Summary
- Higher interest rates in Sweden pushed interest income up 23% from last year.
- Their loan book does look conservative, but we would expect some increases to NPL in 2023.
- The bank has a good dividend policy and a generous payout ratio of 50% of earnings.
- With the share price up 44%, it leaves investors with a low ERP.
Investment thesis
We have been an investor in Sweden's oldest bank Swedbank AB ( SWDBY ) (SWDBF) for a few years now.
A company we started investing in when they experienced turbulent times of cleaning up money laundering activities.
We stated in our last article of 20th July last year that " Swedbank provides stability in an unstable world".
Since that time, the share price is up 44%.
Swedbank has just published its FY 2022 financial results, so it is a good time to revisit the investment thesis.
FY 2022 Financial results
Swedbank delivered a net profit to shareholders of SEK 21.88 billion for FY 2022, which was 5% higher than the year before.
EPS was SEK 19.43, up from SEK 18.56.
The market liked what they saw and drove the share price up to SEK 206 on the news. Its P/E is still quite attractive at 10.6.
Return on equity was 15.8%. Management is confident that they can keep this high ROE for years to come.
Their CET1 capital ratio stands at 17.8% with a buffer above the minimum regulatory requirements of around 340 basis points.
- Net Interest income
The two largest sources of revenue for a bank are interest income and fee generation. Swedbank's net interest income was up 23%, or SEK 6 billion, for the year to SEK 33.2 billion.
This improvement was mainly a result of higher deposit margins and a better return on central bank investments.
- Fees & commissions
Total fees and commission income came in at SEK 14.22 billion, which was just 4% lower than last year. Turbulence in the markets and falling asset prices affected net commission income. Other income was up 6% mainly from insurance-related income
Asset management was broadly stable. In terms of Swedish mutual fund flows, Swedbank saw net inflows totaling SEK 28 billion, mainly from institutional clients.
- Non-Performing Assets
The Nordic countries have experienced galloping real estate prices in combination with ultra-low mortgage rates and banks keen to offer loans to home buyers in a competitive market.
In Sweden, private property prices went up as much as 30% compared to the pre-pandemic level. That is quite a jump in a short time of just 3 years.
Stefan Ingves, the head of Sweden's Riksbank from 2006 to 2022 said in an interview on CNBC recently:
I've persistently time and time again said that the debt level in the household sector is just way, way too high and there will be a day of reckoning and eventually rates will go up, and now rates have gone up"
As of November, last year, prices had come down by 13% from the peak in February of 2022. Most banks believe we will get a 20 to 25% reduction in prices. However, what that means is basically that prices will fall back to pre-Covid-19 levels. That in itself is not too worrying. More important is whether people will be able to pay their loans.
The unemployment rate in 2022 in Sweden was 7.3% and is expected to be 7.4% this year.
The bank took credit impairments in Q4 of SEK 679 million connected to the weaker macroeconomic outlook. Provisions on individual engagements were only SEK 30 million. For the whole year, credit impairment was SEK 1.5 billion.
Fortunately, they do have a prudent loan to value in their commercial and residential property loan book.
- Cost to Revenue
Full-year underlying expenses were in line with their cost cap of SEK 20.5 billion, which was set two years ago.
As salaries are a high component of the cost of running a bank, we like to look at how inflationary pressure also affects the bank.
In 2022 staff costs were SEK 13.3 billion, up SEK 507 million from the previous year. Swedbank expects to incur higher costs of staff this year as they have advised that from SEK 1 to 1.2 billion additional costs in 2023, the bulk of this comes from salary increases.
During 2022, the bank also made impairments for IT systems and goodwill of around SEK 1 billion. The bank tax to the government also ended up at SEK 1 billion.
For the full year, AML investigation costs totaled SEK 443 million. It is not a small amount of money, and it would be good to see them putting this to rest. Their CEO Jens Henriksson did mention during the recent Q&A session with analysts that a process like this usually takes 3 to 5 years. They have been in talks with the U.S. authorities for a bit more than 3 now about settling their AML case.
Hopefully, it can be resolved this year.
In terms of their cost-to-income ratio, their target is to maintain it at 0.4. For two consecutive quarters, it has been below 0.4.
Return of capital to shareholders
Swedbank has a clear dividend policy of distributing 50% of its net profit. The board of directors is proposing to pay a dividend of SEK 9.75 for 2022, which is SEK 0.50 up from last year's ordinary dividend of SEK 9.25. That is an increase of 5.4%.
Foreign investors, like ourselves, pay a withholding tax of 15% depending on where they reside. As such, we always take this into account when we calculate our yield. The yield will then work out to 4.1% which is in line with most large banks these days.
It leaves investors with a small equity risk premium. However, it is what it is. That is on par with the stock market these days. Few companies' dividends presently offer much of an ERP.
To our knowledge, Swedbank does not do any share buyback for now.
As a matter of fact, due to their share-based compensation program. The bank distributed at no cost to their employees 1.64 million shares. The average number of shares increased by 1.1 million in 2022.
business prospects
The macroeconomic development in both Sweden and the Baltic countries deteriorated in 2022. With interest rates, energy costs, and inflation impacting many households, consumers have been tightening their belts. There has been an increase in the number of bankruptcies from small and medium enterprises, and the retail sector is reporting sales slowing down.
We do believe that this trend is going to continue at least for the first half of 2023.
It is important to bear in mind that the Swedish central bank had a negative interest rate of between 2015 and 2020 with 0.5% being the lowest level.
In July last year, we shared with you that the Swedish Riksbank at that time forecasted that the policy rate might go to 2%. This was too optimistic, as the inflation numbers from the second half of last year were higher than expected. In October last year, the CPIF inflation was 9.3%
As a result of this high inflation number, the committee decided in their meeting in November last year to increase their policy rate by 0.75% to 2.5%. At that time, they set their new target for the policy rate to be just below 3% this year.
Conclusion
The financial sector has been an excellent place to be invested in as the interest rate environment normalized. Yes, that is what we think it is, although some may disagree.
At SEK 206 per share, the good news for Swedbank's higher interest income seems to be baked into the price level. At the present share level, we would be reluctant to add more capital. The "easy money", if there is such a thing, has already been made.
Therefore, our stance changes to that of a Hold.
For further details see:
Swedbank's Share Price Is Up 44% In Half A Year, Fairly Valued Now (Rating Downgrade)