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Western EuropeJuly 2 2006

You’ve never had it so good

Corporate profits are up, bad debts are down and there’s a palpable air of prosperity in downtown Oslo, says Nigel Dudley.
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Every Friday in June, Norwegians got into the habit of withdrawing as much cash as they could from ATMs. They did so because they were living in fear that the bank unions would strike and the employers would respond by imposing a lock-out on the 24,000 workers, effectively leaving the country without a functioning financial system.

Just as it looked as if the confrontation between the unions and the banks over the rights to negotiate pension and insurance benefits was reaching meltdown, the government intervened, saying it would introduce legislation to force the two sides into mediation.

There is little doubt that a strike, which would in time have caused the closure of most ATMs and the entire clearing system, would have caused more problems for union members and banks customers than for the institutions themselves. As one banker noted privately: “All we would have to do is sit on the money and earn ourselves good profits.”

Stellar year

Even without this bonus it has been a good year for Norwegian banks. Despite intense competition, which has led to margins being squeezed to unprecedented levels, business is expanding and some financial institutions are producing their best ever results.

The largest bank, DnB Nor has announced pre-tax operating profits of NKr3.7bn (€470m) for the first three months of this year, the highest ever quarterly profits in the group’s history, with total income rising by 19%. This followed an extremely successful 2005, in which pre-tax operating profits rose 25% to NKr13.1bn.

“The expansion in volumes both in Norway and abroad reflects a high level of activity in the corporate and retail markets,” says group chief executive Svein Aaser. He says that the “most pronounced increase is taking place in the shipping and offshore sectors, where our international operations are now on a level with our domestic business volumes.”

He also highlights the “high revenues achieved by DnB Nor Markets, the sound growth in premium income in Vital, Norway’s largest life insurance company, and the strong sales of the new asset management products under the Save Smart concept”.

Oil fillip

DNB Nor, which is the dominant bank in Norway with a 30%-32% share of the retail market, has, like the other banks, benefited from the booming national economy, where public finances have prospered from the continued high oil price.

The result is that corporate profits are up, bad debts are down and there is a palpable air of prosperity in downtown Oslo. It is not, however, reflected in political and economic contentment. There has been a rash of industrial confrontations. Before the bank unions threatened to strike, the country’s brewery workers downed tools, truck drivers took industrial action and unions and owners in one five-star hotel were confronting each other over pay.

In part, this is an indication of a period of high employment and economic prosperity, which gives unions the confidence to put pressure on employers, but this is also laced with a fear that employers will hire cheap labour from Poland, thereby undermining job security.

And there are complaints too about the banking system. Customers used to years of banking with local financial institutions now say that the international competition from other Scandinavian banks has led to a reduction in the quality of service.

This is a theme that DnB Nor, in which the Norwegian government has a 34% stake, warms to. It says that its large distribution network, which includes 400 post offices, more than 1200 grocery shops and 250 branches, enables it to be much closer to its customers.

“The local savings banks provide tough competition in local markets. But our distribution network puts us on a level playing field with them and gives us an advantage when competing with foreign banks,” says deputy chief executive Tom Grøndahl.

He also argues that on the corporate side “people are concerned where the credit decisions are made. We have gained business because people want decisions taken as close as possible to them. Norwegians don’t want credit decisions taken about them in Stockholm.”

However, international banks dismiss these concerns. They point out that most of their credit decisions are taken by executives who are very close to their customers and that, as a larger institution, they have a stronger capital base from which to make loans.

The reality is that the combination of a dominant local player and several aggressive international banks is making the market extremely competitive. According to Tore Hopen, managing director of Privatbanken, which was bought last year by Swedish bank SEB: “Customers are becoming more aware and the entrance of international banks has put considerable pressure on margins. Unless you add value in another way, you have to be the cheapest provider to get the business. It is good that there is now an efficient market and advanced customers.”

At the Swedish-based regional bank Nordea, Øyvind Solvang, head of corporate business in Norway, agrees that “competition is fierce, with the Nordic and local banks all competing particularly hard for the business of the top 15% of firms”.

A further reason that margins have been so tightly squeezed is that most Norwegians prefer to borrow at floating rates. “This distinguishes the Norwegian market from, for example, the Danish one. Here, 80% of lending is floating rate, where as there 80% is fixed rate,” says Mr Hopen.

He says that the banks are “looking for more fee income and cross selling, as well as increasing the number of non-balance sheet products. But housing finance is the glue that links you to the customer – and in Norway that will always be a floating rate product.”

The market is certainly growing. Bankers estimate that there is real growth of 3% in the economy and credit growth is much higher. “We estimate that it will be double digit in 2007 and 2008 and high single digit in 2009. We have seen a strong growth in retail lending but that is now slowing – what is growing fast is corporate lending,” says Mr Grøndahl.

But one banker says the amount of floating rate lending means that “volume growth has been neutralised by margin decreases. Revenue has been reduced.”

There seems no likelihood that this pressure will ease. According to Janne Thomsen, Norway analyst at the risk analysts Moody’s Investors Service: “Margin pressure is expected to continue due to competition and even increase when mortgage lending may be financed by covered bonds. The final legal framework is still not fully in place, having been delayed several times in the past few years.”

These factors are balanced by positive indicators that are helping the banks produce stronger results. Costs are well under control and, after deteriorating in 2002, asset quality has continued and is now at pre-2002 levels.

“Provisioning levels remain prudent and the results of the banks and savings banks reflect the trend of continued write-backs and less need for provisioning. Other risks, such as foreign exchange, equity and interest risk are limited,” says Ms Thomsen.

Online banking

Another advantage is the extensive use of other forms of service delivery. “A decade ago, banking here used to be branch-oriented. But customers have adapted to internet banking, where Norway is one of the most advanced countries in the world,” says Mr Hopen.

The International Monetary Fund (IMF) agrees that the financial sector, buoyed by favourable macroeconomic conditions, “appears to be in good health” and is “well managed and supervised, and resilient to shocks. Declines in loan losses and earlier cost cutting have improved the performance of the banking sector, which is well-capitalised and profitable.”

It also points out that “life insurance companies have increased their buffer capital, although they may still face challenges from the combination of low interest rates and reliance on guaranteed-return products”.

Trouble ahead

There are, however, clouds on the horizon. There is some concern about the rapid credit expansion and the asset boom (most notably seen in the historically high housing prices and strong equity prices), which, the IMF warns, “could become increasing sources of risk in the years ahead”.

It adds: “Total credit to mainland Norway, as a percentage of GDP, is at a historically high level and rising, with mortgage lending being an important component of the increase. Since mortgages carry floating interest rates, the debt burden on households, though still relatively low, is expected to increase as interest rates return to natural levels.” Indeed, the expectations are for there to be further rises on top of the recent 0.25% implemented by the central bank.

Bankers accept there is a risk but they point out that margins are still good on housing loans and that they still provide excellent security.

Few bankers expect there to be an end to the intense competition as the foreign presence in the market becomes ever stronger. As well as Nordea Bank Norge, which has 14% of total assets, the key players in the market are Danske Bank, whose Norwegian subsidiary Fokus Bank has 4%-5%, and Handelsbanken with 3%.

And the foreign presence is growing ever stronger. Last year, SEB bought Privatbanken, Islandsbanki bought BNBank and Bankia was bought by Santander Consumer Finance.

Nordea is looking to increase its mortgage business while increasing the number of young customers and students, while SEB, which has a merchant and investment bank, is putting considerable effort into developing Privatbanken.

“The strategy is to get a significant market share in the affluent segment and above and to develop business with SMEs and larger companies,” says Mr Hopen.

The key question is how DnB Nor responds to the challenge. Domestically there is some concern that it has a dominant market share and that it is government-owned. One banker says: “When someone has too big a market share and too much involvement with the government, they inevitably have a bigger say in how things are implemented.”

Growth limits

However, it seems unlikely that DnB Nor will be allowed to grow much further by acquisition – though it might try to swallow some small savings banks – and the bank is committed to organic growth and international expansion.

According to Mr Grøndahl: “As one of the leading shipping banks in the world, we have a strategy of going after the big industrial shipping customers and meeting their needs across the world. We are opening a branch in Shanghai in August.

“We are also very strong in the energy business. There is a representative office in Houston. Moreover, through the purchase of Monchebank in Russia, we will have a foothold in an area where trade between Norway and Russia is increasing within three of DnB Nor’s core areas of activity – energy, fishing and shipping.”

The bank is also counterattacking those Nordic banks that are looking at its domestic market by establishing a presence in Stockholm and through DnB Nord, a joint venture with Nord/LB Norddeutsche Landesbank, which started operations in January this year, has subsidiaries or branches in Denmark, Estonia, Finland, Latvia, Lithuania and Poland.

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