DBRS Assigns Debt Ratings to Danske Bank, Senior at A (high), Stable Trend

DBRS has assigned Senior Unsecured Debt & Deposits ratings of A (high) and Short-Term Debt & Deposits ratings of R-1 (middle) to Danske Bank A/S (Danske or the Bank). Further, DBRS has assigned its AAA / R-1 (high) ratings to all liabilities guaranteed by the Danish state. The trend on all ratings is Stable. The ratings consider DBRS’s designation of Danske as a Critically Important Banking organisation (CIB) in Denmark.

The CIB designation is consistent with DBRS’s introduction of a floor rating in Demark. As a CIB, Danske’s ratings are subject to the floor rating, which is A (high) for long-term debt and deposits and R-1 (middle) for short-term debt and deposits at the bank level. The level of the floor reflects DBRS’s expectation that the Danish state will provide support, if necessary, to prevent any CIB from weakening below this rating level. DBRS views A (high) / R-1 (middle) as the level of creditworthiness that market participants demand for CIBs to be viewed as stable counterparties. CIBs need to be perceived as reliable partners in undertaking a wide range of financial transactions. DBRS views the floor as the level of support at which the Danish state will sustain its CIBs to ensure that its financial system is fully functioning. The CIB designation provides an uplift of two notches to the ratings, as Danske’s intrinsic rating has been assigned at A (low).

The intrinsic rating for Danske considers the Bank’s strong franchise in Denmark and the Nordic region, the earnings generation potential within that franchise, and the bolstered regulatory capital position. Offsetting factors include the ongoing earnings pressures owed to elevated credit costs attributed to the current difficult operating environment.

The Bank has a strong franchise in its domestic Danish market. Danske maintained 28.5% market share in bank and mortgage lending and 30% deposit share, at 30 September 2009, as well as strong shares in trading and investment banking, life insurance, pensions and asset management. Importantly, the Bank’s home Nordic business segments have sizeable earnings generation ability. Moreover, Danske’s sizeable Nordic branch network and its profitable Nordic capital markets business both add to the franchise strength. Further, given the leadership position in Denmark, protecting this position is of the essence, as this region adds significantly to the franchise and boasts of sizeable earnings generation ability. The Bank is also currently resizing its activities in Ireland and the Baltics, where severe economic stress has reduced growth expectations and demand for financial services.

Danske’s poor operating performance reduces its intrinsic strength. Large impairments for loan losses and write-downs of goodwill have had a material impact on net earnings. Nonetheless, the Bank recorded a small net profit of DKK 1.3 billion for the first nine months 2009. Net profits were down 81% from the year-ago period. Yet, profit before loan impairment charges and taxes, at DKK 24.2 billion in same nine months, was almost double the year-ago amount, driven by sizeable gains generated in the Danske Markets segment. While DBRS recognises that a level of these gains will likely not be sustainable, they nonetheless provide additional gross income to help absorb the costs of the current credit cycle. DBRS anticipates continued pressure on earnings, given the expectation that the Danish economy and housing markets will remain under stress well into 2010. Moreover, earnings will remain pressured, given Danske’s, albeit limited, presence in the highly-stressed Baltic region, Ireland, and Northern Ireland. Income is also under pressure from reduced loan demand, persistent deposit margin pressure, the cost of participation in the government liquidity and capital support schemes and the higher cost of long-term funding. Working through the difficult current environment, whilst minimising the impact on the Bank’s franchise and balance sheet, remains an ongoing challenge.

Danske’s risk profile is impacted by geographic considerations, given 10% of the loan book resides in highly stressed regions, such as the Baltics, Ireland, and the UK. However, it is important to note the remainder of the loan book is in the less volatile-Nordic region, representing some 90% of the loan book. The current environment has impacted loan performance. Indeed, gross non-performing loans (NPLs) were 4.5% of total lending at 30 September 2009. Asset quality continues to deteriorate in the Bank’s domestic market, where unemployment is expected to rise further and real estate values are expected to continue to fall. Moreover, given the size of the Bank’s capital markets business and the volatility inherent in this business, DBRS sees the capital markets segment as adding to the overall risk profile of the Bank.

Danske has taken measures to strengthen its capital position. Regulatory capital has been bolstered by the injection of DKK 26 billion in hybrid capital by the Danish state in Q2 2009. This action has increased the Tier 1 ratio to a solid 12.6% (based on full Basel II implementation) and total capital to 16.3%, at 30 September 2009. However, Tier 1 capital, excluding hybrids, was less strong at 8.5%, highlighting the significant amount of hybrid capital. Nonetheless, the convertibility feature of the hybrids partially offsets the hybrid concentration. In light of the current environment and the challenges facing Danske, DBRS views the increased loss-absorbing capital positively, as the enhanced capital position better enables the Bank to manage the impact of the challenging economic environment, while supporting its efforts to reduce the risk inherent in its balance sheet. Replacing the government hybrids may prove to be a challenging and expensive proposition; however, given that the hybrids become callable only in 2014, the Bank has the time to manage this.

Danske has a rather diverse funding profile yet wholesale funding totalled 64% of funding (DBRS-calculated) at 30 September 2009. The Bank’s funding and liquidity profile continues to improve. Initially by its participation in the government’s debt guarantee programme and then as Danske continues to make progress in increasing deposits and raising unguaranteed unsecured debt. Since the middle of Q3 2009, has solely issued debt without a government guarantee. Nonetheless, guaranteed funding still amounted to a significant portion of the Bank’s 2009 long term unsecured debt issuances. In DBRS’s view, going forward, the Bank faces the challenge of further diversifying its funding profile, decreasing its wholesale funding reliance, thereby increasing its deposit funding component. Notably, deposits only account for 36% of the funding stack. Bonds issued by Danske’s mortgage subsidiary Realkredit Danmark (Realkredit) at DKK 663 billion continue to provide a stable source of funding.

The trend on all ratings is Stable. As discussed above, the ratings are at the floor, reflecting DBRS’s view that Danske is a CIB in Denmark. Given the long- and short-term ratings are at the floor, further weakening in the Company’s intrinsic strength will not result in a concurrent downgrade of the final rating below the floor rating. Conversely, a significant improvement in the intrinsic rating could result in a final rating above the floor.

The AAA / R-1 (high) ratings for Danske’s liabilities covered under the guarantee scheme reflect the Danish state’s ability to honour its guarantee, as determined by DBRS’s internal assessment of the sovereign. All future issuances of Danske that fall within the scope of the guarantee will carry the AAA / R-1 (high) ratings.

Support Assessment
DBRS continues to ascribe implicit systemic support to banks in Denmark. As such, a SA-2 Support Assessment has been assigned. The SA-2 reflects DBRS’s expectation that some form of systemic support would be provided to Danske. The ongoing, strong support provided by the Danish government is consistent with the CIB and SA-2 designations.

Note:
All figures are in DKK unless otherwise noted.

This rating is based on public information.

The applicable methodologies are Analytical Background and Methodology for European Bank Ratings, Second Edition and Enhanced Methodology for Bank Ratings – Intrinsic and Support Assessments.

This is a Corporate (Financial Institutions) rating.