DBRS Comments on SEB’s 3Q11 Results – Senior at AA (low), Trend Stable

DBRS Inc. (DBRS) has today commented that its ratings for Skandinaviska Enskilda Banken AB (SEB or the Bank), including the AA (low) Senior Unsecured Debt & Deposits rating and the R-1 (middle) Short-Term Debt & Deposits rating, are unaffected by the Bank’s recently announced 3Q11 results. The trend on all ratings remains Stable.

SEB’s 3Q11 results indicate solid operating profits from continuing operations, further improvement in asset quality, and ongoing progress towards improving the balance sheet. For the quarter, SEB recorded pretax operating profit from continuing operations of SEK 3.7 billion, decreasing from SEK 4.3 billion in 2Q11, but up 30% from the year ago period. DBRS notes that 2Q10 results included significant restructuring costs, which were not present in the current quarter. Nonetheless, 3Q11 results benefitted from good levels of business volumes and client activity, and another release of loan loss provisions, albeit it much smaller than in 2Q11. In addition to a SEK 188 million write-down associated with Greek sovereign debt, the quarter’s results were negatively impacted by seasonal effects from lower customer activity and lower valuations in the financial markets. Importantly however, on a year on year comparison, SEB’s year-to-date results evidence positive momentum, with operating income from continuing operations at SEK 12.4 billion for 9M11 almost doubling from SEK 6.8 billion in 9M10. Proving the strength of the Bank’s underlying earnings generation ability, 9M11 results were attained despite the Swedish government’s stability fund fee of SEK 450 million (SEK 150 million in 3Q11) and the Greek sovereign bond write-down, which totalled SEK 355 million for the nine months ending 30 September 2011. Furthermore, DBRS notes that bottom line profitability continues to be impacted by costs associated with the divestment of the Bank’s German retail operations; positively, costs from discontinued operations continued their decline in 3Q11 and, at SEK 1.0 billion for 9M11, are down 39% from 9M10.

Illustrating the strength and overall positive momentum of the franchise, on a segment level, SEB’s businesses enjoyed resilient performance. All operating business segments remain solidly profitable benefitting from respectable top-line revenue, reduced or low net credit losses and good customer activity. Of note, the Baltics segment, which had been a poor performer in the past, recorded yet another quarter of positive results. Indeed, with SEK 545 million of operating profits, the Baltics segment enjoyed its fifth consecutive quarter of profits, benefitting from improving net interest income resulting from higher lending volumes and continuing reversals of net credit losses, albeit at a slower pace. Life was the only division which reported an underlying decrease in profitability for the quarter reflecting the impact from the volatile market conditions in the resulting decrease in income from traditional insurance products.

SEB’s results indicate solid asset quality metrics. Group-wide net credit losses (from continuing operations) have enjoyed ten consecutive quarters of improvement, and evidenced net recoveries in the past five quarters. Given the recoveries, Group-wide net credit losses as a percentage of total operations were a positive 13 basis points (bps). Credit losses remain a very low 5 bps in the Nordic region and were a positive 179 bps in the Baltics, owed to the release of provisions. Total non-performing loans (NPL) declined 30 bps from 2Q11 to 1.4% of total lending. DBRS recognises the encouraging trend in NPLs and notes that the Bank benefitted from the prudent steps taken in the recent past to reduce its Baltic exposure, which now stands at a 9.8% of total lending (excluding repos and gross of reserves). In addition to an increased focus on managing and reducing credit risk, the relatively strong economic performance of the countries within SEB’s larger operating footprint, and improved economic situation in the Baltic States, have positively impacted credit performance. However, DBRS comments that potential spillover effects from economic uncertainty, the troubled financial markets, and European sovereign debt concerns are likely to subdue economies in SEB’s footprint for the near to medium-term.

In terms of peripheral European sovereign debt, DBRS views SEB’s exposure as manageable. After booking the SEK 188 million write-downs on Greek sovereign debt in 3Q11, the total book value of peripheral European sovereign exposure totalled SEK 745 million. This is split nearly evenly between Greece, which is marked at 49% of face value, and Italy, which is marked at 90% of face value. SEB does not have sovereign exposure to Ireland Portugal or Spain. However, excluding the aforementioned sovereign debt, SEB holds SEK 13.8 billion (nominal) of covered bonds and structured credits with exposure primarily to Spain, totalling SEK 11 billion (nominal). DBRS considers any potential loss content embedded in these holdings as manageable for SEB given the strength of its earnings generation ability and relatively low credit costs.

DBRS considers SEB’s diverse funding profile as well-managed, although the Bank’s wholesale funding remains elevated, especially when compared to its European peers. Wholesale sourced funding accounted for 49% of the total at 30 September 2011, which includes a substantial portion of covered bond funding. Excluding covered bonds, wholesale funding reliance would be a manageable 37%. SEB continues to enjoy solid market access to funding. During 9M11, SEB raised SEK 91 billion in long-term debt, of which covered bonds accounted for SEK 73.1 billion. Including the 12 October 2011 issue of a 2-year EUR 750 million senior unsecured issue, SEB’s funding requirement of SEK 98 billion for 2011 has been met. The Bank’s matched funding period (time for which cash reserves cover projected outflows) remains over 24 months. Additionally, the Bank’s SEK 308 billion liquidity reserve bolsters its funding and liquidity profile.

Capitalisation is solid and has strengthened during 2011. At 30 September, SEB reported a Tier 1 capital ratio of 16.2% and a Core Tier 1 capital ratio of 13.9% (full Basel II implementation) at 30 September 201. DBRS notes that regulatory capital ratios benefit from the continuing decline in risk-weighted assets, which primarily reflect the sale of SEB’s German retail operations. Given the Bank’s solid underlying earnings generation ability, it’s improving credit performance, diverse liquidity profile, and sound capitalisation, DBRS views SEB as well-positioned for the forthcoming changes in regulatory capital requirements.

Notes:
All figures are in Swedish Krona (SEK) unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include publicly available company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This commentary was disclosed to the issuer and no amendments were made following that disclosure.

This rating did not include issuer participation and is based solely on publicly available information.

This credit rating has been issued outside the European Union (EU) and may be used for regulatory purposes by financial institutions in the EU.

Lead Analyst: Steve Picarillo
Approver: Alan G. Reid
Initial Rating Date: 14 December 2006
Most Recent Rating Update: 2 March 2011

For additional information on this rating, please refer to the linking document under Related Research.