Olly Russ

Banking on European growth

Olly Russ

Nordea’s decision to relocate from Sweden to Finland has two important implications for investors in the sector: first, banks are once again welcomed by governments following their post-crisis fall from grace; secondly, and consequently, the Europe-wide trend for higher tax and capital requirements may have finally met effective resistance from bank management.

Both these points we think augur well for future dividend streams and we continue to hold Nordea – which yields around 6% - as a core component of the respective 9% and 12% banks sector allocations (as at 31 August 2017) in the Liontrust European Income Fund and Liontrust European Enhanced Income Fund.

In the Nordics, the banking sector appears to be in rude health. In fact, with banks in many senses representing warrants on domestic GDP, the pick-up in growth rates across the continent (see below) bodes well for the European sector as a whole. Bond yields have recently moved up in response to inflationary signs, and the ECB should shortly announce tapering of its quantitative easing programme. All else being equal, this points to a general backdrop of rising yields – again favourable to the banking sector.

European GDP growth rates, year-on-year, Q2 2017

European GDP growth rates, year-on-year, Q2 2017

Source: Bloomberg, 21.09.17

Back in February, the left-leaning Swedish government proposed a new tax on banks, since it was estimated that their profitability could withstand a further raid. Bjorn Wahlroos, Chairman of Nordea Group, warned that the bank might be forced to relocate its headquarters in order to avoid yet more tax and regulation. Since this threat has long been a gambit favoured by corporates to avoid the spectre of tax rises, the Swedish finance minister once again prepared to ignore the bleating and pursued the tax rise regardless, gambling that the corporate outrage generated would once more prove mere hot air (think HSBC and the interminable rumours of relocation to Hong Kong).

However, Sweden had reckoned without the formidable Wahlroos. The Funds have long been invested in Sampo Group, which Dr Wahlroos has brilliantly steered from being a small Finnish insurer to a Scandinavian financial powerhouse. Using Sampo Group as a battering ram, Dr Walhroos acquired a 20% share of Nordea and catapulted himself into the Chairman’s role, making him arguably the most powerful banker in the Nordics. Nordea at once set about the business of studying the potential options of re-domiciling the bank into a more favourable jurisdiction: the two alternative candidates selected were Finland and Denmark. Even as recently as this month, analysts though remained sceptical that the bank would in fact be so bold as to relocate its HQ, as no doubt, did the Swedish government. Yet on 6 September, Nordea announced it was indeed to relocate its HQ to Helsinki.

There are several interesting aspects to this move. The first is that banks have now demonstrated to everyone (even politicians)  that HQ relocation is possible even for a major financial group, who might be regarded as traditionally less mobile than most corporates. That opens the possibility of regulatory and tax arbitrage. Readers might be surprised to learn that there isn’t in fact a single market in banking regulation, and interpretation of the rules is often done at a local regulatory level. Meanwhile, tax harmonisation across Europe is of course a long way from fulfilment. This means that the ability of European governments to raise further taxes or capital requirements for banks has been severely curtailed, as banks can now issue the credible threat of relocation.

The second aspect is that both Copenhagen and Helsinki were pitching for the business. The HQ of Nordea group of course brings with it considerable prestige and also tax revenues. However, back in the depths of the financial crisis, countries were desperate to offload banks from the public balance sheet. The Swiss banking giants indeed were told to recapitalise and submit to stringent ongoing capital requirements or relocate to New York, or wherever else would have them. Such was the size of potential liabilities of the banking sector for certain economies, it entailed writing cheques that even relatively sizeable nations might be unable ultimately to cash. This has now changed completely, with countries effectively bidding for banks to headquarter in their capitals.

This is not without risk. Nordea’s publicly acceptable reasoning for moving HQ was to submit itself to stricter supervision from the ECB, and domicile in a place which had access to the European Stability Mechanism in extremis – i.e. a eurozone country. That is, they believed that if Nordea required a rescue in some putative future crisis, the Swedish state (and hence taxpayer) might lack the resources to bail them out. Euro membership ensures access to the bottomless depths of the ECB pocket if needed, while neither Stockholm nor Copenhagen are currently in the eurozone, and therefore are not automatic members of the Banking Union.  It is unlikely that this was a particularly convincing argument for Finland though, which as a nation would be harder placed to rescue a major bank than Sweden. And if the board of directors of Nordea were rumoured to favour Copenhagen as somewhat warmer, the fact that Dr Wahlroos is Finnish might well have tipped the scales in favour of Helsinki, quite apart from the temptation of being regulated by the ECB.

The real reason is more likely to be the potential for freeing up capital under a more generous (or at any rate less punitive) regulatory regime, as well as avoiding arbitrary tax increases, although this is of course a politically sensitive subject in Sweden. It hardly encourages the public to form a rosier view of bankers if they announce they are moving to another regime to cut their tax bills.  Nordea has made little of the potential for additional capital returns so far, although this was unquestionably a prime motivation for the move, and we expect to see more announcements in this direction in due course.

Nordea and Swedbank sit at the core of our Funds’ banking allocation. As the chart below shows, Nordic banks in general have the highest yields combined with the deepest capital cushions. This provides these banks with the ability both to grow and return capital to shareholders simultaneously, whilst providing security against any future crisis. For as we have seen over the last decade, investing in banks is not without risk.

Nordic banks offer high dividend yields and strong balance sheets

Nordic banks offer high dividend yields and strong balance sheets

Source: Bloomberg, 20.09.17, Western European banks > €5bn mkt cap.

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Monday, September 25, 2017, 8:47 AM