A zero-rate environment in Norway will put the country's savings banks' net interest margins and profitability under pressure. On top of rising loan losses, it could have a "dramatic impact" on the Norwegian banking sector, according to Nordic Credit Rating, which found that some banks risk falling foul of capital requirements.

The Norwegian savings bank business model is typically based on taking customer deposits and providing retail mortgage loans. There are more than 100 savings banks in Norway and they play an important role in the banking sector, claiming some 45% share of the retail lending market, with large Nordic commercial banks such as DNB ASA, Danske Bank A/S, Nordea Bank Abp and Svenska Handelsbanken AB (publ) accounting for most of the remaining market.

Customer deposits are one of the most important funding sources for savings banks, which have benefited from widening deposit margins as Norges Bank hiked policy rates once in late-2018 and three times in 2019.

In 2019, the average net interest margin at 18 of Norway's largest savings banks rose to 1.87% in the fourth quarter from 1.65% in the first quarter, according to S&P Global Market Intelligence data.

For the first time in its history, Norges Bank lowered its key policy rate to zero percent May 7, the third cut in under two months, from 1.5% due to the worsening economic situation. The zero percent rate is likely to continue to 2023, according to the central bank's forecast.

A zero-rate environment will prompt "large headwinds" to savings banks' net interest income, particularly in the short term because of a lag between repricing of lending and deposit rates, said Žilvinas Jusaitis, senior analyst at Norne Securities, a Norwegian investment bank.

While banks took immediate action to lower lending rates in order to support their customers, the repricing of deposits takes months, he said. Norwegian savings banks have reduced the mortgage lending rates by up to 40 basis points. In total, customers have absorbed more than 83% of the policy rate cuts over the last two months, according to Jusaitis.

Additionally, since the Norwegian interbank offered rate, or Nibor, is usually set on a quarterly basis in a bank's funding, the benefits from lower funding costs will only be fully visible in the third quarter of 2020, he said.

Jusaitis expects that net interest income for Norwegian savings banks will take a more than 7% dip in the second quarter of the year and be "relatively flattish" in the third quarter, with net interest margins likely to fall around 15 bps through 2020 and 2021.

Deposit spreads down

Nordic Credit Rating expects Norwegian savings banks to take an even harder hit from the interest rate cut. The credit rating agency found in an analysis that a representative savings bank's net interest income could drop 24% by 2021 due to the effect of lower short-term rates. It would bring net interest margins down 45 bps and lower return on equity by 20% to 30%.

Banks will face a significant fall in combined deposit and mortgage spreads, particularly in the second and third quarters of 2020, the analysis said. It forecasts the average deposit spread to fall 152 bps from the fourth quarter of 2019, which is not mitigated by the anticipated 13 bps increase in lending spreads.

This scenario is based on the assumption that savings banks are unlikely to lower deposit rates below 10 bps on average, said Geir Kristiansen, analyst at Nordic Credit Rating. This would be similar to what happened in Sweden, where banks avoided cutting deposit rates below zero even after the central bank had introduced a negative rate in 2015.

Banks in competitive regions will feel the impact of the policy rate change on their margins, according to Kristiansen. The growth of niche consumer lending banks — which charge higher prices on lending and are thus able to pay better rates on deposits — is prompting "real competition for deposits in Norway," together with the presence of large Nordic banks, he said.

SpareBank 1 SR-Bank ASA in Stavanger and Sparebanken Vest in Bergen are examples of savings banks that will face strong competition, while those that are dominant in their regional or the local market, such as SpareBank 1 Nord-Norge in Northern Norway, may be less sensitive to the rate cut, he said.

Other developments could work in savings banks' favor, Jusaitis said. Household savings might grow due to economic uncertainty, which could increase banks' flexibility in determining deposit rates.

Furthermore, a zero-rate environment helps to support households and corporates' creditworthiness and lending volumes, and ultimately reduces the risk of credit losses, he said.

Growing loan losses

Like their European peers, Norwegian savings banks are facing higher loan losses due to the coronavirus crisis and oil price slump, with the cost of risk in the first quarter of 2020 rising to an average of 44 bps among the 18 banks in S&P Global Market Intelligence's sample.

While savings banks are predominantly mortgage banks, the share of corporate loans within their lending is on average 33%, according to Nordic Credit Rating's analysis. Of this, an average of 44% consists of loans to commercial real estate, which "would pose a major risk in a protracted crisis," it said.

Loan losses so far are a result of general macroeconomic developments as exposure to short-term high-risk sectors such as retail, hotel and restaurants is relatively low, at an average of 5% to 6% of total corporate exposures, Jusaitis said. Savings banks generally do not have a large exposure to oil sectors either, he said.

Norwegian savings banks are well prepared to survive the impact of the coronavirus crisis due to their strong capitalization, Kristiansen said. Common Equity Tier 1 ratios in S&P Global Market Intelligence's sample were on average 17.2% in the first quarter of 2020.

Nevertheless, some banks could be at risk of breaching their pillar 2 buffer requirements if loan losses reach the levels of 1991 amid the country's last major banking crisis, according to Nordic Credit Rating, which identified Sparebanken Sør, SpareBank 1 SR-Bank, Sparebanken Møre, SpareBank 1 SMN, Totens Sparebank and Sparebank 1 Nordvest as banks that are most exposed.