one of our major concerns, we think that if housing prices were to fall sharply, banks would have to increase the amount of collateral with possibly negative repercussions for new issuance. chart 10: 2013-2015 refinancing needs by payment rank,abc,100% this structural funding imbalance is also exacerbated by extremely high levels of loan-to- deposit ratio, which reach 230% in the case of danske bank. this deposit shortfall has left scandinavian banks reliant on wholesale market funds and covered bonds in particular. in chart 10,we show the composition of the next three years refinancing needs by payment rank and covered,danske senior secured junior secured,nordea,seb senior unsecured first lien loans,bonds count for around 80% of the total. source: bloomberg, hsbc calculations we acknowledge that, for scandinavian issuers,the covered bond market has been active and “open for business” even in the height of the crisis. however, we worry about any negative development relative to real estate prices in the region that could affect the cost of new issuance. also, the heavy usage of covered bond issuance is leaving the banks balance sheet very,both the swedish and the danish regulators are being quite proactive in addressing the funding imbalance of their banking system. in the first stance, the finansinspektionen, the swedish fsa is planning to introduce a binding liquidity coverage ratio (lcr) requirement of more than 100% from january 2013. it also,chart 9: scandinavian banks present very high loan to deposit ratios and a low deposit base,250% 200% 150% 100% 50% 0%,loan to deposits,deposits on total assets,60% 50% 40% 30% 20% 10% 0%,source: bloomberg, company data, hsbc calculations 7,70%,60%,50%,40%,30%,20%,10%,30%,25%,20%,15%,10%,5%,0%,european credit research financials 16 october 2012 disclosed, in the last available financial stability report, that the swedish fsa could introduce separate lcr requirements for the euro and us dollar for the major swedish banks with effect from january 2013. the riksbank, the swedish central bank, also recommends that swedish banks reduce their structural liquidity risks and approach the minimum level of 100% in the net stable funding ratio (nsfr). moreover, from the end of 2012 danish banks will need to comply with the requirement introduced by the danish fsas “supervisory diamond”. the framework was introduced in june 2010 and set limits for five benchmarks: large exposures as a per cent of capital base (less than 125% of the capital base); lending growth (less than 20% per year); property exposure (less than 25% of total loans and guarantees); stable funding (funding ratio of less than 1); and excess liquidity coverage (greater than 50%). in the case of breaching of the above limitation the bank will enter into a dialogue with the danish fsa to implement a suitable response, which could,capital scandinavian banks have, on average, strong capital ratios compared with peers, as shown in chart 13. however, very high core tier 1 ratios also reflect low rwas to total assets, among the lowest in europe. although risks to nordic loan books may have been relatively benign compared with other countries, the risk weighting appears low in certain cases, especially when taking into account the evolution of the real estate market in the region. moreover, scandinavian banks are mainly retail and commercial banks, rather than investment banks, as shown in charts 11 and 12. chart 11: total lending on total assets,abc,include sharpened supervision, risk disclosure statement, functional investigation by the fsa,0%,2010,danske,2011 nordea,seb,h1 2012,and request of statement from the bank on its finances. in more severe cases the fsa could order the bank to limit certain business areas, products or customer segments. early this year the danish mortgage association, suggested phasing-out one year covered bonds for financing long-term mortgages. we see all those measures as very positive for the respective banking systems and ultimately indicate the awareness of the scandinavian,source: company data, hsbc calculations chart 12: credit exposure to households on total assets,regulators of one of the major weaknesses in their,2010,danske,2011 nordea,seb,h1 2012,financial systems. source: company data, hsbc calculations 8,rwaontotalassets,ct1ratio,shba,barc,sweda,nda,danske,seb,bnp,rabo,rbs,cbk,ingbank,lloy,san,ucg,dnb,isp,bbva,40,35,30,25,20,15,10,5,0,european credit research financials 16 october 2012 chart 13: scandinavian banks show high core tier 1 ratios as well as one of the lowest rwa on total assets 60% 50% 40% 30%,20% 16% 12%,abc,20% 10% 0% rwa on total assets source: bloomberg, company data, hsbc calculations a positive move on the matter came from the swedish fsa. the regulator started to address the question of risk weights, and it will probably lead to an increase in the average risk weights for mortgage lending in sweden. risk weights also affect banks lending policies, in addition to the more obvious effect on capital. so, extremely low weights could have also helped the booming of mortgage lending which fostered, so far, real,8% 4% 0% core tier 1 ratio char