In our opinion Ringkjøbing Landbobank is not just Denmark’s best run bank – it is also one of the very best banks in both a European and global context. It has been so for quite a few years, actually.
Bank services can be hard to differentiate – what one bank can provide, others might just as well. For this and other reasons, it is important to be highly cost-efficient, to minimise losses and to carry a strong financial buffer to survive through rough waters.
Extremely low, and for long periods even negative, interest rates have been a challenge in terms of ability to generate earnings, in particular for European banks since the financial crisis. The demand for loans has also been somewhat limited, which has no doubt made the competition stiffer, and in turn lowered the sector’s net interest margin and earnings ability. Increased regulatory demands and rising capital requirements have further pressured profitability and the returns on equity.
In circumstances such as these, Ringkjøbing Landbobank really stands apart from the crowd. The bank is Europe’s most cost-effective retail bank and has been so for a decade. This position has been hard won, and it is based on a sound and sensible corporate culture that is not just reflected in the management, but in every corner of the bank. The focus is on pursuing business activities where earnings are high and where the capital can be allocated profitably while avoiding unnecessary risks. When this is achieved in tandem with keeping costs on a tight leash, it can lead to a value creating business – and this also holds true for the banking sector.
Acquisition of a regional bank
For many years, the bank’s cost / income ratio has been at an industry-leading 32 percent – by comparison, major banks in both Denmark and the United States, often have costs amounting to 50 percent of income. This is a sign of how efficient the bank is, and a reflection of how it carefully considers whether costs are unnecessary or helps to grow the business. The return on equity is similarly at a high level – 20 percent before tax. This level of value creation is not merely an indication of how efficiently the bank is run, it is also an indication of how the bank focuses on the areas where management has identified competitive advantages via an in-depth knowledge of the sector and can have security in predictable cash flows or assets.
The reported figures for Landbobanken in 2018 were impacted by the acquisition of Nordjyske Bank in the spring of 2018. As the acquired bank was not close to being as profitable or efficiently run as Landbobanken, the reported figures reflect this. However, we see great potential in the acquisition – Nordjyske Bank had the same amount of costs as Landbobanken even though the balance sheet was only half the size. When acquiring the bank, Landbobanken, in addition, acquired almost five billion Danish kroner in excess deposits, and this will be an attractive foundation for expanding the bank’s lending portfolio at low cost levels, as the deposits are a cheap source of capital with which to finance lending. The merged bank has a loan book in excess of 32 billion kroner. Nordjyske Bank’s lending was also of a strong quality.
The first indication of management’s expectations was synergies from the merger amounting to around 120 million kroner, the equivalent of more than 20 percent of the cost base in Nordjyske Bank. We consider this a conservative estimate. When another Danish bank, Jyske Bank, made a bid for Nordjyske Bank prior to Landbobanken’s acquisition, the management at Jyske Bank deemed it realistic that the merger could result in savings of between 250-300 million kroner – more than half of the cost base. We strongly believe that the management of Landbobanken can optimise and focus on the corporate culture in the acquired bank in order to increase the focus on profitability.
As in many other industries, there are ample opportunities to use technology and data to significantly streamline processes, including standardisation and centralisation. Ringkjøbing Landbobank’s employees working with technology and data will remain situated in Denmark. At the same time, we note that Nordjyske Bank and Landbobanken have been using the same IT platform, Bankdata, and this will increase the opportunities to identify savings and ease the merger process.
A careful credit policy
Despite low or no growth in lending in the Danish bank sector over the last years, Landbobanken’s lending grew by approximately nine percent annually between 2012 and 2017. In 2018, the merged bank managed to grow its lending by approximately seven percent while the “old” Landbobank once again grew its lending by nine percent. Though the net interest income shrank in 2017, the net interest income grew by almost two percent in 2018. A significant amount of new customers has thus been gained over the last few years, and we do not assess the merger of the banks as having resulted in nervous customers – nor do we see indications that customers wish to leave the bank, as the customer satisfaction scores continue to be nationally leading.
Loans at Landbobanken are managed conservatively and sensibly. In fact, after an inspection by the Danish Financial Supervisory Authority (FSA) in 2018, it was noticed that the quality of the commercial lending was above average for comparable banks and financial institutions. Following the FSA’s inspection and review of the lending book, Landbobanken felt “forced” to adjust and increase the expectations for the year’s results due to strong growth in the bank and a reversal of loan-loss provisions. While many Danish banks have reversed loan-loss provisions quarterly since the end of 2016, Landbobanken only did so in the first quarter of 2018 after the visit from the FSA. This is despite loan-loss provisions amounting to almost five percent of the lending, which we find as being extremely conservative.
Bank Director Jørn Nielsen is part of the bank’s executive board and is head of credit. He has been with the bank since 1991 and has been head of credit since 2009. Over the last 30 years, the average annual losses from lending have been virtually zero – or to be exact; 0.05 percent. The worst year in this period was all the way back in 1992, when the year’s losses amounted to 0.8 percent of the total lending. The FSA also found that the bank’s lending was “characterised by a strong and centralised credit organisation and relatively low lending limits have been delegated.”
Thus, all loan applications must go through the executive board, where Jørn Nielsen, together with CEO John Fisker, must approve them – and it should also be mentioned that all loan applications must be able to be written clearly and concisely on a single piece of paper. If the reasoning and the collateral provided for a loan requires more than a single page, it is likely that there are unnecessary elements of risk associated with it – and the bank does not want to issue loans under such circumstances. Takeaway restaurants or hotels are probably not found in the books.
Lending to doctors is an excellent medicine
The centralised and healthy credit culture also means that the bank has identified niches that are attractive to lend to. These niches include areas where security for the loans can be provided either in the asset or where there is some form of collateral in the asset’s cash flows. Landbobanken finances the debt for more than every fourth transfer of medical and dental practices in Denmark. Doctors and dentists’ clinics generally generate strong cash flows, and secondly, they have a client list that can also be sold if their businesses are sound. Further, bankers have a saying that it requires alcoholism, a gambling problem or something of the kind, before doctors are unable to repay loans.
Previously, one of the largest growth areas in lending was for wind parks where ongoing electricity sales prices where guaranteed – so the bank had a higher level of certainty in the future cash flows from the wind park owners. However, due to the fall in the guaranteed prices, and changes in the guarantee period for wind parks being reduced to 10 years (previously it was 20), lending to wind parks is now a smaller proportion of the lending portfolio. However, there is still great potential in lending to those buying solar panels.
Despite what the name indicates (Landbobanken means ‘Farmer’s Bank’ in Danish), Landbobanken’s lending to the agricultural sector is only seven percent of its total, and the vast majority of this lending are first priority mortgages amounting to low percentages of the total value of the assets. This means that the bank is not exposed to much risk, even in periods where the agricultural sector is in rough financial waters, as was the case in 2018 due to the warm and dry summer in Europe.
By identifying and focusing on niche markets, the bank’s staff gain a lot of specialized knowledge and thereby not only do they become experts in assessing business opportunities, they also become better at identifying risks – and above all, unnecessary risks. Landbobanken’s strong growth in net interest income and fees has systematically been higher than the general growth in the banking sector, but this should not be viewed as an indication of the bank being willing to assume more risk or having more lenient criteria for lending. Instead, we see this as an indication that focusing on what makes a difference – and then allocating the required resources – is rewarded.
CEO John Fisker is constantly on the lookout for new opportunities
Despite a significant expansion beyond the bank’s original local area in West Jutland, the bank, as mentioned, has not experienced any major credit losses. This is a clear sign of the healthy credit culture. In relation to expanding the business into low-risk areas, the bank has opened a private banking office in Holte (north of Copenhagen) focusing on providing services to wealthy customers. This is where Regional Manager Stig Haldan, in our view, is growing a business that has high customer retention and low capital requirements at a healthy pace. For banks, like so many others, it is about making the right business deals with the right customers – and it can create a lot of value if you are able to offer the same banking customers additional services. Costs per customer are relatively fixed, so additional business with the customer will generate incrementally higher earnings. The focus is thus more on how much business the customers bring, rather than the number of customers.
CEO John Fisker has been with the bank since 1995, and he became CEO in 2012 when Bent Naur stepped down after 25 years of running the bank. Together, they helped to develop and execute the niche-focused strategy that still forms the backbone of the bank’s workings. With his high energy, John Fisker continues to pursue new, profitable and low-risk business opportunities.
Management’s high levels of optimism are, however, not a variable when it comes to determining provisions for potential loan-losses. As mentioned, lending is supported by significant provisions equivalent to almost five percent of total lending, and the bank’s core tier-1 ratio exceeds 15 percent – and, it should be noted, this is based on the FSA’s standard calculations, and thus not based on an internally risk models. The risk weighted assets therefore do not take into account that Landbobanken’s lending has, over long periods of time, proven to be more creditworthy and with losses below the banking sector average.
The bank’s loans are less than six times the bank’s core equity, and the total balance sheet is a mere eight times the core equity. These are very low levels. Thus, we find Landbobanken being very strongly capitalised, and this is good for the co-owners and minimises risk.
The target is for the core tier-1 ratio to be 13.5 percent. This lowering can be achieved via expanding risk weighted assets by growing the business, which is the solution that we prefer – and based on the high quality and high value creation that Landbobanken delivers, it seems very sensible as well. At the same time, management is disciplined about distributing capital to the owners via both dividends and share buyback programmes. In 2018, 64 percent of net income were distributed via a dividend of ten kroner per share, the equivalent of a direct yield of almost three percent, and on top of this there was a share buyback programme of 190 million kroner, equivalent to further two percent of the market value. The pay-out ratio of 64 percent has increased by one percentage point a year in the past few years. Thus, there is additional capital to generate more attractive growth in the banking business with an attractive five percent of the market value being distributed to the owners.
We are generally sceptical when it comes to bank acquisitions. However, management at Landbobanken had reviewed the books of Nordjyske Bank and had a reasonable insight into its lending, which should minimise the unforeseen risks of the acquisition. Around 46 percent of the lending in Nordjyske Bank went to retail customers with a generally low risk and the potential losses per loan in this area are less significant for a bank.
That said, making money during good times is not an indication of a bank’s true quality. True quality can only be seen on the basis of the long-term development over both good and challenging times, with the global financial crisis being a great indicator. During one of the most challenging economic environments of modern times, Landbobanken managed to get by without taking any of the state-guaranteed hybrid loans that were offered in Bank Packages I and II by the Danish Government. The return on equity never dropped below 12.5 percent after tax, even through the tough years during and after the financial crisis. As we see it, this indicates true quality – and therefore we find a lot of value in Landbobanken.