Valuation of the Nordic banking sector is low

The rise in market rates that began in March, has continued as strong in recent months and the 12-month Euribor, which is the most common reference rate for housing loans in Finland broke the 2.0% landmark last Friday. For most Nordic banks net interest income is the main source of income and the rapid rise in interest rates will clearly boost the sector's earnings development in the next few years. For example, among the banks we monitor, Aktia has estimated that a one percentage point increase in the interest rate level would improve its net interest income by about EUR 30 million and the positive effect of a similar interest rate shock for OmaSp is about EUR 20 million.

Increased interest rates are not only a positive for banks, as rising interest costs, the current high inflation rate and weakening economic development will reduce the credit demand of households and businesses. In the short term, the rise in interest rates also creates a clear headwind for banking businesses dependent on capital markets. Moreover, the possibly looming economic downturn is likely to increase the credit losses of the banking sector. Even considering these negative factors, we expect that the impact of the increase in interest rates will be net positive for most of the companies.

The Nordic banking sector is currently priced at a 12 month forward-looking P/E ratio of 9x, which represents more than a 20% discount on the industry’s historical levels. Considering the earnings leverage the increasing interest rates bring for the next few years, we feel the current valuation paints too gloomy a picture of the sector's earnings outlook. In the light of historical valuation multiples justifying the current pricing would, according to our estimates, require a relatively deep recession and a clear deterioration of earnings.

Overall, we are quite positive about the banking sector and believe that the valuation levels that have been pushed down already provide a clear safety margin for potential negative news. Our positive views are reflected in our recommendations for both Aktia (Buy) and OmaSp (Buy).