DBRS Comments on Handelsbanken’s 1H12 Results – Senior at AA (low), Trend Stable

DBRS Ratings Limited (DBRS) has today commented that the ratings for Svenska Handelsbanken AB (SHB or the Bank), including SHB’s AA (low) Senior Unsecured Debt & Deposits rating, remains unchanged after the Bank’s 1H12 results. The trend on all ratings remains Stable.

For 1H12, the Bank’s operating profit totalled SEK 9.1 billion, 13% higher YoY, and a record first half for the Bank. The half-year results benefited from solid growth (17% YoY) in net interest income, which at SEK 13.1 billion, is the largest driver of total income (revenue). Growing business volumes and improved interest margins were the primary drivers of the expansion in net interest income. Importantly, growth in net interest income was broad based, rising 31% in branch operations outside of Sweden and 11% in the Swedish operations. Solid growth in net interest income more than offset a 5% reduction in net fees and commissions to SEK 3.7 billion reflecting lower equity market related commissions. DBRS considers the very solid results as evidencing the strength of SHB’s franchise and the ample earnings generation ability of the Bank’s diverse business model.

Importantly, all core business areas reported higher operating profits demonstrating the strength across SHB’s businesses. Branch office operations in Sweden enjoyed continued positive momentum, reporting operating profit of SEK 6.6 billion, up 7% YoY. Segment results were bolstered by an 11% expansion in net interest income stemming from the factors discussed above and good cost containment, which more than offset a slight uptick in credit costs. The fees paid to the Stabilization Fund and the deposit guarantee reduced net interest income by SEK 394 million in 1H12. Realizing the benefits of the Bank’s efforts to improve branch efficiency, the segment’s cost-income ratio improved to 33.7%, 170 basis points lower than in 1H11. The Branch operations outside of Sweden segment generated record operating profit of SEK 2.2 billion for the half-year. The solid segment performance primarily reflects increased net interest income which increased by 31% from 1H11 to just over SEK 4.1 billion. All four country segments reported improved operating profits. Of note, operating profits generated in the branch operations in the UK increased 103% over last year to SEK 508 million. Branch operations in Finland continue to generate solid operating profit at SEK 313 million. Furthermore, branch operations in Norway continues to see solid growth in operating profit, which at SEK 967 million increased some 86%. As expected given the focus on growing operations outside Sweden, the cost-to-income ratio for this segment remains elevated at 48.5%, relative to SHB’s Swedish operations at 33.7%, but has fallen from 56.7% at 30 June 2011. Despite another half-year of solid earnings, DBRS sees maintaining solid earnings momentum as more difficult going forward given the slowing U.K. economy and uncertainty in the Euro zone and potential contagion effect which may impact economies in a number of countries within SEB’s operating footprint.

SHB continues to successfully execute on its strategy to expand its presence in the U.K. with 129 branches operated by the Bank in the U.K. Segment revenues continue to grow in line with the branch expansion increasing 44% from last year. DBRS notes that during the half-year, loan losses fell to SEK 13 million, an 84% improvement from the year prior. DBRS views the geographic diversification afforded by the U.K. franchise as well-planned and sees profitability in this segment improving as branches mature and the franchise becomes entrenched. Overall, given the Bank’s low risk appetite and its success in operating businesses outside Sweden, DBRS sees SHB as well-positioned to gain from the diversification benefits of its U.K. expansion. Nonetheless, given the uncertain direction of the UK economy, DBRS remains cautious.

DBRS considers SHB’s conservative approach to credit as underpinning the Bank’s solid asset quality measures. Credit performance remains solid illustrated by the continued low loan losses. In fact, net loan losses were SEK 579 million for 1H12 or a low 7 basis points (bps) of total lending, remaining below pre-crisis levels. Net impaired loans are very low at SEK 2.8 billion and account for only 16 bps of total lending, down from 23 bps in 1H11. DBRS views the Bank’s very solid and consistent credit performance throughout the most recent stressed environment as a factor that distinguishes the Bank from many of its peers.

DBRS views SHB’s funding profile as sound and well-managed. The benefits of SHB’s diverse and well-managed funding profile were clearly demonstrated in 1H12 as the Bank maintained good access to the markets despite general market volatility. During the six months to 30 June 2012, SHB issued a total of SEK 124 billion of long-term debt, comprised of SEK 42 billion of senior funding and SEK 82 billion of covered bonds. Importantly, DBRS notes that SHB has prefunded all of its maturities through 1H13. DBRS considers this achievement as illustrating SHB’s conservative approach to managing its funding profile, which translates into relatively low funding costs for the Bank even during periods of elevated market turbulence. Nonetheless, SHB still has a tendency towards wholesale funding. At 30 June 2012, wholesale funding represented 67% of total funding. However removing covered bonds, this reliance is reduced to 32%. Deposits ended half-year at SEK 680 billion a modest reduction on a linked-quarter basis, but up 11% YoY. The quarterly fall in deposits was attributed to lower volumes of short-term corporate deposits. The Bank continues to expand its liquidity reserves, which now exceed SEK 750 million. Within the liquidity reserves, DBRS notes that cash funds and liquid assets held at central banks totaled SEK 537 billion, while the volume linked with bonds amounted to SEK 85 billion. The remainder of the reserve is mainly comprised of unutilized issue amounts for covered bonds.

Regarding capital, SHB continues to strengthen its already strong capital position. Solid internal capital generation and favorable credit risk migration more than offset higher lending volumes. As a result, the Bank recorded a Basel II Tier 1 capital ratio of 19.4% and a Core Tier 1 ratio of 16.8% compared to 17.4% and 14.8% a year ago. DBRS views SHB as well-positioned for the anticipated changes in regulatory capital requirements. Under the Bank’s current interpretation of Basel III regulations, the Bank estimates that its Core Tier 1 capital ratio would be reduced by between 1.5% and 1.8%. At the half-year end, the Core Tier 1 ratio according to Basel III was around 15.0%.

Notes:
All figures are in SEK unless otherwise noted.

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

The sources of information used for this rating include 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 the disclosure.

Lead Analyst: Peter Burbank
Approver: William Schwartz
Initial Rating Date: 7 December 2009
Most Recent Rating Update: 24 January 2012

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