Report for 2nd quarter 2023

KBN’s net interest income in the second quarter of 2023 was NOK 507 million, as compared to NOK 477 million in the same period in 2022. A good level of growth in KBN’s lending in the first six months of the year, together with higher interest rates, contributed to the increase in KBN’s income. KBN’s lending portfolio increased by NOK 5.5 billion in the second quarter, primarily as a result of a good level of growth in fixed-rate loans. KBN’s green lending grew by NOK 1.2 billion in the second quarter. KBN’s result for the accounting period in the second quarter of 2023 was a profit of NOK 280 million as compared to a loss of NOK 77 million in the same period in 2022.

KBN’s core earnings¹ totalled NOK 360 million in the second quarter of 2023, compared to NOK 342 million in the second quarter of 2022. KBN’s core earnings in the second quarter were affected by a realised gain of NOK 101 million before tax resulting from KBN repurchasing subordinated debt capital, while its second-quarter 2022 core earnings were affected by the reversal of a tax expense of NOK 54 million. After adjusting for these non-recurring items, KBN’s core earnings were approximately unchanged from the corresponding period in 2022. Higher operating costs and an increase in the portion allocated to owners of additional Tier 1 capital reduced core earnings, while the increase in net interest income increased core earnings.

KBN’s net interest income totalled NOK 507 million in the second quarter of 2023, as compared to NOK 477 million in the corresponding period of 2022. The main reason for the increase in net interest income was rising interest rates. Money-market interest rates increased further in the quarter as a result of Norges Bank increasing its key policy rate by 0.25 percentage points at its meeting on 3 May 2023 and by 0.5 percentage points at its meeting on 22 June 2023. Norges Bank signalled that there would be further increases in the time ahead. Norway’s key policy rate now stands at 3.75%. KBN increased its standard variable rate by 0.15 percentage points with effect from 30 May and by 0.5 percentage points with effect from 10 July.

KBN’s result for the period in the second quarter of 2023 was a profit of NOK 280 million, compared to a loss of NOK 77 million in the same period in 2022. In the second quarter of 2023, KBN recognised a net unrealised loss on financial instruments totalling NOK 143 million, compared to a net unrealised loss of NOK 583 million in the second quarter of 2022. KBN’s fixed-rate lending and associated hedging instruments contributed a net unrealised loss of NOK 128 million in the second quarter of 2023, primarily as a result of a widening of credit spreads for the local government sector. There was an equivalent net unrealised loss of NOK 508 million in the second quarter of 2022. KBN started to apply hedge accounting to all its new fixed-rate lending with effect from 1 January 2022. The application of hedge accounting to KBN’s fixed-rate lending will over time reduce the size of the portfolio of fixed-rate loans carried at fair value, and this will reduce the unrealised gains and losses included in KBN’s earnings.

KBN’s liquidity portfolio and associated hedging instruments contributed a net unrealised loss of NOK 3 million for the second quarter of 2023, while KBN's own bonds and associated hedging instruments contributed a net unrealised loss of NOK 12 million, which shows that the fair value of these items was relatively stable in the quarter. KBN’s unrealised gains and losses are expected to reverse, either as market conditions normalise or as the instruments approach maturity. Sales of securities from the liquidity portfolio resulted in a realised loss totalling NOK 7 million in the second quarter.

KBN’s provision for losses is relatively limited due to the fact that Norwegian municipalities cannot be declared insolvent. KBN’s liquidity management portfolio is also of very high credit quality. KBN decreased its provision for losses in the second quarter of 2023 by NOK 7 million.

KBN’s total operating costs for the second quarter of 2023 were NOK 75 million, compared to NOK 63 million in the same period in 2022. The increase in operating costs was due to a higher level of activity and inflation.

KBN’s core earnings² in the first six months of 2023 totalled NOK 640 million as compared to NOK 591 million in the first six months of 2022. KBN’s core earnings in the first six months of 2023 were affected by a realised gain of NOK 101 million before tax resulting from KBN repurchasing subordinated debt capital, while its core earnings in the first six months of 2022 were affected by the reversal of a tax expense of NOK 54 million.

KBN’s net interest income in the first six months of 2023 was NOK 1,015 million, compared to NOK 913 million in the same period in 2022. The increase was primarily due to higher interest rates in combination with higher lending margins and good lending growth.

KBN’s result for the period in the first six months of 2023 was a profit of NOK 669 million as compared to a loss of NOK 429 million in the same period in 2022. KBN recognised unrealised losses on financial instruments totalling NOK 29 million in the first six months of 2023, compared with unrealised losses totalling NOK 1,405 million in the same period in 2022. Net unrealised losses on the portion of KBN’s fixed rate lending carried at fair value caused by an increase in credit spreads were the main reason for the unrealised losses in the first six months of 2022 and 2023.

KBN’s total operating costs for the first six months of 2023 were NOK 151 million, compared to NOK 129 million in the first six months of 2022. The increase was due to a higher level of activity and inflation. The annual salary settlement comes into force with effect from 1 January, but is only disbursed and expensed starting in July. The impact on costs of the salary settlement process is therefore recognised in its entirety in the second six months of the year. KBN’s cost-to-income ratio³ for the first six months of 2023 was 14.4%, compared to 14.9% in the same period in 2022. The reason for the decrease in the cost-to-income ratio was the increase in KBN’s income.

Based on its result from ordinary activities, KBN’s annualised return on equity in the first six months of 2023 was 7.5%, compared to -5.6% in the same period in 2022. Based on its core earnings, KBN’s annualised return on equity in the first six months of 2023 was 7.8%, compared to 7.1% in 2022.

KBN’s total comprehensive income for the period in the first six months of 2023 was NOK 628 million, compared to a loss of NOK 282 million in the same period in 2022. KBN’s total comprehensive income in the first six months of 2023 includes a gain of NOK 40 million after tax on KBN’s bonds as a result of a change in KBN’s own credit risk.

Table 1: Result for the period and total comprehensive income

KBN’s lending portfolio totalled NOK 336 billion⁴ at the end of the second quarter of 2023. The lending portfolio increased by NOK 5.5 billion in the second quarter, while it decreased by NOK 4.0 billion in the second quarter of 2022. In the second quarter, the relatively unattractive terms available to KBN’s customers in the capital markets created better market conditions for KBN’s long-term instalment-based loans. The favourable market conditions for fixed rate loans, with long-term fixed rates being lower than floating rates, resulted in many customers choosing to change from floating to fixed-rate loans.

Increasing demand for new loans is expected over the course of the rest of the year. The fact that credit spreads in the capital markets continue to be wide is making it less attractive for KBN’s customers to obtain shorter maturity financing in the capital markets. KBN therefore expects there to continue to be a good level of demand for refinancing using long-term instalment-based loans. The figure below shows the changes in KBN’s quarterly lending growth from 2021 until the present.

KBN continued to experience a good level of growth in its green lending, and its portfolio of green loans increased by NOK 1.2 billion in the second quarter of 2023, as compared to NOK 1.5 billion in the same period in 2022. KBN granted green loans in the quarter to municipalities and county authorities including Møre og Romsdal county authority and Bergen municipality. At the end of the second quarter, KBN’s green lending represented 13.2% of its overall lending portfolio. KBN’s target is for 15% of its lending to be green lending by the end of 2023.

The annual rate of debt growth in the local government sector as at the end of June 2023 was calculated to be 5.9%. After adjusting for borrowing from the Norwegian State Housing Bank, the rate of debt growth was 5.1%. Strong growth in prices and higher interest rates mean that weaker investment growth and thus lower debt growth are expected in 2023 compared with previous years. After adjusting for borrowing from the Norwegian State Housing Bank, KBN’s market share at the end of June was 50%.

Chart 1: Quarterly lending growth in billion kroner

The rate of inflation fell in the first six months of 2023, but it remains materially above the targets set by the central banks of many countries across the world. A number of central banks consequently raised their key policy rates. Norway’s central bank raised its key policy rate by a total of one percentage point over the course of the first six months of the year. Despite this, the rate of inflation in Norway remained high, and was running at 5.4% at the most recent assessment in July. The US dollar and Euro strengthened against the majority of currencies in the first six months of the year, including the Norwegian krone. The Norwegian krone strengthened somewhat in connection with Norges Bank’s interest rate decision in June, but nonetheless remains at a historically low level. The market expects further interest rate rises in Norway in 2023, but there is much uncertainty about how high interest rates will go. The uncertainty is leading to a high level of volatility in the fixed income market and the equity market, and for the Norwegian krone.

The credit spreads on local government and covered bonds fell at the start of the year but rose again over the following months. At the end of the second quarter spreads were higher than at the start of 2023. The outlook for future changes in the spreads on local government and covered bonds is uncertain, both in Norway and internationally.

In 2020 the UK’s Financial Conduct Authority (FCA) decided that LIBOR would be discontinued and would cease to be quoted with effect from 1 July 2023. The reference rate therefore had to be replaced by a new, risk-free reference rate for current contracts and activities. For the USD, LIBOR was replaced by the Secured Overnight Financing Rate (SOFR) reference rate. KBN did not have any bonds with a floating LIBOR rate at the time of the transition, but it holds a significant portfolio of financial derivatives with USD LIBOR as their reference rate. The transition is regulated by a transition clause in the ISDA agreement for financial derivatives, which means a change in the reference rate from three-month USD LIBOR to USD SOFR with a spread premium of 26.16 basis points. In line with this, KBN converted all its ongoing derivative contracts to USD SOFR in the second quarter. The conversion did not have a material impact on KBN’s earnings in the quarter.

KBN’s funding activities in the second quarter of 2023 were at a relatively normal level. The uncertainty in the markets during the period did not impact KBN’s access to the international capital markets to any significant extent, and KBN completed its funding transactions as planned. The weakness of the Norwegian krone relative to the US dollar increased KBN’s liquidity as a result of liquidity inflows from cash collateral from currency hedging instruments over the second quarter, and KBN's funding activities were therefore somewhat less extensive during the quarter. In the first six months of 2023 KBN’s new borrowings totalled approximately NOK 32.9 billion through 26 bond issues in nine currencies, as compared to NOK 47.5 billion in the first six months of 2022. The figure below shows the breakdown of new borrowings by currency.

Chart 2: New borrowings by currency in the first six months of 2023

KBN continues to enjoy low borrowing costs and good market access thanks to its AAA/Aaa rating.

KBN’s liquidity portfolio totalled NOK 124 billion⁵ at the end of the second quarter of 2023 as compared to NOK 108 billion at the same point in 2022. KBN’s liquidity portfolio is managed with the aim of matching its financing requirements, including lending growth, for the subsequent twelve months, and it is managed on the basis of a low-risk investment strategy.

The liquidity portfolio is principally held in zero-risk-weighted assets that are particularly liquid. Investments denominated in foreign currencies represent 50% of the portfolio. Fluctuations in the value of the Norwegian krone relative to other currencies will therefore result in fluctuations in the size of the liquidity portfolio in NOK terms. The weakness of the krone in the first six months of 2023, including in the second quarter, therefore explains the increase in the size of the portfolio relative to the same time last year and the start of 2023.

At the end of the second quarter of 2023, KBN’s total common equity Tier 1 capital was NOK 15.8 billion, its total Tier 1 capital was NOK 19.3 billion, and its total primary capital was NOK 20.1 billion. KBN’s total assets at the end of the second quarter of 2023 amounted to NOK 516 billion, up from NOK 492 billion at the end of 2022. KBN’s total assets at the end of the second quarter of 2022 amounted to NOK 496 billion. The increase from the end of 2022 is primarily due to liquidity inflows from cash collateral from currency hedging instruments caused by the weakening of the Norwegian krone, growth in KBN’s lending, and an increase in the NOK value of balance sheet assets as a result of currency conversion.

In the second quarter, KBN repurchased NOK 1.2 billion of subordinated debt capital and in connection with this issued an additional Tier 1 capital instrument with an equivalent initial redemption date as the subordinated debt capital. The repurchasing of the subordinated debt capital resulted in a realised gain of NOK 101 million before tax, which was recognised to income in the quarter. The transaction strengthened KBN’s Tier 1 capital adequacy ratio and its leverage ratio.

At the end of the second quarter of 2023, KBN had a common equity Tier 1 capital adequacy ratio of 18.6%, a Tier 1 capital adequacy ratio of 22.7%, and a total capital adequacy ratio of 23.6%. The capital adequacy ratio requirements imposed by the authorities at the end of the second quarter were 15.3% (common equity Tier 1 capital), 16.8% (Tier 1 capital) and 18.8% (total capital).

KBN received the Financial Supervisory Authority of Norway’s (Finanstilsynet’s) decision regarding its Pillar 2 requirement (SREP) on 11 April 2023. The Financial Supervisory Authority of Norway has determined that KBN must have a Pillar 2 capital requirement that represents 2.1% of the basis for calculation under Pillar 1. KBN’s Pillar 2 capital requirement has thus been reduced by 0.1 percentage points. The Pillar 2 requirement is intended to address risks that the undertaking is exposed to and that are not, or are only partially, covered by the general capital requirements in Pillar 1. The requirement must be satisfied with at least 56.25% common equity Tier 1 capital and at least 75% Tier 1 capital, whereas previously it has to be satisfied 100% with common equity Tier 1 capital. The requirement came into effect on 30 April 2023.

KBN’s leverage ratio at the end of the second quarter was 4.0%, as compared to the requirement of 3.0%.

Capital adequacy figures are sensitive to large fluctuations in exchange rates, particularly the USD-NOK rate, because these impact the size of KBN’s balance sheet both through the conversion into NOK and because changes in the value of KBN’s outstanding currency hedging contracts cause fluctuations in cash collateral. When the krone weakens, KBN receives collateral, the size of KBN’s balance sheet increases and KBN’s capital adequacy decreases. When the krone strengthens, KBN’s capital adequacy increases. The figures for weighted capital adequacy are also temporarily affected by changes in the value of KBN’s hedging contracts until the cash collateral is received the following day and the additional effect is offset. KBN has internal buffers that are intended to ensure its capital adequacy does not fall below the regulatory requirements as a result of such exchange rate fluctuations.

In 2022, KBN increased its long-term climate target for reductions of own emissions to at least a 55 per cent reduction by 2030, compared to the 2019 level. The emissions trajectory implies a CO₂ emission of a maximum of 70 per cent of the 2019 level in 2023, corresponding to approximately 130 CO₂e for the year. There has been an increase in calculated emissions from 2022 to 2023, mainly due to more normalized travel activity in 2023. KBN is equally well placed to reach the target of the desired reduction in own emissions⁶.

Norges Bank raised its key policy rate to 3.75% by means of its May and June 2023 monetary policy committee meetings, and it has communicated that it will probably increase the rate further at its 17 August meeting. Norges Bank has stated that the reason for the increase is the need to reduce inflation. The goal of monetary policy is for the annual rate of growth in the consumer price index to be as close as possible to 2% annual growth. Norges Bank’s forecast for its key policy rate indicates that it will reach 4.25% this autumn. The future path of the policy rate thereafter will depend on economic developments.

The war in Ukraine, uncertainty about the economic outlook, and the turmoil in the banking sector earlier in 2023 have caused long-lasting uncertainty in the fixed income market. The widening in credit spreads for local government sector issuers in the capital markets has continued in 2023, and at the end of the second quarter spreads for five-year financing were approximately 8 basis points higher than at the end of 2022. It is still uncertain whether credit spreads will fall through late summer and the autumn, or whether they will stabilise at a higher level. This, in combination with the increases in money market rates, has made it more expensive for our customers to finance their investment spending. Seen in isolation, these factors may result in a decrease in demand for financing going forward, and KBN also expects to see a lower rate of growth in borrowing by the local government sector in 2023 relative to previous years.

The level of demand for KBN-issued bonds continues to be good, and the increase in the credit spreads on KBN’s bonds has been relatively moderate. This means that KBN is in a good position to improve its profitability and to further strengthen its long-term capitalisation and lending capacity.

KBN has good access to liquidity and will continue to provide its customers with attractive financing for local government sector projects right across Norway.

We confirm that the half-year financial statements for the period 1 January 2023 to 30 June 2023 have, to the best of our knowledge, been prepared in accordance with IAS 34 Interim Financial Reporting, and that the information contained in the financial statements gives a true and fair view of the company’s assets, liabilities, financial position and results as a whole.

We also confirm that, to the best of our knowledge, the half-year report provides a true and fair overview of important events during the accounting period and their effects on the half-year financial statements, and also of the material risks and uncertainties facing the company during the next accounting period.

Oslo, 10 August 2023

The Board of Directors and Chief Executive Officer of Kommunalbanken AS