DBRS Comments on Svenska Handelsbanken’s 3Q12 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, remain unchanged following the Bank’s 3Q12 results. The trend on all ratings remains Stable. The quarter was highlighted by sustained positive franchise momentum, improved efficiency, continuing solid asset quality metrics, prudent pre-funding of future debt maturities, and bolstered regulatory capital.

The Bank recorded its most profitable third quarter ever with an operating profit of SEK 4.4 billion for 3Q12, up 1% from 3Q11 but down 3% from 2Q12. The relative decline versus 2Q12 was largely driven by lower net interest and net fee and commission income. Lower interest rates adversely impacted deposit margins and exchange rate movements due to a strengthening Swedish Krona combined to reduce net interest income by 2% quarter-on-quarter (QoQ) to SEK 6.5 billion. Further, seasonal weakness typical of the third quarter and the troubled broader European economic environment contributed to lower levels of client activity. This negatively impacted both lending and guarantee commissions as well as equity brokerage and advisory fees. As a result, net fee and commission income fell 5% QoQ to SEK 1.7 billion. Despite the 4.2% QoQ decline in total income (revenues), SHB recorded positive operating leverage for the quarter as total expenses fell 6.0% due to exchange rate movements and seasonal trends. DBRS considers the solid results as evidencing the strength of SHB’s franchise and the ample earnings generation ability of the Bank’s diverse business model.

SHB’s sustained positive franchise momentum underscores the sound profitability across its core business segments. SHB continues to retain leading positions among various regional customer service surveys and benefits from significant market shares across its operations, particularly in its domestic markets. As a result, Branch office operations in Sweden, generating 74% of 9M12 operating profits, reported 3% QoQ growth in operating profits to SEK 3.3 billion helped by a 5% QoQ decline in total expenses due to seasonally lower other administrative expenses, which improved the segment’s cost-to-income ratio to 32.9%. Branch office operations outside Sweden reported 5% QoQ growth in operating profits to SEK 1.2 billion for 3Q12, representing the highest quarterly operating profit ever achieved by this segment. Results in this segment benefitted from rising net interest income due to higher business volumes as well as lower expenses (cost-to-income ratio of 45.4%). Together, these more than offset declining fee income and trading income. Of note, SHB continues to successfully execute on its diversification strategy of expanding its U.K. presence organically. Its 124 U.K. branches delivered operating profits of SEK 268 million for 3Q12, which improved 3% QoQ and 62% year-on-year (YoY). SHB’s complementary businesses, Handelsbanken International and Handelsbanken Capital Markets, were however affected by lower levels of client activity and seasonality, resulting in operating profits falling 50% QoQ to SEK 59 million and 73% QoQ to SEK 56 million, respectively. Looking forward, DBRS expects that maintaining solid earnings momentum in its core business segments may become more difficult given the uncertainty in the Euro zone, as well as the potential contagion effects that may impact economies in a number of countries within SEB’s operating footprint.

DBRS considers SHB’s conservative approach to credit as the foundation underpinning the Bank’s solid asset quality track record. Credit performance remains solid and is illustrated by the continued low level of loan losses. In fact, net loan losses were SEK 856 million for 9M12, or a low 7 basis points (bps) of total lending, well below pre-crisis levels. Net impaired loans are also low at SEK 3.1 billion and accounted for only 18 bps of total lending in 9M12.. DBRS views the Bank’s very solid and consistent credit performance throughout the most recent stressed environment as a factor that highlights the strength of the Bank.

SHB’s funding profile is sound and well-managed in DBRS’s view. The benefits of SHB’s diverse and well-managed funding profile were clearly demonstrated in 9M12 as the Bank maintained good access to the markets despite general market volatility. During 3Q12, the Bank issued SEK 79 billion of long-term debt, consisting of SEK 34 billion in covered bonds and SEK 45 billion in senior bonds. This follows issuance of SEK 124 billion of long-term debt (SEK 42 billion of senior funding and SEK 82 billion of covered bonds) during 1H12. Importantly, DBRS notes that SHB has prefunded all of its maturities through year-end 2013. 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.

Although SHB still has a tendency towards wholesale funding, a large portion is linked to the relatively more stable Swedish covered bond market. At 30 September 2012, wholesale funding represented 66% of total funding, but was materially lower at 38% after adjusting for covered bonds. Deposits at the half-year totaled SEK 698 billion, up 6% YoY and benefitted from a flight to quality as investors continued to show confidence in the Bank. This helped SHB to expand further its liquidity reserves, which now exceed SEK 750 billion. Within the liquidity reserves, DBRS notes that cash funds and liquid assets held at central banks totaled SEK 498 billion. The remainder of the reserve is mainly comprised of volume linked bonds and unutilised issue amounts for covered bonds. DBRS notes that SHB reported a liquidity coverage ratio (LCR) of 139%, which exceeded the regulatory minimum based on the current definition.

Regarding capital, SHB continues to strengthen its already strong capital position. The Bank recorded a Basel II Tier 1 capital ratio of 20.5% and a Core Tier 1 ratio of 17.9% compared to 17.4% and 14.7% 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 have been 15.9% at 30 September 2012.

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.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Peter Burbank
Approver: Roger Lister
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.