Sparebank 1 Ostlandet

OSE:SPOL

Earnings Call Transcript 2022-Q3

[Richard Heiberg, executive]

I wish you all welcome to the presentation of the figures for the Third Quarter for SpareBank 1 Ostlandet. My name is Richard Heiberg, and I'm the CEO of the company. With me, I have the CFO, Geir-Egil Bolstad, and he will come in later on when I have gone through some highlights first.

We had a return on equity in the quarter of 9.4% and strong underlying development in the core banking operations. We had solid growth in net interest income with 12.3% on a yearly basis and 5.1% last quarter, mainly from repricing and good lending growth. And the lending growth was 9.6% in the last 12 months and 1.8% in the last quarter. We have restructured the accounting services operations and established SpareBank 1 Forretnings Partner Ostlandet or SpareBank 1 Business Partner Ostlandet in English.

We had good underlying trend in net commission income, a growth of 10.2% in the last 12 months, mainly positive contributions from payment services and sales of insurance and mutual funds, commission from that sales. And then we had also a quarterly fall due to particularly the real estate brokers and also the demerger effects from the accounting services. We have net financials with only NOK 10 million. Low profit contribution reflects weak results in the SpareBank 1 Group and negative value changes from the financial items. Our operating expenses increased by 4.9% on a 12-months basis, but we had a reduction in last quarter, mainly due to this demerger effects. Loan losses of NOK 19 million, mainly due to increase in model-based provisions for credit loss.

Our financial targets and achievements for the third quarter, we had so far this year, return on equity with 9.7% as our target is 11%. We have, of course, not paid out any dividend so far, but our long-term payout ratio is stable with 50%, and that will probably then also come at the year end, both to the customers as a customer dividend and ordinary dividend to the owners. Our CET1 ratio was 18.2%. That means it's far above the regulatory requirement that was 14.8%, plus 1% in management buffer in the end of third quarter. And we had a cost increase in the mother bank of 6.7%, while our target is maximum 4%. We will come into these things later on.

Some macro figures. The Central Bank of Norway has a policy rate path, still increasing the policy rates into the next year and leveling off in the second half of next year. We see increased inflation and it is expected to come down again a little bit during next year. And we see that the expectations from the companies is rather negative to the month coming up. We also see some increase in the unemployment rate, but still on a low level.

We also expect a fall in prices of homes and also in commercial real estate buildings next year. We have had another strong quarter for core operations when we see net interest income plus net commission income and deduct operating expenses, we had NOK 583 million in the third quarter. That's the highest single quarter ever. And it accounts for compared to the equity, almost 13% of the equity. We have continued strong lending growth, 16.6% in the corporate sector and 7.1% in the retail sector, and that is on a 12-month basis. And as I said earlier, 1.8% in the last quarter. And it's far above the national figures for 12 months lending growth.

Also, deposits have shown a high growth with 10.5% in the corporate sector and 6.7% in the retail sector on the 12-months basis. Here, we have a seasonal drop in deposits last quarter with 1.1%. We have made-up some strategic objectives towards through 2025 to reach the ambition to be the best relationship bank in Norway. We have 4 strategic objectives. We know our customers and create the best customer experience; we create tomorrow's relationship bank in an open and engaging working environment; we are a clear driver for the sustainable transition, and we have one of the most attractive ECCs on the Oslo Stock Exchange.

We are a strong challenger in the capital region, where we have high growth in population, and we also have a very healthy growth market for our bank as well as the -- so the capital region is a very important region for us. And also the Inland region, here, we continue to develop our already very strong position. And we are strengthening the operations in Oslo. We have a local presence and competent financial advisers as an important order to become the best relationship bank. And now we have decided to open another branch office in the Okern area in Oslo. This is quite a new city district in Oslo with very high new housing contraction activities. And we also hired another 10 retail or financial advisers in the retail market. We have already onboarded 5 of them, half of them.

We aim to be the best at cross sales. This is also very important to broaden or to widen the top income line of the company. And as we can see here, we are on top among the 4 regional banks within the SpareBank 1 Alliance when we look at the commission fees from the Fremtind insurance company and also from the pension company. We have all-time high customer satisfaction index, and this is a very important factor in achieving our strategic objectives. And we see that both in the retail market and in the corporate market, we have increased the satisfaction index quite substantially to 70 points in retail and 69% in the corporate sector.

As I mentioned earlier, we have restructured the accounting and payroll and advisory business. We have demerged the consultancy operations over the former daughter company, TheVit and sold-off that and at the same time, we have changed the name of TheVit to SpareBank 1 Business Partner, I can say it in English. And this will now, in the future, consist of payroll and accounting operations as well as advisory services. This daughter company has around 120 employees in 9 offices in the Eastern part of Norway. And Mr. Ivar Mjelde is the CEO of the company. And this will also involve a much stronger degree of cooperation with the parent bank in the corporate division of the parent bank through the concept of bank plus accounting.

We have got new and encouraging feedback on our ESG efforts. We have got the second place in sustainable banking revenues ranking 2022, done by The Banker. And we have also been in place at the 8th place in the world's most socially responsible banks 2022 published in Newsweek. And this means that SpareBank 1 Ostlandet is the only Nordic bank rated among the Top 10 in those 2 rankings.

We also extend our green loan portfolio, and that is also very important to achieve the net zero ambition in the future. We have extended the green agriculture loans and we have also introduced corporate solar energy loans. That means we have now quite a broad portfolio of green loan products to both the corporate market and also to the personal market.

Then I will leave the table to Mr. Geir-Egil Bolstad, the CFO of the company. Thank you.

[Geir-Egil Bolstad, executive]

Hello, everyone. I'm pleased to have the opportunity to take you through the numbers of this third quarter. This quarter is a bit of a mixed bag with respect to the results. The main positives are the strong underlying performance of the Bank. We are to a certain extent, chasing the increasing interest rates and that's quite evident in the numbers that we're presenting. We have a reduced profit after tax, but there are positives within that picture.

The return on equity is on the weak side this quarter and year-to-date at 9.7%. The CET1 is rock solid at 18.2%. We have a very strong lending growth and also a strong deposit growth, at least taking into account the last 12 months. We have seen somewhat weaker third quarter, and that's quite consistent with what we've seen in previous years. And finally, we have booked some more loan losses this quarter compared to previous quarters, mainly model-based, as we see no rise in realized losses.

A typical bankers slide, I have to say. Comparing the third quarter this year with last year, we see quite a rise in net interest income. And of course, in a way, the bread and butter of conducting banking business. Also a very nice development in the net commission income, at least when correcting for the commission income from the covered bond companies. What is dragging the results quite a bit is the net financials, both from the ownership interest and also from other financial assets and liabilities. The operating expenses, a bit flattened compared to the last quarter. As Richard mentioned, we have seen some restructuring within the accountancy business. Nevertheless, at the group level, we see operating expense underlying at a level that is covered by increasing inflation and cost levels. Finally, impairment loans and guarantees, we see still quite low levels, still what we would say being below normalized levels. So all-in-all, year-to-date, we have an acceptable cost-to-income ratio, but very low loan losses and a return on equity, that's still not at the level we would like to see it.

A nice and good story is the net interest income. Here you see on the columns with an addition of the commission fees from the covered bond companies. In a way, you can refer it to it as real net interest income. And we post an all-time high this quarter, bringing the net interest income margin of total lending to 1.62%. That is quite an improvement over the previous quarters, but we are still not back to pre-pandemic levels. Having said that, we have seen a quarter-on-quarter 5.1% increase year-on-year, 12.3% increase. And we still have some expected changes on the lending side with the money markets in a way moving in anticipation of rises in policy rates. And normally, Norwegian banks use changes in policy rates to communicate changes also in the customer rates.

On the commission income side, some takeaways. A very strong quarter also this quarter on payment services as part of the summer vacation, July, August in Norway, typically using debit and credit cards to a large extent. So clearly, rebounding quite well from same quarters from the previous years. So a strong development there. Commission income from the real estate brokerage companies is stable year-on-year, but we have seen both a seasonality effect from the second quarter, but also we have to be clear on we see a weakening in the property market with supply of used housing on the market, exceeding that of the demand we're seeing. So holding times are increasing, but still the levels of those commissions are holding out quite well.

Commission fees from mutual funds, a bit reduced. It doesn't show on the slide, but a bit reduced following a reduction of assets under management following the development in the equity and interest rate markets or bond markets, I have to say. Very positive fees from the insurance side, increasing quite a lot. So commission fees year-on-year see a rise of more than 12.5%. Other operating income holding up quite good, the same also commission income from credit cards.

Profits from subsidiaries. First of all, our leasing subsidiary, SpareBank 1 Finans Ostlandet; it's a fully market-funded company, meaning that customer rates are lagging that of the money market rates that are reflecting in the funding costs. So quite a decrease in the income side and net interest income in that company, but we do expect going forward that over-time, the increase in funding costs will be transferred to the customers. So a weak quarter in itself, but that has its clear explanation in the money market rates, front-running policy rates and also customer rates. I was mentioning the situation in the real estate companies, a weaker quarter compared to the third quarter last year, but still posting positive numbers and again, gaining market share in the Inland region being quite stable in the capital region. With respect to the Forretnings Partner or Business Partner translated more directly into English, it's a weak quarter, clearly affected by the restructuring, as Richard mentioned.

I have a slide with some pro forma numbers for you. Quite a busy slide. But the takeaway point is, if you have a look at the tables on the top right-hand side, we have tried to isolate the earnings this quarter from the accounting side, cleaning out the consultant side that has been demerged. So an indication of the underlying profitability in the third quarter was a minus NOK 3 million after-tax or pretax profit, sorry. In that number, we have one-offs of around NOK 2 million on the income side, negative affected and also an additional restructuring-related cost of NOK 2 million, that's also non-recurring. So to give you some look and feel for the underlying performance of the accounting and salary business, correcting for the demerger, we see some slight positive numbers. But then again, have a look at these numbers, we will be quite happy if you reach out and we can explain them in more details. But the reported numbers, as on the previous slide, is negative with NOK 0.7 million.

Profits from joint ventures have seen quite a decline, especially from the SpareBank 1 Group since the same quarter last year. These numbers on group are the majority share of the profit, the controlling interest, order controlling owners have a profit share of some NOK 89 million, and the profit share for our bank then is around NOK 11 million this quarter, and that's a reduction from some NOK 54 million profit contribution from SpareBank 1 Group the same quarter last year. So clearly a weak quarter from SpareBank 1 Group. Other companies, our savings company, SpareBank 1 Forvaltning is doing quite a good job, delivering solid, but again, as a savings company, delivering different kind of savings and investment products.

Assets under management has clearly declined as a consequence of declining equity and bond markets around the world. Boligkreditt, Naeringskreditt, these are our covered bank companies delivering quite stable results. Much of the purpose of these companies is providing cheap funding for both the retail and the commercial side and doing so. So expected profit after tax should be around the risk free rate and they're very much living up to that. SpareBank 1 Betaling, that's the payment company, a negative profit this quarter, very much influenced by the payment application Vipps that has delivered quite a poor quarter.

The star for the time being, in the portfolio being BN Bank, that's a commercial bank owned by SpareBank 1. Our ownership stake is 10% and the bank is delivering very good profitability and a very much increased profitability compared to the same period of last year, both as a consequence of increased net interest income, but also a very good cost control, a good capital management and also having low loan losses.

I mentioned net income from financial assets and liabilities. You have the share of profit and loss from associated companies and joint ventures at NOK 37 million. That's some improvement from last quarter, but it's still not at the level we saw at the end of last year. So hopefully, this will not be the normalized level going forward. We still have losses on other financial assets and liabilities. Clearly, as a consequence of what happened in the market, the liquidity portfolio, considering some NOK 20 billion has seen mark-to-market revaluation with accounting effect of minus NOK 40 million. Securities issued on the funding side, including hedges, has seen a positive contribution this time of some NOK 40 million, whereas our fixed rate lending hedging included has delivered a small negative contribution. And finally, equity instruments, our investment in TOTG SpareBank and in Visa in total delivered around a negative NOK 10 million.

Operating expenses. Having a look at the right-hand side, first of all, it's been stable development on the parent bank since last quarter. But year-to-date, the increase is of 6.7% compared to the same period last year. Clearly, not satisfactory and quite a bit above the financial target of 4%. It has to be said that this target was set at the start of the year, where we haven't really seen the effects of the increasing inflation just yet. But underlying that, we have also seen an increase in staffing and also the effects of rising electricity prices and so on. We do guide it will be difficult to reach to 4% cost target for the year, but we hope and we believe that at the end of the year, we will not see a 6.7% cost increase. On the group level, the quarterly figures are influenced by the demerger of the consultancy bit in our business partner subsidiary. So it's a bit flattered by that, taking into account or correcting for that, it would be more flattish, but we have also seen in the real estate agents that the commission-based salaries is also influenced by a weaker real estate or housing market.

A bit on the loan loss provisions. What you see here and I bring you to the bottom table is that the net write-offs or the realized losses is still a very modest NOK 9 million. We see actually a reversion of individual impairments this quarter, whereas we have increased the model-based loss provision, Stage 1 and Stage 2. Underlying that is an increase in the pathways of the expectations for the probability of default and also loss-given default, especially within the commercial real estate business. This adjustment to especially the LGD pathways are consistent with quite a turnaround and quite a price reduction in the commercial real estate market, consistent with what the Central Bank has in its latest monetary policy report forecasted for years to come.

A bit on the exposures in different stages. We see a small increase in the Stage 2 exposures, following the reevaluation and rescoring of the commercial real estates in our cash flow models, it's quite a modest increase. Going forward, we will work around the entire portfolio rescoring, taking into account a different outlook going forward. Having said that, having a look at the loans in Stage 3 on the right-hand side, we actually have seen quite a reduction in exposures in Stage 3 as a consequence of exposures being deemed to be healthy again after being considered problem loans in the previous quarters. So it's a bit of a difference these days having a look forward compared to what we actually see when we are evaluating the individual exposures.

On the retail side, we have to expand and exaggerate the graphs here to really see the increase in the applications for mortgage payment deferrals. If you have a look at the scale we received in September, 141 digital applications for payment deferrals within the mortgage business. And if you compare that to what we saw in the spring of 2020, we are still at very modest levels. And again, just to remind you, we believe that we have quite a low risk lending book on the housing mortgage side with most of our LTVs in the below 70% LTV bucket.

A bit more on the commercial real estate side. It's an important part of the lending of the business. It's the second largest customer segment in total. And within the corporate side, it is by far the largest segment, the second largest being agriculture. Financing real estate is a bit about 2 things; it's cash flow generating type of real estate and is also development projects, quite a bit of difference in the business dynamics of those 2. I'm going to dig a bit deeper on the following slides. But what we do see is that around 3-quarters of the commercial real estate portfolio consists of buildings and real estate for lease.

Digging into that, we believe that is very important through our credit policy to go after appealing an attractive real estate with a very good location. We do divide into different categories, categorizing as Central, Best and more of a normal and also acceptable type of location. And it's worth noting that more than 90% are in the 2 best buckets of Best and Central. Another takeaway is the share of lending according to the different type of tenants is quite diversified, making for a diversified income stream for our customers. And finally, geographical distribution. Most of our lending within this business is done in the capital area of Oslo and Viken and in the central part of the Inland County. And of course, one final point to make is that the tenants in this commercial real estate is funded by the bank. More than 98% of those tenants have leases with KPI adjustments. So when the KPI is rising as we see today, so will also the lease payments to our customers.

Again, also a bit on the LTV side. We believe that we have a conservative lending book on the corporate side as well as mentioned previously on the retail side. A bit on the project side, loans to real estate projects, we see that quite stable exposure for the last couple of quarters. What we see is a natural consequence of buildings being completed is an increased draw-down on construction loans. That is what you expect as these projects are nearing completion. If I look into our credit policy is that we require in normal situations, 60% presales, but in more challenging market environments, we do increase the requirements for presales and also the level of equity for new projects.

Finishing off with a bit on the capital status. After being quarter-by-quarter, very stable on the CET1 of 18%, we saw a small increase of 20 basis points this quarter, partly driven by value adjustments or OCE effects in our covered bond company of around 30 basis points. again implying that a very, very stable development in the CET1 taking into the growth and also the running profitability of the bank. Of course, as we always say, it leaves ample room for future growth, also for dividends, but it's important also to note that in the more challenging macro environment or with a more challenging macro backdrop, this we consider to be a very solid CET1 ratio.

So without repeating all of Rich's initial points, it's a bit of a mixed bag this quarter. The most important things we see is that the underlying banking operations is much improved with a strong increase in the net interest income and the commission income. Also very good credit growth, important for the bank, more sort of issues or things that we would like to see better is, of course, a lower cost growth and of course, a more favorable net financial picture, but this is driven by more like external factors.

And finally, looking forward, we have strengthened the loan loss provisions but we have not yet seen any increase in the realized loan losses.

So I will leave you with this slide. And of course, if you would like any more comments or discussions on the bank or the third quarter accounts, please do not hesitate to reach out. You can find the contact information on our homepage and also in the back of this presentation. Thank you, and goodbye.