DBRS Comments on DNB’s 3Q12 Results – Senior at AA, Trend Stable

DBRS Ratings Limited (DBRS) has commented today on the 3Q12 results of DNB Group (DNB or the Group). DBRS rates DNB Bank ASA’s (the main operating Bank) Senior Unsecured Long-Term Debt & Deposits at AA. The trend on the ratings is Stable. For the quarter DNB reported net profit of NOK 3.5 billion compared to NOK 4.6 billion in 2Q12 and NOK 2.5 billion a year ago. Excluding adjustments for basis swaps and net mark-to-market on other items, underlying pre-tax operating profit improved 4% quarter-on quarter (QoQ) and 52% year-on-year (YoY) to NOK 5.8 billion.

Results were underpinned by solid growth in profit across all business areas reflecting higher volumes, expansion in lending spreads, good cost containment and continuation of favourable credit performance. The solid QoQ growth in underlying pre-tax operating profit was driven by higher net interest income and underlying net other operating income growth. The net interest income of NOK 6.8 billion, up 3% QoQ, was driven by higher business volumes and wider lending spreads, which more than offset narrower deposit spreads. Underlying net other operating income (adjusted for the effect of basis swaps) of NOK 4.2 billion for 3Q12, was up modestly on a linked quarter basis. Meanwhile, underlying expenses (adjusted for non-recurring costs) remain well-controlled reflecting DNB’s continuing focus on enhancing efficiency. Operating expenses were essentially flat QoQ at NOK 5.0 billion, resulting in a stable cost-to-income ratio at 48.8%. Overall, in an uncertain global macroeconomic environment, DBRS considers DNB’s ability to deliver another quarter of solid underlying profits as evidencing the strength of the franchise and the sound earnings generation capacity of its diverse business model.

Strong business volumes and higher lending spreads powered double digit net interest income growth in the Retail Banking segment. As a result, Retail Banking reported a record quarter with pre-tax operating profits totalling NOK 2.4 billion. In the Large Corporates & International (LC&I) segment, pre-tax operating profit declined 7% QoQ to NOK 1.9 billion on reduced net other operating income and a slight increase in operating expenses. Pre-tax operating profits of NOK 1.3 billion for 3Q12 in the DNB Markets segment were 7% higher sequentially reflecting sizeable credit market gains owing to narrower credit spreads which more than offset lower customer revenues owing to subdued client activity. Meanwhile, the Insurance and Asset Management segment recorded pre-tax operating profits of NOK 426 million for 3Q12 on the back of positive financial market trends bolstering performance at DNB Livsforsikring and higher assets under management boosting commissions at DNB Asset Management. Of note, the DNB Baltics & Poland segment, recording its third consecutive profitable quarter, generated NOK 78 million for 3Q12. Following an announced strategic shift in this segment, DNB entered into an agreement to sell its Polish retail operations; subject to regulatory and customer approval. The transaction is expected to close in 2Q13. DBRS does not view the sale of the Polish retail business as impacting the rating and notes that the decision is consistent with DNB’s announced strategy to focus on the corporate market internationally.

Credit trends remained favourable in the quarter reflecting a stable macroeconomic environment in the Nordic region as well as DNB’s well-managed risk appetite. To this end, all portfolios, with the exception of the shipping portfolio, experienced declining write-downs and provisions in the quarter. Write-downs on loans and guarantees, at NOK 521 million for 3Q12, declined 24% on a linked quarter basis. As a percentage of average loan volume, write-downs remain below normalised levels at 16 basis points (bps). Net non-performing and net doubtful commitments totalled NOK 19.6 billion at 30 September 2012, up slightly from 2Q12 and year-end 2011. As a percentage of net lending, net non-performing and net doubtful commitments amounted to 1.47% at 30 September 2012, 2 basis points (bps) higher QoQ but 3 bps lower than at year-end 2011. At the end of 3Q12, DNB’s portfolio segment Transportation by Sea and Pipelines and Vessel Construction, which includes shipping, accounted for 10% of lending and 38% of DNB’s NOK 14.0 billion net non-performing and net doubtful commitments (ex. DNB Baltics and Poland/DnB NORD). DBRS notes that DNB announced that in the period up to 2015, the Group will rebalance its lending portfolio to reduce its exposure to shipping and commercial real estate (CRE) while increasing its focus on the energy, offshore, telecom, and healthcare sectors. DBRS views this rebalancing initiative positively as it will lower the Group’s credit risk profile by reducing concentrations in the lending book while improving capital efficiency.

DNB continues to make progress on reducing its long-term liquidity risk profile by ensuring that the majority of loans are financed through stable funding sources (which DNB defines as customer deposits, long-term securities, subordinated loan capital and equity). Demonstrating the Group’s success in strengthening its funding profile, at 30 September 2012, long-term stable funding sources covered 113.9% of customer loans, up from 112.8% in 2Q12 and 106% at year-end 2011. Deposits were slightly lower QoQ at NOK 843 billion. As a result, DNB’s ratio of deposits to lending moderated slightly to 64.5% at 30 September 2012 from 65.3% at 30 June 2012. Nonetheless, DBRS notes that the ratio of deposits-to-lending in DNB Bank ASA was a solid 115.8% at 30 September 2012. Those loans not financed via covered bonds at mortgage subsidiary DNB Boligkreditt are fully financed by deposits. Liquidity is further bolstered by the highly-rated EUR 15.5 billion international bond portfolio, of which 86% is AAA rated.

In terms of capital, the Group ended the quarter with a common equity Tier 1 capital ratio (Basel II/transitional rules) at 10.0%, including 50% of profit for the period. Based on the Group’s current interpretation of Basel III regulations, the Group estimated its Basel III common equity Tier 1 capital ratio to be 10.8% at 30 September 2012. DNB targets a Basel III common equity ratio of 12.0%-12.5% by 2015. In DBRS’s view, DNB’s regulatory capital position is likely to continue to strengthen. This is based on earnings generation, the expected further Risk Weighted Assets reductions resulting from the rebalancing of DNB’s large corporate loan portfolio, as well as other measures introduced to reduce the Group’s exposure to capital intensive activities.

Notes:
All figures are in NOK 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 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.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Peter Burbank
Approver: Roger Lister
Initial Rating Date: 18 September 2006
Most Recent Rating Update: 2 March 2012

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