DBRS Comments on Danske Bank’s 1H12 Results – Senior Unaffected at A (high), Trend Stable

DBRS Ratings Limited (DBRS) has commented today on the 1H12 and 2Q12 results of Danske Bank A/S (Danske or the Bank). Danske’s ratings, including its A (high) Senior Unsecured Debt & Deposits rating and its R-1 (middle) Short-Term Debt & Deposits rating, are unaffected by the results. The trend is Stable. DBRS’s intrinsic assessment (IA) for Danske is at A (low). The ratings consider, however, DBRS’s designation of Danske as a Critically Important Banking organisation (CIB) in Denmark, for which the rating floor is A (high) with a Stable trend for banks. As such, Danske’s ratings are supported by DBRS’s floor ratings for CIBs in Denmark.

Danske recorded pre-impairment profits of DKK 11.1 billion for the half-year ending 30 June 2012, up 21% from 1H11 and 35% from 2H11. Pre-tax profits of DKK 4.1 billion for 1H12 reflected similar improvements and represented Danske’s best half-year result since 2008. For 1H12, results were boosted by stronger net interest income, stable fee income, higher net trading income, and lower expenses. Net interest income (NII) rose to DKK 12.4 billion in 1H12, up 9% from 1H11. Higher lending margins were the main driver of improved NII, but were partly offset by pressure on deposit margins, which were impacted by declining short term interest rates. Meanwhile, net trading income rose to DKK 5.7 billion for 1H12, up 5% from 1H11, benefitting from improved market activity earlier in the year in bond and derivative trading. The resilience of Danske’s earnings is supported by its enhanced emphasis on cost containment. Expenses for 1H12, at DKK 13.5 billion, were down 4% from the prior year mainly due to reduced expenses for the Danish Guarantee Fund. The overall cost reduction programme remains on track for completion at the end of 2013. The Bank’s cost-to-income ratio improved to 55% at 30 June 2012.

From a segment perspective, Danske continues to derive the bulk of its pre-impairment profits from its Banking Activities segment (64%). Within the Banking Activities segment, pre-impairment profits rose in all sub-segments except Ireland, backed by multiple rate increases on select lending products, resulting in an 11% increase in pre-impairment profits for the segment to DKK 7.2 billion for 1H12. The Danske Markets and Treasury segment also increased its pre-impairment profits, up 8% year-on-year to DKK 3.4 billion, driven primarily by stronger client activity in 1Q12. Danske Capital, on the other hand, reported an 11% year-over-year decline in pre-impairment profits to DKK 331 million due to an unfavourable shift in the mix of assets under management. Meanwhile, net income from insurance activities at Danica Pension more than doubled to DKK 883 million despite intensifying price competition regionally. This reflected a change in the discount yield curve for long yields by the Danish Ministry of Business and Growth, which resulted in a DKK 1.3 billion reduction in liabilities and boosted the amount that may be drawn on to cover capital losses by DKK 1.1 billion.

Danske’s results indicate a mild deterioration in asset quality metrics stemming mostly from Danske’s Irish exposures, Danish commercial property exposures, and shipping. Bank-wide loan impairment charges totalled DKK 7.0 billion in 1H12, or 0.73% of lending, up from 0.58% in 1H11. Similarly, Bank-wide impaired credit exposures rose from 2.99% at 31 December 2011 to 3.08% at 30 June 2012. Impairment charges in the Retail Banking Denmark sub-segment, which represents 49% of total lending, remain low at 0.24%. However, commercial property exposures remain a concern in Denmark, where Danske has DKK 121.1 billion in gross exposures (12.7% of lending in Denmark), with impaired loans elevated at 13%.

The Irish and Northern Irish Banking Activities sub-segments (5.6% of total lending) continue to generate disproportional loan impairments, combining to account for 54% of Bank-wide impairment charges. The bulk of these impairments stem from Irish commercial property exposures. DBRS notes that Danske has earmarked commercial property, personal customer investment property, and certain consumer industries exposures within its Irish banking activities sub-segment as non-core. Notably, half of the DKK 38.1 billion in the non-core Ireland portfolio represents commercial real estate exposure, of which 83% is impaired. The core Ireland portfolio amounts to DKK 26.8 billion in gross exposures, of which 13% is impaired. DBRS anticipates that impairments emanating from Danske’s Irish and Northern Irish sub-segments will remain a drag on performance throughout 2012. Another portfolio of concern, in DBRS’s view, is Danske’s shipping book, which has the potential to produce large, ‘lumpy’ impairments. The slowing global economy and strong inflow of new shipping capacity, especially in dry bulk, continues to pressure the international shipping market. As a result, despite being well-diversified, impaired credit exposures in the shipping book rose to 5.8% at 30 June 2012 from 3.8% at 31 December 2011 due mainly to a few large exposures.

DBRS views Danske’s funding and liquidity profile as stable. DBRS notes that Danske experienced some wholesale deposit outflow during 1H12 as a ratings downgrade meant that some short-term money market deposits were not renewed. Positively, the deposits held by the banking units did not exhibit a similar trend. Danske’s loan-to-deposit ratio (including loans and issued mortgage bonds at Realkredit Danmark) was 115.8% at 30 June 2012. With regard to wholesale funding, despite increasingly challenging funding market conditions, Danske issued DKK 59 billion in covered bonds and DKK 17 billion in senior debt during 1H12. While Danske redeemed all its state-guaranteed bond issues by the end of July 2012, it did draw on the three-year Danish Central Bank (DKK 15 billion) and European Central Bank (DKK 40 billion) lending facilities. At 30 June 2012, wholesale sourced funding accounted for 63.6% of the total funding base, which includes a substantial portion of covered bond funding. Excluding covered bonds, wholesale funding reliance would be a relatively more manageable 38.2%. Danske’s liquidity position is bolstered its liquidity reserve, which exceeded DKK 300 billion at 30 June 2012. Danske’s bond portfolio is a sizeable component of its liquidity reserve and includes DKK 5.8 billion in net exposure to Irish, Portuguese, Spanish, and Italian government bonds. DBRS notes that 84% of the bond portfolio is rated AAA. Danske has indicated that it expects to be compliant with the Basel III LCR requirements by year-end 2012.

In terms of capital, the Bank reported a solid Tier 1 capital ratio of 16.2% and a Core Tier 1 capital ratio of 12.1%. DBRS anticipates that the regulatory capital ratios will continue to benefit from reductions in risk-weighted assets as Danske focuses on optimising efficiency. The quality of capital has improved following the repayment of DKK 2 billion of state hybrids in May 2012, however state hybrids still constitute 2.7% of total capital.

Notes:
All figures are in DKK unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include publicly available company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This commentary was disclosed to the issuer and no amendments were made following the disclosure.

Ratings assigned by DBRS Ratings Limited are subject to EU regulations only.

Lead Analyst: Peter Burbank
Approver: William Schwartz
Initial Rating Date: 18 January 2010
Most Recent Rating Update: 12 April 2012

For additional information on this rating, please refer to the linking document under Related Research.