DBRS Comments on SEB’s 1H12 Results – AA (low) Rating Unaffected, Trend Stable

DBRS Ratings Limited (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 1H12 results. The trend on all ratings remains Stable.

DBRS views SEB’s solid results as evidence of the Bank’s continuing momentum in a challenging environment, as well as its progress in reducing credit risk and improving the balance sheet. SEB recorded an operating profit of SEK 7.7 billion for the half year ending 30 June 2012, decreasing from SEK 8.5 billion in 1H11, but up from SEK 6.9 billion in 2H11. Importantly, DBRS notes that SEB’s results a year ago benefited from SEK 985 million of reversals of net credit losses. Excluding credit losses, SEB reported a profit before credit losses of SEK 8.1 billion in 1H12, a 9% improvement from 1H11. For the half-year, results demonstrated the strength of the Bank’s resilient underlying earnings generation ability, with total operating income (revenues) improving 2% year-on-year to SEK 19.5 billion. Revenues benefited from increasing business volumes, which boosted net interest income 3% over the comparable period a year ago to SEK 8.7 billion. This was complemented by a 22% increase in net financial income reflecting stable customer-driven trading income and valuation effects in the liquidity portfolio. Moreover, SEB’s financial results benefited from solid cost containment. Despite higher customer volumes, SEB’s operating expenses in 1H12 were 3% lower year-on-year at SEK 11.4 billion. As a result, SEB’s cost/income ratio improved to 58% from 61% a year ago.

Demonstrating the strength of the franchise, on a segment level, SEB’s businesses enjoyed resilient performance in 1H12 with the majority of operating business segments reporting growth in operating profit. Retail Banking increased its operating profit by 60% year-on-year (YoY) to SEK 1.9 billion evidencing the benefits of SEB’s investment in its SME business are being realised. Indeed, SME clients have increased 20% over the last two years. Within Merchant Banking, operating profits in 1H12 were 9% higher YoY at SEK 4.1 billion. Despite heightened market uncertainty stemming from the Euro zone, Merchant Banking benefited from good customer activity and volumes in Global Transaction Services and stable flow-oriented earnings in Trading and Capital Markets. In the Bank’s market-leading Life business operating profit was 3% lower at SEK 987 million, largely reflecting the effect of the acquisition of Irish Life International, which resulted in a 6% increase in unit-linked income but also a 10% rise in expenses. Lower performance and transaction fees were the primary driver of the 6% decline in Wealth Management’s operating profit to SEK 673 million. Meanwhile, the Baltics segment, which had been a poor performer in the past, recorded yet another period of positive results recording its eighth consecutive quarter of profitability. For 1H12, the Baltics generated SEK 540 million of operating profits, which was down significantly from 1H11 reflecting the non-recurrence of the significant release of provisions for loan losses a year ago.

SEB’s results indicate sound and improving asset quality metrics. In 1H12, Bank-wide net credit losses remain low at SEK 475 million or 0.07% of total lending. Credit losses in the Nordic operations, which represent 73% of the loan book, remain a very low 0.06%. Within the Baltics, which account for 9% of total lending, credit losses were 0.25% reflecting normalization of provisioning levels following a number of quarters of provision releases. Bank-wide non-performing loans (NPLs) declined 9.5% from year-end 2011 to SEK 16.4 billion and, importantly, have declined for ten consecutive quarters. The reduction reflects improved asset quality of the lending book as well as the effect of the sale of the Ukrainian retail operations. At 30 June 2012, NPLs represented 1.3% of total Bank lending down from 1.7% a year earlier. DBRS sees the improvement in credit performance as reflecting the impact of SEB’s actions taken over the last two years to limit exposures to more volatile regions, especially the Baltics. In addition to management’s increased focus on managing and reducing credit risk, the relatively strong economic performance of the countries within SEB’s operating footprint, and improved economic situation in the Baltic States, have positively impacted credit performance. However, DBRS comments that the economic uncertainty resulting from the crisis in the Euro zone has slowed economic growth in several of these countries; as such, DBRS remains cautious.

DBRS views SEB’s well-managed funding profile as benefiting from its diverse range of funding sources. Demonstrating these benefits SEB continues to enjoy good market access despite challenging capital market conditions. To this end, during 1H12, SEB raised SEK 61 billion in long-term debt (SEK 21 billion in 2Q12), of which covered bonds accounted for SEK 38 billion. As a result, SEB has covered 90% of its 2012 funding requirements. At 30 June 2012, wholesale sourced funding accounted for 49.0% of the total funding base, which includes a substantial portion of covered bond funding. Excluding covered bonds, wholesale funding reliance would be a manageable 33.2%. During 2Q12, elevated market uncertainty resulted in SEB benefiting from a flight to safety as deposit inflows increased resulting in the Bank’s deposit base growing 11% quarter-over-quarter to SEK 850 billion. As a result, SEB’s loan-to-deposit ratio improved to 131% from 144% at the end of 1Q12. SEB’s liquidity profile is bolstered by a core liquidity reserve of SEK 339 billion (excluding trading assets and unutilised collateral in the cover pool), which is more than sufficient to cover the Bank’s short-term funding needs. SEB estimates its Basel III Liquidity Coverage Ratio to be 108% at 30 June 2012.

Capitalisation remains solid with a Tier 1 capital ratio of 17.5% and Core Tier 1 capital ratio of 15.3% (Basel II, no transition floors) at 30 June 2012. Capital strengthened from year-end 2011 on a 7% reduction in risk-weighted assets primarily due to transition to an IRB model for non-retail real estate RWAs and solid organic capital retention. Based on static business volumes and the Group’s current interpretation of Basel III, SEB estimates its pro-forma Basel III, Core Tier 1 capital ratio would be 12.8% at year-end 2012, well-above Swedish regulatory requirements. Tangible equity-to-tangible assets amounted to a solid 3.9% at 30 June 2012. Given the Bank’s solid underlying earnings generation ability, improving credit performance, diverse liquidity profile and sound capitalisation, DBRS views SEB as well-positioned for expected changes in the regulatory environment.

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 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.

Lead Analyst: Peter Burbank
Approver: Alan G. Reid
Initial Rating Date: 14 December 2006
Most Recent Rating Update: 11 May 2012

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