Description

Description

Handelsbanken is a 145 year old high quality, conservative Swedish bank with one of the best cost structures in the world and a strong reputation for excellent customer service.  I know that an old bank with great customer service sounds like an oxymoron but Handelsbanken has used their customer focus to drive returns.  They operate full service banks in a decentralized manner, similar to Expeditors International in the freight forwarding industry, where the branches are responsible for their own profitability and underwriting decisions.  It trades for just over 12x earnings, 1.5x book value, and pays a dividend yield of just under 6%.

Handelsbanken operates in the following six home markets: Sweden, the UK, Denmark, Finland, Norway and the Netherlands.  It has 836 branches across its six markets (as well as 13 others that are immaterial to the thesis), with the largest market being Sweden at 463 branches.  However, the growth of the bank is being driven by the UK, its second largest market and highest ROE market. 

The bank uses its decentralized business model to drive profitability on a branch by branch basis which has resulted in an efficiency ratio of 46% over the last 10 years, great by any measure and even compared to Wells Fargo at 58%. For example, for the 175 branches that Handelsbanken has opened in the UK since 2000, each branch has started with an average of ~5m kr in expenses and grown to 15m kr in expenses 11 years later.  Compare that to the income at those same branches, which stared at 3m kr but grew to 42m kr over the same period.  This latent growth is similar to Costco’s continued growth on a same store basis and is an important driver of lower risk growth going forward.

On the income side, they generate ~75% of their total income from interest and the remaining 25% from fees/commissions.  The track record of loan losses is impressive, with max losses of 2% in the ’92 Nordic banking crisis.  Since then, their actual loan losses have run well below 1% with a range of 0-20bps from ’97 through today and a current rate of 10bps.  A quick snapshot of the period since pre-GFC is below.

Handelsbanken has grown book value/share at a 6%+ annualized clip over the past ten years, while also paying a mid-single digit dividend yield (just under 6% in total but only ~4.5% as an ordinary dividend).  They’ve generated 13-14% ROEs over the same period.  They’ve grown branches at a mid-single digit rate to 836 core today (849 in total). 

There’s a great book called A Blueprint for Better Banking which provides a nice history on some of the cultural aspects of Handelsbanken and the importance of the branch manager in their decentralized model.

One minor technical detail- there are two shares classes, A and B shares, but A shares are by far the most liquid and also carry 1 vote/share vs. the B’s which carry 1/10 of a vote/share.  While we’re on shares, the registry lists two Swedish foundations as each owning ~10% of the outstanding shares, with one of them having a board representative.

Risks

We all know how valuable a long track record is in banking…that’s to say not at all (Lehman was founded in 1850, Barings bank was founded in 1762 and Washington Mutual in 1889).  Given that, it’s impossible to truly understand every detail behind a bank’s balance sheet.  However, their model of extreme accountability/responsibility combined with a conservative balance sheet at least significantly increases the odds that an investor won’t find a fatal surprise in Handelsbanken’s balance sheet one day.  They have a ~20% Common Equity Tier 1 ratio (vs. ~13% for Wells Fargo, an arguably well capitalized bank).  However, they do get to this ratio through a different method vs. Wells.  Handelsbanken’s equity is only ~5% of Assets but they have low Risk Weighted Assets and therefore end up with a strong CET 1 ratio. Given that, their funding is an important source of risk.

On the liability side, they’re ~43% deposit funded, 39% debt funded (of which the mix is ~50/50 bonds/commercial paper).  Given this, it’s clearly a risk but their liquid and lower risk assets help mitigate the risk.

Their loan book is ~60% in Sweden, with the UK as a distant second.  The loan book is also well diversified with ~43% in mortgages although once you combine the property related loans, ~85% of their loan portfolio is tied to real estate.  Their disclosures are really detailed at started on p.80 of the Annual but given the space limitation, I’ll leave it at that.

Interest rates risk- ~70% of the assets and 60% of their liabilities are adjustable within 3 months so therefore the potential for an asset/liability mismatch on the rates side isn’t a major concern.

The Swedish kroner is marginally overvalued using The Economist’s Big Mac Index.  However, given the negative rates in Europe, you can hedge the SEK using three month forwards for a positive carry of ~50bps (or just under 2% annualized). From an economic perspective, their marginally net short or long their core market currencies, with the largest gross FX exposure being long the NOK at 130m kr, which is still relatively small compared to Handelsbanken’s balance sheet but, if you’re going for precision, maybe use a 50% hedge ratio and then just take the remaining currency exposure.

FinTech seems to be all the rage these days so call me old school but I think there will be a place for traditional, low cost banks in the digital realm.  I certainly don’t think all of the stodgy, big banks will thrive but I don’t think the financial innovation will put a bank like Handelsbanken out of business over night.   

Catalyst

•       Coupon clipping of just under 6%/ year + compounding in book value at a mid-single digit rate/year

•       The market decides Europe isn’t going to implode and rerates the stock