Resilient interest margins Fondsfinans Research – Sparebank 1 SMN 3Q14 Update

Recommendation: BUY – Target NOK 74 3 November 2014

Prepared by Analyst: Geir Kristiansen, Fondsfinans AS, tel: 23 11 30 11, e-mail: [email protected]

This report was prepared by an analyst engaged by Fondsfinans AS, the Norwegian affiliate of Fondsfinans Inc., who is not registered as a research analyst with FINRA or subject to FINRA rules governing research. See page 15 of this report for Important Disclosure Information.

1

Resilient interest margins INVESTMENT CASE

We are impressed by the net interest margins reported by the savings banks, and believe that cheaper funding will give resilience to lending margin pressure also going forward. We increase our target price for SMN to NOK 74 (70), which implies a P/B of 1.18x 2014E and a P/E of 9.4x 2015E.

Strong revenues -

Positive effect of lower deposit margins and funding costs – more to come We increase NII estimates for 2015/16 by 11%/13% Impressive contribution from associated companies (SpareBank 1 Gruppen)

SPAREBANK 1 SMN – 3Q14 UPDATE

Operating expenses under control -

Slightly below expectations in 3Q Restructuring charges in 4Q – We expect NOK 25m Zero growth target in mother company – We cut costs forecasts by 5%/6%

Low loan losses – confident management 2

Loan losses in line Management sees no need for increased group provisions – already at a high level Low exposure to high-risk sectors

Net margin surprised positively 3Q14 REPORT

Deviation table Key figures (NOKm ) Net interest incom e

Actual 463

FF est. 427

Other op.revenues

530

500

Total revenues

993

927

Total OPEX Personnel expense

425 235

435 240

-2.2 % -2.0 %

Pre-provision profit (PPP)

568

493

15.3 %

24

22

11.3 %

Pre-tax profit (PTP)

545

471

Tax expense

101

99

Net profit

443

372

370

19.1 %

EPS

2.21

1.85

1.94

19.3 %

SPAREBANK 1 SMN – 3Q14 UPDATE

Loan losses

Cons.

Dev. 8.4 % 6.0 %

951

498

7.1 %

15.7 % 2.1 %

Stronger than expected revenues - Strong margins - NOK 50m higher contribution from the SB 1Group - NOK 27m weaker net financials

Lower OPEX - Restructuring charges in 4Q14

Loan losses in line - Confident management

II Source: SMN, Bloomberg, Fondsfinans research

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We are not worried about interest margins ESTIMATES

Changes in estimates Estim ate changes

Curr.

Prev.

Curr.

Prev.

NOKm

2015E

2015E

2016E

2016E

2015E

2016E

Net interest incom e

1,958

1,765

2,046

1,806

10.9 %

13.3 %

Non-interest income

2000

2,136

2079

2,191

-6.4 %

-5.1 %

Total revenues

3,958

3,902

4,125

3,997

1.4 %

3.2 %

OPEX

-1757

-1845

-1796

-1919

-4.8 %

-6.4 %

Pre-provision profit

2,201

2,056

2,329

2,078

7.1 %

12.1 %

-180

-152

-294

-230

18.6 %

27.9 %

2,021

1,904

2,035

1,848

6.1 %

10.1 %

-424

-400

-427

-388

6.1 %

10.1 %

1,596

1,504

1,607

1,460

6.1 %

10.1 %

7.9

7.5

8.0

7.2

6.1 %

10.1 %

Loan losses

SPAREBANK 1 SMN – 3Q14 UPDATE

Pre-tax profit Tax expense Net profit EPEC (rep.)

Change (%)

Less pressure on margins (p 6) - Deposit rates down more than lending rates (so far) - Falling funding costs in the bond market

Lower contribution from net financials - Potential gain from sale of real estate project (Grilstad Marina) is not included

Lower opex (p 7) - Target 0 growth in mother bank

Higher loan losses (p 8) - Uncertain macroeconomic development

Source: SMN, Bloomberg, Fondsfinans research

4

Strong growth in retail lending (8% YoY) LENDING

Customer lending (NOKm) and growth NOKb 9.5 % 140 120

% 10.0 %

9.4 %

9.0 %

8.2 % 7.4 %

7.4 %

8.0 %

100 5.7 % 5.0 %

80

7.0 % 5.4 %

6.0 % 4.5 %

5.0 %

60

4.0 %

40

3.0 % 2.0 %

20

SPAREBANK 1 SMN – 3Q14 UPDATE

- 7.6% growth in retail lending in 3Q14 (YoY) - 2% growth in corporate lending

1.0 %

0

0.0 %

Gross lending to customers (incl. transf. Volume)

Source: SR Bank, , Fondsfinans research

5

SMN is gaining market share in the region, despite strong competition from DNB.

Growth YoY

We assume a moderate 3.6% growth in lending in 2015/16, including transferred loans

Margins boosted by lower lending rates and funding costs LENDING MARGINS

Net interest income and margin NOKm 600

1.64 % 1.54 %

500 400

1.44 %

1.44 %

1.51 %

1.47 %

1.50 %

1.56 %

% 1.8 % 1.6 % 1.4 %

1.27 %

1.2 % 300

Deposit rates down more than lending rates (so far) - Retail lending margins down by 9 bps QoQ - Retail deposit margins up by13 bps.

1.0 % 200

0.8 %

100

0.6 %

0

0.4 %

NII

NIM

SPAREBANK 1 SMN – 3Q14 UPDATE

Customer margins

Falling funding costs in the bond market - EUR 500m loan in 2Q14 at lower rates - SMN has still mainly old, costly funding - This will be re-financed at lower rates - 17% in 4Q4 and 2015 - 16% in 2016

Source: SR Bank, , Fondsfinans research 6

Substantial reduction in long term funding costs

FONDSFINANS RESEARCH - NORWEGIAN FINANCIALS

LONG TERM FUNDING COST

7

Strong cost focus also in SMN OPERATING COSTS

Cost/Income NOKm 57.0 %

% 60%

500 450 400

50.3 % 51.4 %

47.9 % 43.3 %

46.9 % 41.8 % 43.2 % 42.8 %

350

50%

40%

300 250

30%

40 employees have to go - We assume NOK 25m in charges in 4Q14 - Digitalization

200 20%

150 100

10%

50

SPAREBANK 1 SMN – 3Q14 UPDATE

0

0%

OPEX

C/I

Source: SR Bank, , Fondsfinans research 8

Target 0 growth in mother company - Subsidiaries are not measured on costs

Low loan losses, confident management LOAN LOSSES

Nominal and relative loan losses NOKm

%

35.0

0.18%

0.16 % 0.15 %

0.16%

30.0 0.13 % 25.0 20.0

0.11 % 0.09 %

0.11 %

0.09 %

0.12% 0.10%

0.09 % 0.07 %

15.0

0.14%

0.08% 0.06%

10.0

Gross problem loans in % of lending at 0.47%, as in 2Q - Provisions ratio 87% (140% of nonperforming loans) - “No need for increased group provisions”

0.04% 5.0

0.02%

SPAREBANK 1 SMN – 3Q14 UPDATE

0.0

0.00%

LLP

LLP in % of AGL

Source: SR Bank, Fondsfinans research 9

Low exposure to high-risk sectors - Total exposure to shipping and offshore of 4.8 - Exposure to construction 3.2%

Double digit RoE calls for P/B > 1 SUMMARY

Key figures (NOKm)

2012

2013

2014E

2015E

2016E

Net interest income (NII) Other op.revenues

1,477 1,590

1,616 1,965

1,793 2,244

1,958 2,000

2,046 2,079

431 596

463 530

Total operating revenues Operating costs

3,067 -1,653

3,581 -1,722

4,037 -1,761

3,958 -1,757

4,125 -1,796

1,027 -444

993 -425

Pre-provision profit (PPP) Loan losses

1,414 -58

1,859 -101

2,276 -83

2,201 -180

2,329 -294

583 -15

568 -23

Pre-tax profit (PTP) Taxes Net profit

1,356 -295 1,061

1,758 -388 1,370

2,193 -405 1,788

2,021 -424 1,596

2,035 -427 1,607

568 -106 462

545 -101 444

6.2 49.5

6.9 55.6

8.8 62.3

7.9 67.6

8.0 72.7

2.3 57.8

2.2 60.0

DPS Net interest income

1.5 1.41 %

1.7 1.45 %

2.6 1.53 %

3.2 1.62 %

4.0 1.63 %

1.50 %

1.56 %

Loan losses (%) Core equity capital ratio (CET 1)

0.08 % 10.0 %

0.13 % 10.7 %

0.09 % 11.9 %

0.20 % 12.6 %

0.31 % 13.4 %

0.07 % 11.1 %

0.11 % 11.5 %

Yield P/E P/B ROE

4.1 % 6.1 0.74 11.7 %

3.8 % 6.7 0.83 13.1 %

4.3 % 6.9 0.97 15.0 %

5.3 % 7.6 0.90 12.4 %

6.6 % 7.6 0.83 11.5 %

SPAREBANK 1 SMN – 3Q14 UPDATE

EPEC BPS

Source: Fondsfinans research 10

2Q14

16.0 %

3Q14

14.9 %

We are impressed by the net interest margins reported by the savings banks, and believe that cheaper funding will give resilience to lending margin pressure also going forward.

We increase our target price for SMN to NOK 74 (70), which implies a P/B of 1.18x 2014E and a P/E of 9.4x 2015E.

Full year and quarterly estimates ESTIMATES

ba

2013

2014E

2015E

2016E

4Q14E

1Q15E

2Q15E

3Q15E

4Q15E

1Q16E

2Q16E

3Q16E

Net interest income Net commission income Other income Total core incom e

1,616 1,136 327 3,079

1,793 1,162 333 3,287

1,958 1,159 277 3,394

2,046 1,202 272 3,520

463 286 74 823

488 285 70 842

484 281 69 834

482 287 69 838

492 294 71 857

500 296 68 864

506 298 68 873

503 295 68 865

515 302 69 886

-1,722

-1,761

-1,757

-1,796

-425

-451

-440

-443

-436

-438

-450

-453

-445

1,357

1,526

1,637

1,724

398

391

394

395

421

426

423

412

440

-101

-83

-180

-294

-23

-28

-34

-41

-49

-56

-63

-71

-78

1,256

1,444

1,457

1,430

375

364

360

354

373

370

360

342

362

Total expenses Pre-provision profit (core item s) Loan loss provision Pre-tax profit (core item s) Total financial incom e

502

749

564

605

170

120

170

138

127

129

181

148

137

Pre-tax profit

1,758

2,193

2,021

2,035

545

484

530

492

499

499

541

490

498

Net profit (recurring)

1,370

1,788

1,596

1,607

444

382

419

389

394

394

428

387

394

Net profit (reported)

1,384

1,758

1,596

1,607

444

382

419

389

394

394

428

387

394

6.9 6.6

8.8 7.7

7.9 8.0

8.0 7.7

2.2 2.2

1.9 1.9

2.1 1.9

1.9 2.0

2.0 2.1

2.0 2.1

2.1 1.9

1.9 1.9

1.9 2.0

2013

2014E

2015E

2016E

3Q14

4Q14E

1Q15E

2Q15E

3Q15E

4Q15E

1Q16E

2Q16E

3Q16E

79,836 115,361 11,036

87,173 118,614 12,373

90,223 122,765 13,455

93,564 127,311 14,554

86,008 117,195 12,131

87,173 118,614 12,579

87,546 119,122 12,484

88,800 120,829 12,873

89,853 122,261 13,267

90,223 122,765 13,661

90,905 123,693 14,308

92,082 125,294 13,906

93,203 126,820 14,300

EPEC (rep.) EPEC (adj.) BALANCE SHEET

SPAREBANK 1 SMN – 3Q14 UPDATE

3Q14

Net lending to customers Total assets Total equity

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Key ratios ESTIMATES

KEY FIGURES ROE ROE (core banking) ROA RORWA RORWA (core banking) C/I C/I adj. Costs in % of total assets Loan loss ratio (gross loans) Net interest margin (normalised) Deposit-to-loan ratio Net Loans/Equity

SPAREBANK 1 SMN – 3Q14 UPDATE

CET 1 ratio (transition rule) Tier 1 ratio (transition rule) Tier 2 ratio (transition rule)

12

2013

2014E

2015E

2016E

3Q14

4Q14E

1Q15E

2Q15E

3Q15E

4Q15E

1Q16E

2Q16E

3Q16E

13.13 % 8.37 % 1.24 % 1.58 % 1.12 % 48 % 56 % 1.54 % 0.13 % 1.45 %

15.02 % 8.62 % 1.50 % 1.92 % 1.20 % 44 % 54 % 1.51 % 0.09 % 1.53 %

12.36 % 7.99 % 1.32 % 1.69 % 1.25 % 44 % 52 % 1.46 % 0.20 % 1.62 %

11.48 % 7.16 % 1.28 % 1.64 % 1.27 % 44 % 51 % 1.44 % 0.31 % 1.63 %

14.89 % 14.85 % 1.49 % 1.91 % 1.97 % 43 % 43 % 1.44 % 0.11 % 1.56 %

12.38 % 11.90 % 1.29 % 1.66 % 1.60 % 47 % 48 % 1.53 % 0.13 % 1.64 %

13.36 % 12.90 % 1.43 % 1.85 % 1.76 % 44 % 44 % 1.48 % 0.16 % 1.65 %

12.27 % 11.81 % 1.30 % 1.68 % 1.62 % 45 % 46 % 1.48 % 0.19 % 1.61 %

12.07 % 11.62 % 1.29 % 1.66 % 1.62 % 44 % 45 % 1.43 % 0.22 % 1.61 %

11.72 % 11.27 % 1.28 % 1.66 % 1.61 % 44 % 45 % 1.43 % 0.25 % 1.62 %

12.23 % 11.80 % 1.39 % 1.80 % 1.74 % 43 % 43 % 1.46 % 0.28 % 1.65 %

10.97 % 10.54 % 1.25 % 1.61 % 1.55 % 45 % 45 % 1.46 % 0.31 % 1.62 %

11.17 % 10.73 % 1.24 % 1.60 % 1.56 % 44 % 44 % 1.41 % 0.34 % 1.62 %

0.70 7.2

0.68 7.0

0.68 6.7

0.69 6.4

0.67 7.1

0.68 6.9

0.66 7.0

0.70 6.9

0.67 6.8

0.68 6.6

0.66 6.4

0.71 6.6

0.68 6.5

10.7 % 12.6 % 14.2 %

11.9 % 13.7 % 16.5 %

12.6 % 14.4 % 17.1 %

13.4 % 15.1 % 17.7 %

11.5 % 13.4 % 16.1 %

11.9 % 13.7 % 16.5 %

12.0 % 13.9 % 16.7 %

12.1 % 13.9 % 16.7 %

12.2 % 14.0 % 16.7 %

12.6 % 14.4 % 17.1 %

13.5 % 15.3 % 18.0 %

12.8 % 14.5 % 17.2 %

12.8 % 14.6 % 17.2 %

We rate SpareBank 1 SR Bank MEDIUM risk RISK ASSESSMENT

High housing prices and high gross debt level to private individuals could trigger a substantial negative price reaction in the future Low oil prices is a risk factor in the medium and long term

SPAREBANK 1 SMN – 3Q14 UPDATE

The bank has exposure to the financial markets. Higher volatility and increased risk premium and credit spreads could affect income and valuations negatively

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Share information SPAREBANK 1 SMN

SPAREBANK 1 SMN – 3Q14 UPDATE

Share data

Share data Sector Bloomberg Risk rating Outstanding shares (million) Market cap (NOK billion) Total assets (NOK billion) Net lending (NOK billion) Free float Average volume (1000s last 12m) High/low 52w Weight PCC index Rel. Perf 3/6/12 Abs. Perf. 3/6/12

Shareholders

Banks MING NO Equity Low 129.8 7.9 118.6 86.0 94 % 153.8 60.5/ 50.0 38.40 % 19/ 17/ 10 14/ 17/ 20

Source: Bloomberg, Fondsfinans research 14

Odin Forvaltning As Sparebankstiftelsen DnB Norge Pareto Aksje Norge Nordea Norge Verdi Odin Norden State Street Vind LV Wimoh Invest MP Pensjon Total number of EC shares

3.1 % 3.1 % 2.7 % 2.7 % 2.4 % 2.2 % 2.0 % 2.1 % 1.8 % 1.6 %

4,042 3,965 3,522 3,477 3,104 2,855 2,654 2,736 2,359 2,058

23.7 %

129,836

Definitions of ratings Buy Low risk: with a potential of min 5%. Medium risk: with a potential of min 10%. High risk: with a potential of min 20%. Neutral Low risk: -5% to +5%. Medium risk: -10% to +10%. High risk: -20% to +20%. Sell Low risk: min 5%. Medium risk: min 10%. High risk: min 20%. Risk ratings are based on price volatility, fundamental criteria and perceived risk. Ratings are: Low (L), Medium (M) and High (H). Target: Our valuation as of today. Time frame of target: Target is what we value the share as of today.

Disclaimer Our research and general presentations, also available at our website www.fondsfinans.no, are provided for information purposes only. They should not be used or considered as an offer to sell or a solicitation of an offer to buy any financial instruments. Any opinion expressed are subject to change without prior notice. Our research and presentations are based on information from various sources believed to be reliable. Although all reasonable care has been taken to ensure that the information herein is not misleading Fondsfinans AS makes no representation or warranty expressed or implied as to its accuracy or completeness.

Recommendation distribution as of 29.10.14:

Companies in each recommendation category that have been investment banking clients over the past 12 months:

Recommendation Buy Neutral Sell Total

Recommendation Buy Neutral Sell Total

Neither Fondsfinans AS, its partners and employees, nor any other person connected with our research and presentations, accept any liability whatsoever for any direct or consequential loss of any kind arising out of the use or reliance on the information given. They do not take into account the specific investment objectives and financial situation of any recipient. Investors seeking to buy or sell any financial instruments discussed or recommended in our research or in separate presentations, should seek independent financial advice relating thereto. Our research and materials from separate presentations may not be distributed, quoted from or reproduced for any purpose without written approval by Fondsfinans AS.

No 50 15 3 68

Percent 74 % 22 % 4% 100 %

No 4 0 0 4

Percent 8% 0% 0%

Our intention is to issue preview and update research on a quarterly basis. Our investment recommendation is elaborated in accordance with “The Norwegian Securities Dealers Associations” standards. This report has not been sent to the company for correction of any factual errors. Fondsfinans is organized with Chinese walls between the Corporate Department and the Research/Broking Department. In addition, Fondsfinans has internal instructions and guidelines for handling sensitive information. The analyst receives compensation that is impacted by overall firm profitability, including investment banking activities. Fondsfinans is under supervision of The Financial Supervisory Authority of Norway. The recommendation has not been changed from BUY. The previous recommendation was issued 10.09.14. Ownership per 13.10.14 in Sparebank 1 Midt-Norge: Analyst (including his/her closely related persons or companies): 0, corresponding to 0% of the company share capital Employees (including their respective closely related persons or companies): 0, corresponding to 0% of the company share capital Group Fondsfinans (including the holdings of its Chairman, his spouse and their closely related companies, Erik Must AS and its 100% controlled subsidiaries): 69.224, corresponding to 0.0% of the company share capital Fondsfinans may hold shares in Sparebank 1 Midt-Norge as result of daily trading/market making. Information on such holdings is not given when of non-significant value. Fondsfinans does not act as market maker in Sparebank 1 Midt-Norge. Fondsfinans has not acted as corporate adviser, lead manager in IPO etc. during the past 12 months. This report was issued and distributed 03.11.14.

15

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