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Morningstar | We Are Relaunching Coverage of Four Main Nordic Banks; P/FVE Look Attractive but Uncertainty Varies

We are relaunching coverage of four main Nordic banks Handelsbanken, Nordea, SEB, and Swedbank with fair value estimates of SEK 110, SEK 85, SEK 95, and SEK 210, respectively. This corresponds to our four-star ratings for Handelsbanken, Nordea, and Swedbank, while SEB trades in three-star territory. We assign a narrow-moat rating to Handelsbanken and Swedbank based on cost advantages and switching costs.

Handelsbanken’s and Swedbank’s strong positions in Sweden--a “good” banking system according to our moat framework--are the foundation of our narrow-moat ratings. Both banks have built strong customer relationships creating implicit switching costs, evidenced by high and stable market shares in deposit and lending volumes in Sweden and being able to successfully fend off new emerging challengers in the last few years without conceding on pricing. We also believe both banks enjoy cost advantages. Swedbank has the lowest cost-to-income ratio of its peers as a result of its digitalisation efforts that have led to strong operating leverage. Swedbank also has a collaboration agreement with Swedish independent savings banks, which contribute about 30% of product sales to Swedbank. Although these sales come at a lower margin, the fact that Swedbank does not need to commit capital to staff and branches for these sales is a structural advantage to the bank which is difficult to replicate by peers. Handelsbanken enjoys cost advantages through lower credit costs because of consistently better loan underwriting, which the bank achieves through its decentralised branch business model. As credit decisions are mostly made at the branches, the bank can better differentiate between borrowers. This may appear less important in a currently benign credit loss environment in the Nordics, but it sets up Handelsbanken to perform better through the cycle.

Although on a price-to-fair value basis, valuations for Nordic banks under our coverage look reasonably attractive currently, we think investors should focus on a sufficient margin of safety before stepping in. We highlight three uncertainties in particular, which are of differing importance to each of the four Nordic banks, but in sum are the largest factors driving our view of these banks and our uncertainty ratings.

First, signs of a global and European economic slowdown, lower for longer interest rate expectations in Europe, and a flattening yield curve have weighed on European financials across our coverage universe. Although we believe the market puts too much emphasis on the effects of this short-term outlook on mid-cycle profitability, we think this negative sentiment could be difficult to avoid in the short-term. We model mostly flat net interest margins in the first two years of our explicit forecast period, while our midcycle assumptions are only marginally higher by between 5 basis points and 10 basis points. At the same time, we forecast provisions for loan losses to increase progressively, already starting in 2019.

Second, on average about 70% of loans to the public on our Nordic banks’ balance sheet is related to real estate markets, which have seen significant growth over the last decade. We model steadily slowing activity in real estate markets across the Nordics rather than a sudden rebalancing, given these markets are driven by high demand supported by demographic trends rather than the availability of low-cost funding. Ultimately, we believe that the structural imbalance of high demand with a subdued supply of affordable housing is likely to persist in the medium term.

And third, reports about anti-money laundering, or AML, issues in the Nordics have put a dent into previous beliefs that Nordic banks are fail-proof. This has not only affected lenders directly involved in these scandals, in particular Swedbank, but the whole group has been trading down as a result. Although the actual involvement in these AML issues differs greatly between the banks, no bank is completely immune to potential future revelations of inadequate fraudulent-activity reporting given all have been fined in the past for insufficient compliance procedures or have acknowledged weak AML processes. Reports allege that EUR 135 billion in transactions flowed through Swedbank’s non-resident portfolio over the last decade, with a portion of this potentially being fraudulent and not adequately reported to regulators by Swedbank. Nordea is alleged to have handled about EUR 700 million in funds related to the Magnitsky case and additionally is being investigated by Danish regulators for potential AML insufficiencies. Potential outcomes of these investigations range from a warning by European regulators to material fines by U.S. regulators. As a result, we have a high uncertainty rating for Nordea and a very high uncertainty rating for Swedbank. Our uncertainty ratings for Handelsbanken and SEB are medium.