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Will Nordea's de-risking strategy finally pay off in the pandemic?

Nordea Bank Abp's de-risking strategy, which has significantly hurt the bank's profitability in recent years, could finally bear fruit during the coronavirus crisis, according to analysts, as the lender prepares to report its second-quarter results.

When Finland-headquartered Nordea, the Nordic region's largest bank by assets posted its first-quarter results, the pandemic's relatively low impact on its numbers was eye-catching. Recording credit impairment charges of €154 million in the first three months of 2020, it had one of the lowest cost of risk levels among Nordic and other European peers.

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Unlike most of its Nordic peers, Nordea had chosen not to update its macroeconomic assumptions under IFRS 9, an accounting standard implemented in 2018 that banks are still in the early stages of road-testing and which requires them to take a forward-looking view when estimating expected credit losses. Nordea believed at the time that it was too early to assess the impact of the crisis.

Whether Nordea will thus be recording sizable loan losses in the subsequent three months of 2020 has become a matter of growing concern for investors, according to a June 2 note by investment bank Berenberg.

De-risking strategy

Yet analysts are optimistic that the bank will manage its way through the pandemic thanks to a strategy that has seen it reduce exposures over the past five years to markets such as Russia, Eastern Europe and the Baltics, as well as the oil, gas and offshore sectors.

"Now is the time when Nordea's de-risking strategy, which hasn't been too successful over the last couple of years, should pay off," said Antti Saari, head of research at OP Financial Group, in an interview.

Acknowledging that the second quarter will be the "real test" for the strategy, Saari expects Nordea's loan losses to be "clearly lower than for most of the Nordic peers" when looking at first two quarters together, or the year of 2020 in full.

He estimates that provisions will peak at €340 million in the second quarter, then fall to €159 million in the third quarter and €141 million in the fourth quarter.

The wait for the strategy, which was launched in 2015, to work in Nordea's favor has been lengthy. So far it has done little but put downward pressure on revenues as the bank scaled down lending substantially.

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The strategy has largely been driven in recent times by the oil price collapse at the time and money-laundering concerns.

"Nordea has destroyed a significant part of its earnings during the last three years because of this strategy — much more than anybody would have expected," Saari said.

The bank's return on average equity dropped to 4.96% in 2019, from 12.34% in 2016. The downward journey reached a low point in the third quarter of 2019, with Nordea reporting a loss of €332 million.

Pandemic 'hiding spot'

Berenberg, too, expects Nordea's de-risking program to now "bear fruit," labeling the Nordic lender one of the best bank stocks for investors to shield themselves from the COVID-19 fallout.

Nordea has been outperforming the STOXX Europe 600 Banks Index significantly since the early days of the pandemic in February, which Berenberg believes can be sustained as "the market assigns higher value to Nordea's better ability to resume capital return sooner relative to the broader sector."

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Although Nordea still faces COVID-19 risks, its de-risking strategy "leaves the bank in a solid position to weather a stress" as its loan book "arguably has fewer risk pockets than peers," Berenberg said.

The lender's loan book's exposure to oil, gas and offshore, at 0.7%, is lower than most European banks, Berenberg noted, while also having low commercial real estate and retail exposures.

Furthermore, Nordea has one of the best capital positions among European banks and a "better ability to cut absolute costs to offset crisis pressures than most banks," Berenberg said.

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The bank recorded a common equity Tier 1 ratio of 16%, giving it a 580 basis-point buffer above regulatory requirements.

Earnings stabilizing

Profitability at Nordea, however, remains challenging, and Saari expects the bank's return on equity for 2020 to land at 6.8%, a poor figure compared to most Nordic peers.

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"But it seems that the ship is turning for Nordea," he said. Apart from facing a potentially lower impact from COVID-19 on loan losses than peers, Nordea has seen "a gradual pickup" in certain revenue lines as well as customer satisfaction, he said.

The bank's net interest income, for example, grew to €1.11 billion in the first quarter, from €1.06 billion a year ago, while net fee and commission income rose to €765 million from €737 million.

"The earnings development is stabilizing, even in the coronavirus crisis," Saari said.

Other analysts, meanwhile, have been more cautious about Nordea. In an April 30 research note, UBS equity analysts said Nordea appears "to have turned the corner" when it comes to its pre-provision earnings — the first line of defense against rising credit losses. However, the analysts said they did not see a high probability of Nordea "materially closing the gap to peers in the short term."

"This makes Nordea more vulnerable should our loan loss assumptions turn out to be too optimistic," the note said.