DBRS Comments on Danske Bank’s 3Q12 Results – Senior Unaffected at A (high), Trend Stable

DBRS Ratings Limited (DBRS) has commented today on the 3Q12 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. The ratings consider DBRS’s designation of Danske as a Critically Important Banking organisation (CIB) in Denmark. As such, Danske’s ratings are based on DBRS’s floor ratings for CIBs in Denmark.

For the quarter, Danske recorded a net profit of DKK 1.3 billion, down 14% quarter-on-quarter (QoQ), but reversing the loss recorded in the same period last year. The improved result versus the prior year reflected stronger net fee and Net Interest Income (NII), as well as sharply higher trading and a return to profitability in insurance. Overall loan impairment charges for 3Q12 fell for the third consecutive quarter by 7% to DKK 2.9 billion. This helped to maintain pre-tax profits at a robust DKK 2.2 billion, although down slightly QoQ. For 3Q12, NII was relatively unchanged QoQ. Although higher lending margins have helped to sustain NII throughout 2012, these have been offset by pressure on deposit margins impacted by the low rate environment. Following two quarters of stronger volumes in bond and derivative trading, net trading income fell during 3Q12 by 27% to DKK 1.7 billion, but remained sharply higher than the DKK 0.3 billion reported for 3Q11. Notably, the Bank reported net income from the insurance business of DKK 427 million for 3Q12, reversing the loss reported for the same period in 2011 and representing the fourth consecutive quarter of profits from the segment. Overall, the results help to underscore the relative strength of Danske’s franchise.

As in past quarters, Danske’s earnings have been supported by effective cost containment. Expenses for 3Q12 of DKK 6.1 billion were 8% lower QoQ reflecting seasonality but also staff reductions and branch closures. The Bank’s cost-to-income ratio stood at 54.5% at end September 2012 up 40 basis points from the prior quarter reflecting lower income generation. As part of its three year plan, Danske aims to drive further cost efficiency via the simplification and automation of systems and processes, with the goal of reaching a cost income ratio of 48% by 2015. Nonetheless, DBRS expects that Danske could be challenged to meet this goal should the core Nordic economies weaken.

From a segment perspective, Danske continues to derive the bulk of its pre-impairment profits from its Banking Activities segment (68%). Within this segment, pre-impairment profit was relatively stable in the Danish, Finnish and Corporate & Institutional Banking areas, but improved in all other areas with the exception of Ireland. Overall, pre-impairment profits for the segment rose by nearly 13% to DKK 3.8 billion for the quarter. The improvement was primarily driven by an 11% decline in expenses which more than offset the 2% reduction in income (revenues).

For the quarter, Danske Markets and Treasury segment reported a 38% decline in pre-impairment profits to DKK 843 million, as results earlier in 2012 had benefited from more buoyant client activity. However, Danske Capital reported an improved result of DKK 220 million, up 20% QoQ as the current period benefited from the absence of one off charges. Meanwhile, results at insurer Danica continued to remain fairly solid, despite a QoQ decline to DKK 427 million. Despite a fall in total premiums for much of 2012, including the third quarter, the segment did not require additional technical provisions as had been the case in 2011. Indeed, Danica was able to book reductions in risk allowances via the income statement for three of its four interest rate groups, and this accounted for much of the turnaround.

Credit performance trends remain favourable across most businesses. Indeed, credit impairments declined for the third consecutive quarter to DKK 2.9 billion, or a loss rate of 0.56%. Impairments declined across all segments with the exception of CIB and Non-Core Ireland. The higher impairments in CIB reflect further provisioning against the Bank’s shipping portfolio as the industry continues to be impacted by the slowing global economy. DBRS remains cautious regarding Danske’s DKK 46.3 billion shipping book, which has the potential to produce large, ‘lumpy’ impairments given the on-going pressure on international shipping markets. Lending in non-core Ireland, which includes commercial property, personal customer investment property, and certain consumer industries exposures, has fallen by 60% since end 2011 to DKK 29.6 billion as of end September 2012, but remains high risk with roughly 64% impaired. From DBRS’s perspective, commercial property exposures are still a concern in Denmark, where Danske has DKK 121.7 billion in gross exposures (12.8% of total Group lending in Denmark) and impaired levels are double digit. Over the medium term, Danske expects a normalised cost of credit of roughly 0.30% across its Danish activities, predicated on normalisation of residential, commercial and agricultural real estate.

DBRS views Danske’s funding and liquidity profile as stable. Danske’s deposit base continues to be the anchor of its funding profile. Importantly, after two consecutive quarters of deposit outflows, deposits grew to DKK 743 billion in 3Q12. As a result, Danske’s loan-to-deposit ratio (including loans and issued mortgage bonds at Realkredit Danmark) was 101% at 30 Sept 2012. Danske maintains good access to the capital markets. As of 30 September 2012, Danske had completed its 2012 funding plan and had pre-funded DKK 25 billion of its 2013 funding plan. Excluding covered bonds, wholesale funding reliance is a more moderate 38.7%. Liquidity is supported by the Bank’s sizeable liquidity buffer, which exceeded DKK 300 billion at the quarter end. Danske’s bond portfolio is a sizeable component of its liquidity reserve and includes DKK 9.1 billion in net exposure to Irish, Portuguese, Spanish, and Italian government bonds.

At end September 2012, the Bank reported a Core Tier 1 capital ratio of 12.7% and a Tier 1 capital ratio of 17.0%, up from 11.8% and 16.0% at year-end 2011. Danske’s capital has been strengthened by a DKK 5.7 billion Tier 2 issuance, as well as the DKK 39 billion reduction in Risk-Weighted Assets driven by the sale of securitised assets. Importantly, following the quarter end, Danske raised approximately DKK 7.0 billion in additional capital which contributes to an improvement in the Core Tier 1 ratio of circa 80 basis points. Although state hybrids still made up 2.8% of total capital at quarter-end, DBRS sees the quality of capital as improving following the share issue.

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: Alan G. Reid
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.

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