Sparebank 1 SR Bank ASA
OSE:SRBNK
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Earnings Call Analysis
Q3-2023 Analysis
Sparebank 1 SR Bank ASA
SpareBank 1 SR-Bank has made a strategic move by announcing a merger with SpareBank 1 Sørøst-Norge, setting the stage to become Norway’s largest savings bank. This merger aims to amplify the banks' capacity to serve customers with larger credits and solidify their position as a dominant player in the Norwegian banking sector. Both shareholders and employees are expected to benefit from this union. The combined entity will have substantial capital and loan books, totaling NOK 500 billion and NOK 375 billion, respectively, aiming for a stronger community presence through the ownership stakes by local savings banks foundations.
Upon completion, SR-Bank hopes the merger will enhance earnings per share for both entities’ stakeholders. They estimate annual cost synergies of NOK 150 million, attributed to complementary operational facilities and anticipate capital synergies of NOK 2.5 billion due to the transition to an Internal Ratings-Based Approach (IRBA) for capital adequacy under the merged structure. A capital increase through a private placement of NOK 1 billion is also planned to maintain a robust capital base, projecting a core capital ratio of 18.6%, exceeding the current target of 17.35%. In the spirit of stakeholder capitalism, the merger is designed to create a powerful narrative for clients, employees, owners, and the broader society.
The bank presents a positive performance from the last 12 months, with an 8.6% growth. The return on equity for Q3 stands at an impressive 14.5%, surpassing the target of 13%. An encouraging macroeconomic landscape is noted, with unemployment rates remaining below 2%, suggesting a relatively stable environment despite upcoming central bank rate hikes. Net interest margins have improved, primarily through managed deposit margins and despite lending margin pressures. Early indicators maintain a picture of stability across both retail and corporate sectors.
There was minimal change in the industry breakdown, and a high-quality commercial real estate portfolio was reported. Operating expenses showed more stability, largely due to disciplined cost management. Wage growth and inflation create cost pressures; however, SR-Bank has leveraged its enhanced distribution network, reflected by opening new branches and recruiting talents. A combined effort to control costs and leverage growth opportunities has built a sustainable platform for profitability.
In the face of inflation and its associated costs, SR-Bank maintains its focus on sustainable and profitable growth, asserting that the merger with SpareBank 1 Sørøst-Norge will enhance this goal. They will gradually integrate the merged entities' operations, starting with the general meeting decisions in December and aiming for an operational merger by July 2024. Excess capital will be distributed to owners if not deployed effectively to underpin profitable growth, demonstrating a proactive and balanced approach to capital management.
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Good afternoon, everyone. Welcome to the quarterly presentation for SpareBank 1 SR-Bank for third quarter '23. I guess the -- we will divide the presentation in to three. One, we have announced the merger today with SpareBank 1 Sørøst-Norge and secondly, we are doing a capital markets transaction, which will be the second part and the third part would be the third quarter results.
We have today announced that SR-Bank will merge with Sørøst-Norge and will become Norway's largest savings bank. We believe that this will make us more able to serve our customers and ability to give larger credits and position us as one of the major banks in the Norwegian market. And we also hope that this would be positive for our employees as well as accreditive to the value of the shares of our shareholders.
Merging Sørøst-Norge, which I'm using that term for short, I hope that's okay, and SR-Bank, we will become, by far, the largest savings bank in Norway. And here, you see we're #1 in 7 today, becoming 6, and it's also fun to see that among those 6, 4 of us will be within the SpareBank 1 alliance. I'll come a bit back to the synergies in the merger and so I'll leave that for now, but we will have a total capital of around NOK 500 billion and a loan book of NOK 375 billion and the book value of our equity of approximately NOK 40 billion.
The technicalities in these mergers are the -- I guess you're familiar with equity share certificates. Sørøst-Norge is today an equity certificate bank, which will be transformed to a limited company with ordinary shares, 1 share, 1 vote. And then the new company will be -- or the limited company will be merged with SpareBank 1 SR-Bank.
In the merged group, 44% of the shares will be owned by local savings banks foundations. And you see the split between them to your right. The dividends stemming from SpareBank 1, Sørøst-Norge, which is the new name of the merged bank will then be distributed to these amongst all shareholders, obviously, but 44% of it to these foundations. And they will do local community grants and give the funds back to the local communities in a good savings bank tradition. And all 7 foundations have given us a positive signal on approving the merger.
As I said, SR-Bank will be the acquiring entity. And I've also told you about the transformation and the compensation in the merger will be a combination of equity capital or shares in SR-Bank as well as the cash element. And if we go a little bit into the details, we have agreed on an exchange ratio of 68.88% to SR-Bank's shareholders and 31.12% to SpareBank 1 Sørøst-Norge's owners. And we will also give an equity consideration of around NOK 1 billion in -- as part of the settlement -- or as a cash consideration as part of the settlement, sorry. We are also today announcing, as I said, a new capital raise of NOK 1 billion which means that the merger will not lead to any loss of capital for the bank -- or the combined bank.
If we look at the financial aspects of the merger, this will be -- increase the earnings per share for both banks and both shareholder groups. The synergies on an annual basis on the cost side are around NOK 150 million per year. They are fairly limited due to the fact that these 2 banks are very much complementary when it comes to distribution facilities. However, on the capital side, Sørøst-Norge is today higher -- sorry, a standard bank for capital purposes, and they would now have the benefit of becoming an IRBA bank as part of today's SR-Bank. And the capital synergies are in the area of NOK 2.5 billion. And as some of you follow us closely may recall, we announced that we are becoming a SIFI bank from September of next year. And we envision that the new group would become a strong competitor and a challenger in the Norwegian market.
We are -- today, we have today announced that we will do a private placement this afternoon after the close of the market at 4:30 today of NOK 1 billion. It's guaranteed to be fully subscribed. And the book building process will start just after the market closes. And it's guaranteed to be subscribed at a price of 2% below today's weighted -- volume weighted average of the trading on the stock exchange today. When it's completed, we will have a core capital of 18.6% compared to our current target, which is 17.35%.
The announced merger, we hope will be a good and powerful story to all our interested, our stakeholders, our clients, our employees, our owners as well as society at large. And we will do our utmost to also make it a very good and strong financial entity and do utmost to take out the synergies that this -- that we have communicated in this story.
So I'll hand you over to Inge, our CFO. And sorry, I forgot to say that Morten Forgaard is also here, Head of Investor Relations, with Inge, our CFO, who also will be the CFO of the merged bank, he is now going to take you through the third quarter results.
Thank you, Benedicte. Probably SR-Bank is well familiar for all of you participating today. We will now become the second largest Norwegian-owned bank in Norway, and we are very pleased to announce today a merger, which will be a very strong platform for profitable growth going forward. If we look at the growth, now it stands at 8.6% last 12-month, we have a strong contribution both from the retail market with 5.4% and also for the corporate market. We now have also growth within the Rogaland country. If we look at the macroeconomics, it looks very prosperous. The unemployment rate stays below 2%. And we expect still unemployment rate to be low as we now probably see the top of the rate curve with 1 expected rate hike of 25 basis points from the Norwegian Central Bank coming up, but then probably we will be at the top.
If we look at the figures, we presented a return on equity of 14.5% of the third quarter. Year-to-date, it stands at 13.9%, which is above our capital target or the ROE target of 13%. On the impairment side, we have a net reversal of 7 basis points so far this year, and that shows and underpins the high quality of our credit portfolio. Growth remains strong, as mentioned on the lending side, also on the deposit side because if you look at the deposit growth and exclude a few customers within the corporate market that we have changed price and thereby deliberately taken away from the portfolio and due to volatility of these deposits, we still have also a steady growth on the deposit side. The capital ratio stands strong at 17.9%.
However, we raised is NOK 1 billion in equity to undoubtedly have both growth capacity and dividend capacity as we enter into the year, which we expect we will be able to merge with our counter party. The cost to income ratio stands at 38.9%, which is also below our target of 40% cost to income ratio. These targets and figures are shown on this slide. And as mentioned, above the target of 13% on return on equity, 53 basis points ahead on the capital -- the common economy equity tier 1 capital ratio and also below on cost income ratio, which should make the bank able to pay dividend according to our dividend policy that says approximately 50% of our profit every year distributed as dividend.
If we look at the figures, you see that we have NOK 172 million increase in net interest income this quarter, that is equal to 12.1%. And that is even with a sharply increasing NIBOR which has put a pressure on the lending margins even this quarter. Year-to-date, we have an increase of NOK 1,191 million, which is equal to 36.9%. And of course, that is underpinned by the annual growth of 8.6%. But also shows that the contribution from net interest margin, which has increased by 27 basis points this year has a large impact on the net interest income. Net commission and other income is seasonally a bit weaker this quarter compared to the last quarter, but if you look at it year-to-date, it's up NOK 157 million, which is 11.8% growth rate, which then is even higher than the lending growth rate at the mentioned 8.6%.
The contribution from the net income on financial investments is close to zero this quarter with only NOK 11 million, which is far below what we regard as a normalized level. On the other hand, we have a net reversal on impairments of 78 this quarter. But if you look at a normalized level on these 2 lines, the hit on the financial is even larger than the reversal effect is on the impairment, that means that underlying profitability of 14.5% really shows the strong underlying profitability within the back.
So we are pretty confident that the quality of earnings is high where we stand now, and we have even 2 more rate hikes that will come into effect due to the 8 weeks in advanced notice that we are obligated to give our customers that will take effect during the fourth quarter. And that means that as the NIBOR curve will flatten, the lending margin also will increase we expect.
This shows the waterfall on the changes from last year to this year. And as mentioned, a major contribution from net interest income. And I believe we won't go into further takes on that. If we look at this side, you can see that the combined margin is slowly improving, even though we have a pressure on the lending margin, we have been able to more than compensate this on the deposit margin as we have kind of moved away from zero interest loan. It's more kind of easy for a bank to have margins on both sides of the balance.
This is even further shown on the retail market, where you can see a significant improvement in the deposit margin, but also clearly shows the pressure on the lending margin, this was as low as 39 basis points this quarter, but then we've had 2 quarters in a row with sharply increasing LIBOR, but even 2 quarters back, you would see a very different margin, which is explained by a flattening NIBOR in June in the first quarter of this year. So the margin on the lending side in the corporate, excuse me, in the retail segment is volatile due to the lag effect on our notice in advance to our customers.
On the corporate side, the margin picture is more stable, and that is due to the fact that both the large extent on the lending side and deposit side is NIBOR denominated. SME and agriculture shows more of the same pattern as the retail market, which is a combination of NIBOR denominated engagements. And what we are pricing, which is decided with a specific rate level. Looking at the early indicators, both on the corporate side and the retail side shows very stable environment. So far, the Norwegian economy as such has performed very well even with the significant rate hikes I just mentioned, the unemployment rate stays low and most Norwegian households are 2-income households, and that also gives a robustness when it comes to the retail sector's ability to service their loans.
Looking at the industry breakdown, there's not much of a change. We have a high quality also in the commercial real estate portfolio, where they had a thorough investigation of the 12 largest exposure, which shows LTV of approximately 55% and with the duration on the tenant side just beyond 5 years. So we don't have any kind of significant worries with respect to the commercial real estate portfolio as of. The operating expenses is flat or actually reduced quarter-on-quarter. But last quarter, we had a NOK 30 million provision which shows that taken into comparison, the cost side is relatively flat from second quarter to third quarter.
If we dig more into the year-to-date cost growth, you will see that in the parent bank, we have an increase of NOK 255 million, in the other business areas or companies within the group, there are more limited changes. And then on the right-hand side, if we dig into the NOK 255 million, the largest factor is the full-time employees and wage growth where the wage growth accounts for NOK 33 million of the NOK 96 million and the number of full-time employees accounts for NOK 63 million. That is due to the fact that we have significantly increased our distribution power. We have opened 2 more branches during last year.
We have had a cooperation with Swedbank, where we have approximately 10 full-time employees transferred from them to us. And also, if you look at the pension and other personnel expenses, last year we had a reversal of NOK 17 million, which explains why we have a significant increase on the pension and other personnel expenses. Also in the administrative expenses, we have mentioned one-off from [indiscernible] of approximately NOK 30 million.
That means that we have a cost pressure due to the wage inflation and the inflation in general. But we also have now a very robust platform for profitable growth. And the merger in between us and SpareBank 1 Sørøst-Norge should improve that position even forever. I believe that ends the presentation on the figures. So perhaps we can just out and then it's open for you to ask questions. So please just unmute and ask questions, and we will do our best to answer.
It looks like we have one hand, that's Håkon Astrup.
Just some questions from me. Start with just the timing on the capital benefit. So just if I understand it correctly, first, you have to merge and then you have to send an application to the FSA and then you have to wait 1 year or a bit more than that. And then you will get the capital benefit. Is that how we should think of it?
Not necessarily.
Well, the merger will hopefully be decided in both general meetings, the fifth of December this year, and then we have targeted to merge operationally from first of July 2024. And then we can start to migrate on the capital side to transfer loans into the IRB models and systems within SR-Bank from Sørøst-Norge. We have the same platforms, the same models in the SpareBank online. So yes, we have to apply. Yes, we are -- we have to ask for permission to do so, but we expect that to -- hopefully, it won't take too long -- too much time or to be too long. But if and when we receive the permission, it will take approximately 3 years until we can put the capital into profitable business.
But that will happen gradually. So that is what we expect to be the full run rate of the capitalization. And of course, awaiting the full run rate, we also have the option of distributing capital to our owners because we will not allow to have too much excess capital over time. So our main ambition is to have a profitable growth, but if we are not able to put the money into work and underpin that ambition, we, of course, will distribute excess capital to our owners.
So just for -- if a new bank were to apply for an approval for IRB model that typically takes more than a year for the FSA to look into that or it has at least in the past. Do you expect your approval to be swifter than that?
I hope I can be more optimistic than that, Håkon. We've actually now waited for 18 months for the approval to spin-off at some markets in to SpareBank 1 market, and we still haven't received permission. So I hope that they will do it a bit faster. But as you know, we can't -- we don't know.
But it is important to bear in mind that we share the same infrastructure. We have a kind of a common center for credit models within the alliance. So we actually are on the same platform and thereby, it should be more kind of easy for the FSA to grant our replication to take this portfolio and onboard it onto our risk system. So it would be -- have been kind of a longer way to go if these were 2 very different banks merging.
And I think it's fair to say, Håkon, also that Sørøst-Norge has stated publicly that they had the ambition to become an IRBA bank. And so they have already started their preparations to become one. So we hope that it will not take too long.
Great. And then just a follow-up on that. So the NOK 2.5 billion in terms of capital relief. What have you assumed there in terms of risk weights, et cetera, is this more or less that you apply SR-Bank's risk weight to Sørøst-Norge or?
Generally speaking, that is the assumption. And it's also aligned with what Sørøst-Norge has expressed as their expected capital release of becoming an IRB advanced bank on a stand-alone basis. So that is also kind of the same calculation that we base this assumption on as we onboard them to SR-Bank's existing advanced IRB system.
Do you see any risk that FSA can be a bit more -- be a bit stricter than that? Or?
Of course, there's always a risk concerning the capital requirements and the risk weights in general. But that is kind of a risk that applies to all Norwegian banks and as mentioned from Benedicte, they have really made thorough preparations of becoming an IRB advanced bank. So this is not kind of a regular standard bank becoming an IRB bank that they have made preparation. So we feel pretty confident that their kind of portfolio is of high quality and fit for being merged with an existing IRB Bank's portfolio.
Perfect. And then just one last question for me before I go back in the queue. But on the -- when do you expect to be more concrete on integration costs and also your medium-term and long-term targets, say, following this transaction?
We hope to be more specific fairly soon at the latest when we announce the actual merger. But I think you can assume, Håkon, that we will rather have financial ambitions in line with what SR-Bank has today and that being the largest of the 2 entities and that will also set sharper ambitions than what we see if we just combine the two today. So...
So the ambition of the 13% return on equity, that remains unchanged. And I believe we can -- we can take that for granted with respect also to the new and merged bank.
But you have to remember, we are obliged to operate as 2 separate entities until the permission is on the table, which means that the new Board has to kind of decide on the new financial targets and so on. So it won't be until the actual merger has taken place officially, although this is what -- so this is more speculation than hard facts.
And the same with integration costs as well, we will not know more before...
That we will probably know a bit earlier because we start that planning and integration planning as we speak. So hopefully, we will be able to provide you with some more information on that fairly to know.
Perfect. I have some more questions, but I can let others ask some as well.
There are no other hands at the moment. You can if you want.
Very good. And then just on the capital requirement for the new entity just to understand the different moving parts there. So I'll start with the SIFI, the extra capital requirement for a large systemically important financial institution.
Today, you have one, do you see any risk that you can end up with say, a similar requirement as DNB with 2% now as you are a slightly larger bank? Or is this in your view very unrealistic?
I believe, Håkon, if you put their volume on our balance, we increased the volume by approximately 40%. As we were suggested and decided to become a SIFI bank. We still haven't exceeded the threshold of the share of GDP or market share. So I regard that risk as very low. Still, we would be kind of a small bank compared to the really larger banks.
And with regards to the Pillar 2 requirement, slightly higher Pillar 2 requirement. So have you done any thing looking at -- one thing is what is SR-Bank's requirement and your target today, but what -- how do you see the total capital requirement for the merged entity?
If you look at their composition with retail and corporate, they are almost 80% retail and 20% corporate, and that is, so to say, only SMEs. So if you look at what have kind of increased SR-Bank's Pillar 2 requirement, all other eco, it is our position within the corporate market. So as we become a larger bank, we actually increased the retail share of the portfolio in the new bank and should by that primary be regarded as less complex taken into consideration that we've become a larger bank. So we don't look at it as if we add complexity into the bank by having this merger in between the 2 banks. And also, if you get concentration risk, both on size and diversification, our geographical should be positive on the Pillar 2.
So just could you explain the logic in raising NOK 1 billion in equity now and paying that out on dividend in the spring to keep the payout ratio high, instead of just cutting the dividend because if you look in the past, there has been volatility in dividends.
And the second question on capital. Should we -- how is sort of the communication with the FSA regarding possible positive effects on the capital? Or should we -- unless you get clarification before the deal is closed, should defer more you raising more equity capital before the deal is closed?
We have announced that we will raise NOK 1 billion, and that's the fixed size. And that is also what has been guaranteed on very favorable conditions. That means a maximum discount of 2%, compared to the 1 weighted price this asset today. And answering your question, why we raised the NOK 1 billion. It is a 3% approximately of our total equity. So it's a very small issue. And as commented from you, we could have kind of avoided that by reducing growth in the combination of perhaps reducing dividend.
But as we move into this period where we don't exactly know when we will have the -- when we will be granted to merge from the Norwegian financial authorities. As we have an increase of 100 basis points as of the third quarter next year, we want to be able to grow the bank in a steady pace, and we also want to service our owners by paying a reasonable dividend to many of our investors' dividend is kind of something that they are not concerned about or it's not regarded as important but also to a lot of the shareholders receiving dividend is important because they are using that money for other investments, paying tax and so on.
So we have kind of discussed the different options, and we decided to raise this NOK 1 billion. But because it is also small, and it is effectively in meaning or very, very low discounts, and this should be regarded as any dilutive element for any of our owners in our opinion.
We don't see any more hands.
Can I have one quick question?
As many as you want, Håkon.
Perfect. Perfect. Just on the -- on the NOK 150 million in synergies. How do you see the split there between funding and say, real or real costs?
Yes. We have announced NOK 150 million. That is equal to approximately 3.5% of the total cost base of the 2 banks consolidated. So it is pretty conservative. We have a portfolio of approximately NOK 32 billion in service, which has been transferred to [indiscernible] carbon bank entity within the Alliance, we should be able to issue from our fully owned carbon bank entity, that will add some synergy on that area, also becoming a larger bank issuing senior in the international space, shouldn't be beneficial when it comes to being more often in the market.
So our expectation is that approximately 1/3 of the synergies will be from the funding and capital side, besides the NOK 2.5 billion in capital synergies and the remaining 2/3 from kind of cutting operational costs with the overhead cost. And of course, what is potentially savings from going from two entities to one.
Perfect. Perfect. And then the last question for me. On the -- in the past, you have had this temporary capital surcharge, given that you're raising money now. And is that -- should I read that this as becoming permanent or you expect to see your risk weights come up for this extra surcharge to be there forever? Or is -- or how should we think there?
But I'm yet to experience. I have to say, to take away capital requirements. If they take it away, they only replace it with something else. So I think you could work from an assumption that our -- the capital requirement would be more or less the same, but potentially with another composition.
Thank you. Any more questions?
I can't see that more questions or any hands that are raised. So I think we'll say thank you very much to everyone that participated and to SR-Bank.
Thank you very much.
Thanks so much, bye.