DBRS Comments on DnB NOR’s Q2 2009 Results – Senior at AA, Negative Trend

DBRS has today commented on the interim results of DnB NOR Group (DnB NOR or the Group). DBRS’s ratings for DnB NOR Bank ASA, the Group’s main operating bank, remain at AA for Senior Unsecured Long-Term Debt & Deposit and R-1 (high) for Short-Term Debt & Deposit. The trend on all ratings remains Negative.

DnB NOR reported net income after minority interests of NOK 1.2 billion for Q2 2009, down 61% from the prior quarter and down 64% from the year-ago quarter. The drop in net profits was driven by elevated write-downs of NOK 2.3 billion on loans and guarantees. Moreover, DnB NOR sustained non-recurring items in Q2 2009 with a negative pre-tax impact of NOK 1.9 billion, which included NOK 1.3 billion in mark-to-market adjustments on swaps and own liabilities and the NOK 570 million goodwill write-down on the Group’s Eastern European joint venture, DnB NORD. Excluding these non-recurring items, earnings before provisions and taxes were NOK 5.3 billion, down 13% from the prior quarter, but up 15% from Q2 2008.

In DBRS’s view, DnB NOR’s Q2 2009 results demonstrate its ability to generate solid underlying pre-tax, pre-provision earnings under challenging conditions. DBRS notes, however, that rising loan impairments absorbed a substantial portion of the Group’s pre-tax, pre-provision income in Q2 2009, which was NOK 3.5 billion, thereby leaving a smaller cushion available to cover additional losses. DBRS expects loan write-downs to remain elevated in the near term, given the negative impact on DnB NOR from the economic crisis in the Baltic region and the economic slowdown in the Group’s core market Norway.

DnB NOR projects credit write-downs of NOK 8 billion to NOK 10 billion for 2009. Only NOK 3.9 billion was realised in the first half, implying higher write-downs in the second half. Importantly, DnB NOR has so far been able to absorb provisions out of current earnings, allowing the Group to remain profitable and generate capital internally. While some near-term earnings pressure is factored into the current ratings and Negative trend, further negative rating actions could result, if credit write-downs erode earnings, causing negative net results and invading capital in coming quarters.

DnB NOR recorded solid results in Q2 2009 from its key business segments. The two largest segments, Corporate Banking & Payment Services and Retail Banking, both increased their pre-tax earnings from the prior quarter, to a combined NOK 3.2 billion. This reflects resilient performance at the Group’s core Norwegian operations, which benefited from stable interest rate spreads, as higher lending margins offset lower deposit spreads due to the low interest rate environment, as business volumes remained stable and credit quality was resilient.

Overall, DnB NOR’s write-downs on loans and guarantees (credit provisions) increased to 0.80% of average lending (annualized), or NOK 2.3 billion in Q2 2009. This was up from 0.55% of average lending in the prior quarter and equal to elevated Q4 2008 levels. Write-downs in Q2 2009 were driven by accelerating credit quality deterioration in the Baltics. Excluding the Eastern European exposures, credit write-downs of NOK 865 million were 14% lower than in the prior quarter, as asset quality in the core Norwegian operations remained stable.

Credit write-downs in DnB NORD, where the Group is active through its 51%-owned joint venture DnB NORD, accelerated to NOK 1.4 billion in Q2 2009, more than double the prior-quarter level. The deterioration was particularly steep in Latvia, where the acute economic crisis caused credit write-downs of NOK 784 million or 13.90% of net lending in Q2 2009. DBRS sees Baltic lending as a key risk for DnB NOR which is reflected in the Negative ratings trend. Credit losses in the Baltics had a substantial negative impact on Q2 2009 results and are expected to cause continued earnings pressure in the near term, as the economic crisis in the region continues. DBRS recognises, however, that DnB NOR’s Baltic exposure is limited, as Baltic lending (on a fully-consolidated basis) amounted to NOK 55 billion or a moderate 4.6% of Group-wide lending as of 30 June 2009. Moreover, part of this exposure is borne by DnB NOR’s joint venture partner, German Landesbank NORD/LB, which owns 49% of DnB NORD. Minority interests absorbed after-tax losses NOK 558 million in Q2 2009, which reduced the burden on DnB NOR shareholders.

DBRS continues to closely monitor DnB NOR’s non-performing and impaired commitments, which rose to 1.56% of total lending as of 30 June 2009, up from 1.18% as of 31 March 2009, mainly due to Baltic loan impairments. DBRS expects credit deterioration in international shipping and commercial real estate (CRE) lending, which are sensitive to the weak economic environment.

DBRS recognises DnB NOR’s gradual progress in strengthening its relatively tight capitalisation. Through earnings retention and helped by the migration to Basel II IRB rules, DnB NOR’s Tier 1 ratio (including 50% of profit for the period) increased to 7.3% as of 30 June 2009, up from 7.0% three months earlier. DBRS notes that Norway’s State Finance Fund, which is offering hybrid capital to eligible banks, represents an option for the Group to quickly strengthen capital, if needed.

The ratings are underpinned by DnB NOR’s solid underlying earnings ability and its dominant position in Norway, where the Group consistently generates over 80% of its total income. The Negative ratings trend reflects the Group’s high-risk credit exposures in the Baltics, in shipping and CRE, which are expected to cause further earnings pressure in the near term. Further, the Group’s relatively tight capitalisation leaves little room for negative net earnings that would invade capital. Moreover, DnB NOR’s reliance on wholesale funding is viewed as a weakness. However, this concern is partly mitigated by the Group’s demonstrated access to unguaranteed market funding, the stable funding provided by the Norwegian central bank’s swap facility, and by DnB NOR’s solid customer deposit base which grew to NOK 595 billion as of 30 June 2009.

Notes:
All figures are in NOK unless otherwise noted.

The applicable methodologies are, Analytical Background and Methodology for European Bank Ratings, Second Edition and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.