Report for 3rd quarter 2023

KBN’s net interest income in the third quarter of 2023 was NOK 556 million, as compared to NOK 473 million in the same period in 2022. A good level of growth in KBN’s lending in the first nine months of the year, together with higher interest rates, contributed to the increase in KBN’s income. KBN’s lending portfolio increased by NOK 5.6 billion in the third quarter. KBN’s green lending grew by NOK 2.4 billion in the third quarter. KBN’s result for the accounting period in the third quarter of 2023 was a profit of NOK 197 million as compared to a profit of NOK 145 million in the same period in 2022.

KBN’s core earnings¹ totalled NOK 298 million in the third quarter of 2023, compared to NOK 249 million in the third quarter of 2022. The increase in net interest income was the reason for the strong increase in core earnings. The main reason for the increase in net interest income was rising interest rates.

KBN’s net interest income totalled NOK 556 million in the third quarter of 2023, as compared to NOK 473 million in the corresponding period of 2022. 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 16 August and by a further 0.25 percentage points at its meeting on 20 September. Norges Bank signalled that there would probably be a further increase at its December meeting, but this will depend on economic developments. Norway’s key policy rate now stands at 4.25%. KBN increased its standard variable rate by 0.4 percentage points with effect from 5 September and by a further 0.1 percentage points with effect from 23 October.

KBN’s result for the accounting period in the third quarter of 2023 was a profit of NOK 197 million, compared to a profit of NOK 145 million in the same period in 2022. In the third quarter of 2023, KBN recognised a net unrealised loss on financial instruments totalling NOK 187 million, compared to a net unrealised loss of NOK 163 million in the third quarter of 2022. KBN’s fixed-rate lending and associated hedging instruments contributed a net unrealised gain of NOK 152 million in the third quarter of 2023, primarily as a result of a moderate decrease in credit spreads for the local government sector. There was an equivalent net unrealised loss on fixed-rate lending and associated hedging instruments of NOK 543 million in the third 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 71 million for the third quarter of 2023, while KBN's own bonds and associated hedging instruments contributed a net unrealised loss of NOK 267 million to its result from ordinary activities, primarily as a result of an increase in basis spreads. 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 5 million in the third 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 third quarter of 2023 by NOK 7 million. The reduction is due to model adjustments and an estimated decrease of default risk.

KBN’s total operating costs for the third quarter of 2023 were NOK 87 million, compared to NOK 67 million in the same period in 2022. The increase in operating costs was due to a higher level of activity mainly related to development, wage growth and inflation.

KBN’s core earnings² in the first nine months of 2023 totalled NOK 938 million, compared to NOK 840 million in the first nine months of 2022. KBN’s net interest income in the first nine months of 2023 was NOK 1,572 million, as compared to NOK 1,387 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 nine months of 2023 was a profit of NOK 866 million as compared to a loss of NOK 283 million in the same period in 2022. KBN recognised net unrealised losses on financial instruments totalling NOK 216 million in the first nine months of 2023, compared with net unrealised losses totalling NOK 1,567 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 nine months of 2022 and 2023.

KBN’s total operating costs for the first nine months of 2023 were NOK 238 million, compared to NOK 197 million in the first nine months of 2022. The increase was due to a higher level of activity, wage growth and inflation. KBN’s cost-to-income ratio³ for the first nine months of 2023 was 15.1%, compared to 15.3% 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 nine months of 2023 was 6.3%, compared to -2.7% in the same period in 2022. Based on its core earnings, KBN’s annualised return on equity in the first nine months of 2023 was 7.6%, compared to 6.8% in 2022.

KBN’s total comprehensive income for the period in the first nine months of 2023 was NOK 758 million, compared to NOK 202 million in the same period in 2022. KBN’s total comprehensive income in the first nine months of 2023 includes a gain of NOK 107 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 341 billion⁴ at the end of the third quarter of 2023. The lending portfolio increased by NOK 5.6 billion in the third quarter, while it increased by NOK 5.9 billion in the third quarter of 2022. In the third quarter of 2023 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.

Increasing demand for new loans is expected over the course of the rest of the year, in line with normal seasonal variation. 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 the third quarter of 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 2.4 billion in the third quarter of 2023, as compared to NOK 3.1 billion in the same period in 2022. KBN's green lending in the quarter included sizeable green loans to the City of Oslo for the Tåsenhjemmet and Majorstuhjemmet nursing homes. At the end of the third quarter, KBN’s green lending represented 14.2% 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 August 2023 was calculated to be 7%. After adjusting for borrowing from the Norwegian State Housing Bank, the rate of debt growth was 6.1%. 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 August was 50.4%.

Chart 1: Quarterly lending growth in billion kroner

Inflation was reduced in the first nine 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 1.5 percentage points over the course of the first nine months of the year. The rate of inflation in Norway was running at 3.3% at the most recent assessment in September, which is a marked decrease from previous months. Core inflation was 5,7 %. This is, however, still higher than Norway’s target rate, and it is not clear how long it will take for it to reach the target. 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. The US dollar and Euro strengthened against the majority of currencies in the first nine months of the year, including the Norwegian krone. The Norwegian krone is at a historically low level. The market is pricing in a 50% probability of a further interest rate rise in Norway, but largely considers the policy rate to have peaked. 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 third quarter spreads were still 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 did have a significant portfolio of financial derivatives with USD LIBOR as their reference rate. The transition was regulated by a transition clause in the ISDA agreement for financial derivatives, which meant that the reference rate changed 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 for the first nine months of the year.

KBN’s funding activities in the third 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 third quarter, and KBN's funding activities were therefore somewhat less extensive during the quarter. In the first nine months of 2023 KBN’s new borrowings totalled approximately NOK 63 billion through 43 bond issues in ten currencies, as compared to NOK 54 billion in the first nine 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 129 billion⁵ at the end of the third quarter of 2023 as compared to NOK 112 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 57% 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 nine months of 2023, including in the third 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 third quarter of 2023 the capital adequacy in KBN was sufficient, with a buffer to regulatory requirements.

Table 2: Capital adequacy key figures

KBN’s total assets at the end of the third quarter of 2023 amounted to NOK 528 billion, up from NOK 492 billion at the end of 2022. KBN’s total assets at the end of the third quarter of 2022 amounted to NOK 529 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.

At the end of the third quarter, KBN had a Pillar 2 capital requirement consisting of 2.1% of the basis for calculation under Pillar 1. 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 has to be satisfied with at least 56.25% common equity Tier 1 capital and with at least 75% Tier 1 capital.

KBN’s leverage ratio at the end of the third 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 target for reducing its own emissions to a reduction of at least 55% by 2030, compared to the 2019 level. This emissions trajectory implies that KBN’s CO2 emissions in 2023 should be a maximum of 70% of the 2019 level, which corresponds to approximately 130 tonnes of CO2e for the year. KBN’s calculated CO2 emissions increased in 2023 relative to 2022, mainly due to more normalized travel activities in 2023. Nonetheless, KBN is in a good position with regard to reaching its target for its desired reduction in its own emissions⁶.

Norges Bank raised its key policy rate to 4.25% by means of its August and September 2023 monetary policy committee meetings, and it has communicated that there is a high degree of probability that it will increase the rate further at its December meeting, but that this will depend on economic developments. Norges Bank has stated that the reason for the increases 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 peak in 2023. The future path of the policy rate thereafter will depend on economic developments.

The war in Ukraine and in the Middle-East, 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 third quarter spreads for five-year financing were approximately 4 basis points higher than at the end of 2022. Viewed in isolation, the third quarter saw spreads decrease somewhat, with the widening in spreads having taken place in the first six months of the year. The fact that spreads remain wide in 2023 reveals the continuing nervousness in financial markets. It is still uncertain whether credit spreads will fall through the autumn and winter, 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.

The level of demand for KBN-issued bonds is 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.

Oslo, 26 October 2023

The Board of Directors and Chief Executive Officer of Kommunalbanken AS