Svenska Handelsbanken: High-Quality Bank With A 4% Yield

| About: Svenska Handelsbanken (SVNLY)

Summary

Handelsbanken is a retail-focused bank with a different business model than usual in the banking industry.

Its low-risk culture and high efficiency leads to very high profitability levels, which are sustainable in the long-term.

Despite its recent dividend cut, it offers a dividend yield of 4% that is sustainable in the long-term.

Svenska Handelsbanken AB (OTCPK:SVNLY) is a high-quality European bank with a different business model and culture. It has a low-risk culture which leads to very low loan losses and is one of the most efficient banks within the European banking sector. This results in very high ROE and capitalization, providing a strong support for an attractive dividend. However, its recent dividend cut to pursue growth seems to be a significant change in the bank's strategy. Despite this, it offers a sustainable 4% yield making it interesting to income investors.

Company Description

Handelsbanken is based in Sweden and is one of the leading Nordic banks. It was founded in 1871 and has currently more than 800 branches in its six most important markets. It provides banking services for corporate and private customers. It is one of the few European banks with an AA credit rating, has a market capitalization of about $27 billion and trades on the U.S. in the over-the-counter market. Its main competitors are other Nordic banks, such as Nordea (OTCPK:NRBAY), Danske (OTCPK:DNSKY) or Swedbank (OTCPK:SWDBY).

Despite its geographical diversification, its domestic market continues to be the largest one for the bank. Internationally, Handelsbanken grows by establishing its business models in selected markets. Handelsbanken has better growth prospects in the U.K. and the Netherlands, where it has a low market share and can grow organically through new branches.

Business Model

Handelsbanken has a different business culture than all other banks, with a decentralized way of working. It abolished budgets in 1972 considering that long-term plans risk creating unwanted incentives and behavior. It has no sales targets, focusing on profitability instead of volumes and does not pay bonuses, given that it believes bonuses should be avoided in risk-taking operations.

Its branches are fully responsible for all customer relationships, approving all credit and business transactions with the customers. Depending on the size of the credit some additional regional or central approvals may be required, but the first approval is always at the branch level.

Given this philosophy, the bank's focus is on the customers' needs and not the sale of specific products. Therefore, it does not perform any central marketing campaigns, being made locally. It also targets specific customers, instead of being a mass-market bank. Handelsbanken tends to consistently focus on the most affluent segment of the population, using its decentralized branch network and personal meetings to provide a superior service.

It has a low risk tolerance with a centralized and non-negotiable credit policy. Its policy is the same in all markets and across the business cycle, with credit decisions based on cash flow and repayment capacity of the customers.

Taking into account this different business model, Handelsbanken is the only European bank that wants to maintain the current size of its branch network over the long-term. While practically all of its peers are targeting digitalization as a mean to cut costs and reducing the number of branches, Handelsbanken is betting that 'old banking' based on customer relationships will remain a sound business model in the future.

Financial Overview

Regarding its financial performance, Handelsbanken's low risk culture leads to low earnings volatility, high-quality underwriting and a funding advantage relative to its peers. Its goal is to have higher profitability than the average of peer banks in its markets. Like its Swedish peers, one of its competitive advantages compared to other European banks is its superior credit quality. This results in above-average profitability levels, which are sustainable in the long-term and justifies its premium valuation.

Like many of its European peers, Handelsbanken has suffered over the past few years from the low interest rate environment. This has pressured its revenues and in the last fiscal year Handelsbanken's net interest income increased by just 1%, to about $4.5 billion. Even though it has reported lending growth, the low interest rate environment is a strong headwind to revenues and its top-line should report modest growth in the next few years.

One of Handelsbanken's distinctive factors is its efficiency, being among the best in the European banking sector. Its cost-to-income (C/I) ratio has been below 50% for the past 15 years and was quite stable at about 45% over the past here years. This figure is among the most efficient banks in Europe and one important reason why its high- profitability is sustainable in the long-term.

Another structural factor supporting Handelsbanken's profitability is its superior credit quality. This has remained robust with an unchanged loan loss ratio of only 9 basis points (bps) in 2016, being in-line with its recent historical average. Since 2009, the bank's loss ratio has been about 10 bps and should remain at these residual levels for the next few years given the bank's strong underwriting track record.

Given this positive operating backdrop, Handelsbanken's net income remained relatively stable in 2016 at about $1.8 billion. Its profitability, measured by its return on equity [ROE] ratio, was 13.1%. This profitability is among the best in the European banking sector and has been very stable over the past few years, showing the sustainability of Handelsbanken's business model.

Regarding its capitalization, Handelsbanken is one of the best capitalized banks in the world. At the end of 2016, its fully loaded core equity tier 1 [FL CET1] ratio was 25.1%. This ratio increased from 21.2% at the end of 2015, showing that the bank is still building capital despite its superior capitalization.

Even though its capital ratio seems extremely high, the Swedish banking regulator is very conservative and requires banks to have very high ratios. Indeed, Handelsbanken wants to keep a 1% to 3% buffer above the minimum regulatory ratio, which is currently set by the Swedish Financial Supervisory Authority at 21.3%. Therefore, Handelsbanken has a smaller excess capital position than its FL CET1 ratio of 25% could suggest, but it has a strong capitalization enabling it to provide an attractive dividend to its shareholders.

Handelsbanken has a very good dividend history, distributing a large part of its annual earnings to shareholders. However, after several years of dividend growth, the bank surprised and recently announced a lower dividend related to 2016 earnings than expected. Its total dividend was announced at SEK 5 ($0.56) per share, a decline of 17% from the previous year.

At its current share price, Handelsbanken offers a dividend yield of 4%. Its stock will trade ex-dividend on Thursday, 30 March 2017 and the dividend should be paid in the next few days. Like many European companies, its dividend payment frequency is annual. Additionally, the Swedish dividend withholding tax rate is 30%, reducing a little bit the income appeal.

Handelsbanken's dividend payout ratio was 60%, a lower level than in previous years when the bank dividend payout was above 70%, and also lower than compared to its Swedish peers. The bank justifies this dividend cut due to its growth ambitions in international markets, namely in the U.K. and the Netherlands. Its guidance on the future dividend path is not clear, but according to analysts' estimates its dividend should recover in the next few years. However, given that management's preference seems to earmark any excess capital to pursue growth, its dividend may surprise again negatively in the coming years.

Conclusion

Handelsbanken is a high-quality bank with a mature and reliable business model. Its good credit quality and efficiency lead to very high profitability levels, which are sustainable over the long-term. In the past, one of its main positive points was its high-dividend yield, but its recent dividend cut was unexpected and may mark a new phase for the bank targeting growth instead of returning excess capital to shareholders. Nevertheless, it still yields about 4% and has a sound business model in the long-term, making it quite appealing to income investors.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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