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Denmark’s two leading banks are gearing up for what Thorleif Krarup, chief executive officer of Unibank, describes as “the coming battle in European banking”. Unibank and its main domestic rival, Den Danske Bank, are threatened by competition that will emerge as banks in Sweden and Germany consolidate. Another cause for concern is that Denmark will be left out of the first round of European economic and monetary union (Emu). Both banks have therefore embarked on ambitious diversification at home and expansion in the Nordic region to safeguard their future in what will be a euro-denominated banking market. Denmark will join Emu only if a single European currency is approved by a national referendum. This effectively rules out adopting the euro on January 1 1999 with inner core countries such as Germany and France. Some analysts believe that even if the Danes vote to accept the euro, there could be a delay before the banks’ systems are able to cope with the single currency. Knud Sørensen, chairman of Den Danske Bank, says that if competition becomes distorted by banks operating in the Emu system obtaining better funding terms, his bank may have to consider moving part of its activities abroad. This, he says, could entail placing daily liquidity management operations in Hamburg or other nearby markets. “But there is still more than two years to go,” he says, “so our position now is to keep a watchful eye on the situation.” Unibank’s Krarup says the bank needs to do its forward planning now to meet the challenges of operating outside Emu. “Clearly, our large corporate clients are strongly affected by interest rates within the EU and they will be demanding services and products in euros,” he says. “We will have to build up a parallel system in order to service these customers. A lot of cash management will be run in euros, there will be a demand for loans in euros and that means we will see an increasing portion of our assets in the single European currency. In the long term this could pose problems for Danish banks so we might have to set up funding bases in Luxembourg or Frankfurt, for instance.” Consolidation in the German and Swedish banking markets within the Emu system, given the potential size of the banks involved and the likelihood of their access to funding at privileged rates, poses big problems for smaller banks struggling to defend their home turf. There is already serious talk about Sweden’s Sparbanken Sverige merging with or taking over Foreningsbanken. And the market believes this could trigger a broader realignment through the coming together of three or four other mergers. “Size will mean a lot within Emu,” says Unibank’s Krarup. “This is one of the main reasons why we are expanding and consolidating our position in the Nordic region. We have come to consider this our domestic territory and we need to build up our presence for the coming battle. This is why we are working to become bigger in the Nordic market.” Safety first at home Krarup believes it would make more sense from the point of view of delivering shareholder value if Swedish and German banks were to consolidate their domestic positions before going after foreign market share. He points out that none of these banks has more than a 5% to 10% share of its respective domestic market, while Unibank and Den Danske hold nearly 60% of the overall Danish banking market and up to 80% of some business areas. Krarup reckons consolidation among German banks will take five or six years. “After that they will start to look at neighbouring markets, and that is when it could become a challenge,” he says. Den Danske’s Sørensen says there is no need for Danish banks to get unduly alarmed by the challenges of Emu and the threat of encroachment by more powerful foreign rivals. “We should not allow ourselves to become overly frightened, but of course we need to be aware of these developments and take the necessary steps,” he says. “We feel that within our bank we have the capacity to cope quite well in terms of management and equity.” The fact is that despite being in what appears to be a vulnerable position, Denmark’s two big banks are by no means pygmies. In the past two years they have shown themselves to be aggressive in taking on new business and moving in on neighbouring markets. Den Danske’s and Unibank’s management teams are considered comparable in quality and efficiency. A major difference is size Den Danske’s total assets of Dkr411.9 billion ($70 billion) are well ahead of Unibank’s Dkr297.2 billion, and Den Danske’s Dkr2.35 billion pre-tax profits are almost double Unibank’s. Den Danske is also considered the more conservative, blue-blooded institution, geared toward big-ticket corporate lending and the upper end of the retail market, while Unibank’s focus is more on middle corporates and the lower segment of the personal sector. The Nordic gambit is a key part of both banks’ strategies to strengthen their defences against the coming European challenge. “We have defined the Nordic region as our natural home territory,” says Den Danske’s Sørensen. “We have opened branches in Helsinki, Stockholm and Oslo and are in the process of opening offices in Malmö and Gothenburg. We are already running quite a book on these three countries, mainly with leading corporates and public authorities.” Sørensen says he does not rule out the possibility of moving into the Nordic retail sector and Den Danske also has ambitions in regional capital markets and investment banking. “One of our strategic aims is to become a bigger and more visible bank,” he says. “Another is to broaden our portfolio in Britain where we have been operating for 15 years. Things have gone very well there and we operate in the UK as core bank for a number of British companies.” Unibank’s Krarup expects cross-border competition to hot up in the Nordic region in the coming years. Unibank has also opened branches in the Nordic capitals and Krarup regards this as a domestic banking region for wholesale operations, securities trading and foreign exchange. “We have similar languages and legal systems,” he says. “In spite of closer ties through the EU and the mass media, there is still a significant cultural gap between the Nordic countries and western Europe.” Krarup showed his determination to consolidate Unibank’s position in the Nordic investment banking market last August when the bank bought Asea Brown Boveri’s international stockbroking activities, ABB Aros Securities. This gave Unibank a stronger regional position in equities, research and corporate finance. Krarup says that with this acquisition Unibank boosted its market share in Nordic equities to about 8% or 9% in Sweden and 10% to 12% in Finland. “We have just started up in Norway and we are now one of the three major players in the Nordic region, along with Carnegie, which belongs to Singer & Friedlander, and ABN Amro’s Alfred Berg,” he says. Denmark’s two big banks were both born of mergers that took place about six years ago. They were ahead of the consolidation game in the rest of Europe and have created economies of scale at home and have begun to use their new-found strength to penetrate markets abroad. Den Danske managed to consolidate the cultures and systems of its two banks with comparatively little pain. Along with Svenska Handelsbanken it emerged unscathed from the Nordic banking crisis of the first half of the 1990s. At the outset Unibank, which attempted a more ambitious merger by trying to put together three banks of different size and cultures, had a rougher time. Then in 1992 Krarup was called in from his job as chief executive of Denmark’s largest mortgage lender to crack the whip. “The merger is now completed but it has taken a long time,” he says. “The new bank wasn’t going forward at the right pace, but now after five years all the systems are in place.” Denmark’s banks are cashing in on a more relaxed regulatory environment and buoyant economic growth, which Krarup expects to continue on a firmer basis than in the past. “There are good opportunities in the market if you can keep a tight rein on credit risks and costs with the next downturn in mind,” he says. Underlying growth in loan demand had been extremely sluggish over the past four or five years and the banks were also adversely affected by an inverted yield curve until recently, short-term rates were substantially higher than long-term ones. Customers therefore rushed to take out long-term home financing from mortgage lenders instead of relying on commercial bank loans. “What we are witnessing this year, which I would expect to see carrying on into 1997, is stronger demand on the back of a normalized yield curve,” says Krarup. “We are now operating on 3.5% overnight rates, which means that we can lend at 6% to 7%, compared with 8% or 9% for the mortgage lenders.” Sørensen reckons Danish banks will benefit from a period of good economic growth that has enabled them to build up a strong capital base and provisions. “The Danish banks are hungry for business and there is a lot of price-cutting and fierce competition,” he says. “Interest margins are shrinking dramatically and if this continues some of the smaller banks could find themselves in trouble. People are taking a lot of risks that would have been considered unthinkable five years ago.” Bad-debt provisions remain at a high level despite the improved outlook. Both big banks are at a provisioning ratio approaching three times their disclosed bad debt portfolio, although unlike British banks the Danes disclose only the level of non-performing loans, not doubtful debts, which typically can amount to 20% or 30% of their non-performing loans. Could Danish banks, which have yet to return money to shareholders, be considered overcapitalized? “It would be hard to say we are overcapitalized,” says Sørensen. “It would be fairer to say we are well provisioned in terms of providing a buffer against losses on our loan book. In that respect we rank in the top European league.” The two big Danish banks operate on exceptionally high Tier 1 capital ratios, nearly 9% in the case of Unibank and 7.5% for Den Danske Bank as a result of its recent insurance acquisition. The banks are required to apply mark-to-market accounting principles on all their assets, so they have to readjust their valuations yearly. Bankers argue that if interest rates start an upward trend, they will need a strong capital base so they are able to absorb losses on their bond portfolios. “We believe that a 7% Tier 1 capital ratio is a reasonable target for Unibank,” says Krarup. “We are confident that we can cover the difference with asset growth over the next couple of years. With the opportunities in commercial banking and other areas now coming into the market I would not say we are overcapitalized. This is also one of the reasons why we have not had a rights issue.” Trimming costs Cost-cutting has become a prominent feature since the two banks put their respective mergers together and Denmark, along with the rest of Europe, entered an environment of low inflation and low interest rates. The market regards Den Danske as the more aggressive cost-cutter. It has reduced its staff from more than 16,000 to about 11,000 over the past five years. “Within our small country this has been a very eye-catching exercise,” says Sørensen. “I cannot say that this will continue at the same pace but we will see more staff shrinkage in the coming years. We will also be in the forefront in introducing new technology. We believe the Danish public is well geared to work with this as up to 40% of all households now have a personal computer.” Krarup says that in the years he has been at the helm of Unibank the group has managed to trim costs by some Dkr1 billion, and he looks forward to the cost base remaining flat this year. “We have set a cost-income ratio target of 60% which we believe is attainable within three years,” he says. This ratio, a measure of a bank’s efficiency, currently stands at 68%. “The reduction will be achieved by cost-cutting, not just by adding on new business,” he says. “This means bringing in new technology and increasing the overall efficiency of our existing systems. With more demand coming into the market we see the need for dramatic cost-cutting.” The two Danish banks are now jostling for position in non-traditional markets such as life assurance and mortgage lending. A lower priority, but one which appears to be on the cards, is the future rationalization of domestic banking. Both banks are keenly aware of the need to trim their cost base further in a low inflation environment. “Until a couple of years ago the mortgage and insurance markets were off-limits to the banks,” says Matthew Czepliewicz, equity research director at Salomon Brothers in London. “Since the restrictions were lifted the mortgage lenders have been losing business to the banks. Den Danske and Unibank have moved into this market in a very aggressive way.” With competition growing in the domestic retail market and banks’ lending margins being squeezed, Unibank decided to diversify into mortgage business two and a half years ago. Since then it has built up a home loan book valued at Dkr40 billion, making it Denmark’s fourth-largest player in the market after the three traditional mutuals. “Demand is starting to return to personal lending and we can foresee a growth rate of 5% to 6% a year, but the mortgage market is showing much more dramatic growth,” says Krarup. “We should easily be able to increase our mortgage book above Dkr100 billion and we have set ourselves a target of Dkr150 billion in the near term, about 20% of the total market. We already have an 18% market share of new gross lending.” Den Danske has also moved into mortgage lending, a business Sørensen calls “a major growth area”. This more conservative of the big two banks considers portfolio management to be another area in which it can build its profile as a universal bank. With the acquisition last year of the Danica group of companies from Baltica Forsikring for about Dkr6.8 billion, Den Danske became a major player in the lucrative life assurance business. Danica raised the value of the bank’s assets under management to nearly $30 billion, large by Danish standards. “This year we set up a separate asset management company and we look forward to good results from that venture,” says Sørensen. He also points to consumer financing as a way forward. Many customers seem to prefer paying over the odds for a loan obtained via the anonymity of a computer-scored application form rather than having to face embarrassing questions from a credit officer in a branch office. A dilemma for the banks in their domestic strategy is how they will deal with competition from small and medium-sized regional and local players. Market participants reckon that in the longer term, especially after Emu, there will probably be room in the Danish market for at most the two big banks. Of the two, Den Danske seems the least enthusiastic about embarking on domestic acquisition trails. “I don’t foresee very clearly an active role by our bank in any future consolidation in the home market,” says Sørensen. “On the other hand, while we are now enjoying the benefits of economic growth and lower provisions, harder times might be around the corner. There could be a situation in which we were called upon by the authorities to help bail out smaller banks in trouble. In that case I could not rule out the possibility of getting involved in some rationalization process, as a result of friendly persuasion by the central bank or in our own interest. But this is not a high priority for us.” Setting pricing Unibank’s Krarup, on the other hand, sees opportunities for further rationalization in the domestic market as the banking sector becomes more polarized between the big players and smaller local banks. Three or four years ago, he says, the small banks and niche players set the pricing in the market. Today this is in the hands of the big banks. The smaller banks, says Krarup, are going to find market conditions even tougher when Emu is instituted. The two large banks can build up a system of access to a euro-based source of funding, but small or medium-sized regional players lack sufficient international exposure or contacts to do so. “We are open to discussion,” he says. “It is quite feasible that some of the smaller and medium-sized banks might like to acquire a larger identity. From a shareholder’s point of view I think it makes more sense to expand and maximize profits on our existing customer base.” Krarup says Unibank’s overall strategy is to broaden its existing business network, attract new customers and “tell the market that if somebody would like to join Unibank we are willing to discuss that possibility”. * |
