NRDBY - Nordea: 11% Yield From A Quality Bank

2023-10-19 13:27:35 ET

Summary

• Nordea is one of Europe's strongest banks with good fundamentals and a high dividend yield of 11%.
• The bank's recent quarterly earnings showed strong net interest income growth but weaker performance in fee and commissions and trading income.
• Nordea's credit quality remains strong, and it has a well-capitalized position, allowing for continued capital returns to shareholders.

Nordea Bank ( NRDBY ) has strong fundamentals and is one of the strongest banks in Europe, making its 11% dividend yield quite attractive for income investors.

As I covered one year ago , Nordea is one of Europe’s strongest banks due to good fundamentals, above-average credit quality and capital position, leading to a sustainable high-dividend yield. Since my last article on Nordea, its total return is above 30% clearly outperforming the market during that period.

In this article, I analyze Nordea’s most recent quarterly earnings and update its investment case, to see if it remains a compelling income investment within the European banking sector or not.

Earnings Analysis

Nordea reported its Q3 2023 earnings today, and were in-line with expectations on the top-line, but above estimates regarding its earnings.

Not surprisingly, Nordea has benefited greatly from higher interest rates in Europe, being a major boost to its net interest income ((NII)) over the past few quarters. In Q3 2023, the bank’s NII increased by 36% YoY, to more than €1.9 billion, with NII representing some 65% of its total revenues in the past quarter. While Nordea is not among the banks more exposed to interest rates, there are some peers with a NII contribution to rates in the 75-80% range, but it is still significantly exposed and this has been a major reason for higher revenue and earnings in the recent past.

Indeed, other revenue lines did not perform that well, given that fee and commissions declined by 4% YoY and trading income was also down by 5% YoY. Overall, its total revenues amounted to €2.95 billion in Q3, an increase of 19% YoY, still a quit good growth rate, but much lower than its NII growth.

Regarding costs, the inflationary environment is naturally a headwind that is leading to higher costs, both through higher staff and general expenses. Nevertheless, its total costs increased by 6% YoY to nearly €1.2 billion in the last quarter, leading to a cost-to-income ratio, a key measure of efficiency in the banking sector, to 42.4%. This is a significant improvement from 48.3% in Q3 2022, as the bank reported positive jaws in recent quarters due to revenues increasing much faster than costs, a trend that is expected to normalize in the near future.

Indeed, Nordea’s guidance is for much more stable NII in the coming quarters as rates should be near their peak in Europe, thus further margin gains are not much likely in the short term. While the bank still aims to have positive jaws in 2024, it will certainly be much lower than in the recent past, thus its efficiency ratio is not likely to improve much in the near future.

Regarding credit quality, this is historically one the bank’s key strengths, and this has not changed much in the recent past despite the increase in interest rates. In Q3 2023, its loan losses were only €33 million, a decline compared to €58 million in Q3 2022, representing only four basis points (bps) of its total loans. This is a very low level of credit risk, which is explained by the bank’s exposure to strong economies across Scandinavia, thus this profile is not expected to change much in the future.

Due to higher NII, contained cost growth and strong credit quality, Nordea’s net income increased by 34% YoY to €1.34 billion and its return on equity ((ROE)) ratio, a key measure of profitability in the banking sector, was 18.5%. This is a very strong level of profitability and among the best in Europe, showing that Nordea is a quality bank in this region.

For the full year, the bank expects to maintain a positive operating momentum in Q4, leading to an ROE above 15% in 2023 (vs. 11.4% in 2022).

Regarding its capital position, Nordea is one of the European banks better capitalized given that its CET1 ratio was 16.3% at the end of September, well above its capital requirement of 12%. This means that Nordea has an excess capital position and can easily continue to return capital to shareholders, both through dividends and share buybacks.

However, the bank’s capital requirements have increased in recent quarters and Nordea expects its CET1 requirement to increase to 13.5% during the next twelve months, thus its excess capital position will become lower in 2024.

Nevertheless, Nordea has a very good organic capital generation capacity and is expected to maintain its attractive shareholder remuneration policy, despite higher capital requirements ahead.

Indeed, Nordea has performed significant share buybacks since its first approval by the European Central Bank in September 2021, and is now performing its fourth share buyback program. This current program has an amount of up to €1 billion and will take place until next March, aiming to return excess capital to shareholders.

Additionally, Nordea’s goal is to distribute 60-70% of its annual earnings through dividends, which seems to be a sustainable payout target considering the bank’s strong fundamentals and capital position.

However, like many European companies, Nordea’s dividend frequency is only annual, which decreases its income appeal somewhat. Its last annual dividend was paid last April, an €0.80 dividend per share. Related to 2023 earnings, its dividend is expected to grow to about €0.95, an increase of 18% YoY, which seems conservative and Nordea has increased its earnings at a faster pace and due to share buybacks its number of shares outstanding has been declining.

Therefore, I think there is some room for Nordea to deliver a higher dividend per share than currently expected, which would be positive for its share price.

On the other hand, the bank’s guidance for the next few quarters was quite conservative, as the bank is cautious on the macroeconomic outlook and expects some softness in the next 12-18 months in economic activity across Scandinavia and said that NII should be near its peak. Given that NII was its major growth engine in recent quarters, this means Nordea’s growth should be much more muted in the short term compared to its recent past, explaining its negative share price reaction today despite its strong earnings.

Conclusion

Nordea is a quality bank in Europe and has delivered a positive operating momentum in recent quarters due to the rising interest rate environment. This means that further earnings growth is not as likely in the near term, making its investment case much more geared to capital returns.

Indeed, Nordea’s current price-to-book value multiple is 1.2x, in-line with its historical average over the past five years, thus its valuation seems to be fair currently. However, its forward dividend yield is near 11%, which seems to be quite attractive and is the main reason to buy its shares right now.

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