DBRS Downgrades Danske Bank to 'A', Trend Stable

DBRS Ratings Limited (DBRS) has today downgraded the Senior Unsecured Debt & Deposit rating for Danske Bank A/S (Danske, the Bank or the Group) by one notch to 'A' and the Short-Term Debt & Deposit rating was lowered to R-1 (low). The downgrade was driven by the removal of the rating floor for Critically Important Banking Organisations (CIBs) in Denmark and formally ends the rating review which was initiated in October of 2013. DBRS has maintained its SA-2 support assessment (SA) for Danske which reflects the Bank’s continued Systemically Important Bank (SIB) designation and provides one notch of upward support to the rating, rather than the two notches provided by the previous rating floor. DBRS has confirmed the intrinsic assessment (IA) of A (low), as well as the BBB (low) rating for Danske’s Dated Subordinated Debt. The rating for Hybrid Tier 1 Capital Notes has been adjusted upward by one notch to BBB (low) in line with DBRS’ updated methodology for rating preference shares three notches below the IA. The trend on all ratings is now Stable.

The IA for Danske takes into account the Bank’s strong franchise in Denmark and its presence in the wider Nordic region, the earnings generation potential within that franchise, and the bolstered liquidity and capital positions which have improved in recent years. Offsetting these strengths are the impact of the relatively lacklustre Danish economy, the Bank’s legacy portfolio in Ireland, and concerns regarding the funding of mortgage operations and related regulatory pressure. In DBRS’ view, these present a still challenging operating environment for Danske, but upward rating pressure could result if regulatory issues are resolved favorably.

Danske’s strong franchise and dominant domestic market share is the basis for the A (low) intrinsic assessment. The Bank’s total market share for lending in Denmark was 26.9% for 2013, and deposit market share was 27.6%. Given the Bank’s leadership position in Denmark, protecting this position is a primary challenge, as this home region facilitates sizeable earnings generation. The Bank’s market shares in neighboring countries are significantly lower, with market shares for deposits of 10.5% in Finland, 4.7% in Sweden and 5.8% in Norway. Danske also has strong shares in trading and investment banking, life insurance, pensions and asset management. Danske’s Nordic branch network and its profitable Nordic capital markets business both add to the franchise strength and provide a level of diversification. That said, given the dominance of its activities in Denmark, Danske’s earnings remain very much tied to the domestic economy.

Financial performance at Danske has improved in the past two years as the Bank has made progress towards decreasing risk and winding down legacy problem operations, including the bulk of its Irish assets. Likewise, the reorganization of the Bank, including an improved focus on customer segments, was completed under the former CEO, who was replaced in 3Q13 after less than two years. For the full year 2013, Danske reported a 50% improvement in earnings to DKK 7.1 billion, yielding a 5% Return on Equity (ROE). The results benefitted materially from decreasing credit costs and provisions. Going forward, the Bank has set ROE targets of 9% for 2015 and above 12% for the longer term, which in DBRS’ view could prove challenging. Nonetheless, Danske’s ability to generate fairly resilient income before provisions and taxes (IBPT) is a key factor supporting the current IA of A (low). Indeed, throughout the crisis, Danske’s operating earnings proved sufficiently large to fully fund all credit costs and provisions.

In DBRS’ view, the Bank’s liquidity and funding profile has improved over the last three years. Overall, Danske was able to maintain its liquidity reserves, while also repaying borrowings from both the Danish National Bank and the European Central Bank (ECB). DBRS notes, however, that Danske’s funding profile, like its Nordic peers, is reliant on covered bonds and other wholesale sourced funding. Notably, wholesale funding sources accounted for 61.4% of total funding at year-end (as calculated by DBRS), which DBRS considers high.

Although DBRS takes some comfort from the Bank’s participation in the Danish mortgage funding market, which has historically remained very liquid, the mortgage bond sector is currently under regulatory pressure. Domestic legislation has been agreed which will reduce refinancing risk for banks by requiring bond investors to assume extension risk if mortgage bonds cannot be refinanced in the market. However, additional costs could be passed onto the end-borrower and could negatively impact credit risk. In addition, the Danish mortgage sector could be negatively impacted by the decision expected in June 2014 by the European Commission (EC) on whether Danish mortgage bonds will be considered very highly liquid (or “L1” assets) for liquidity purposes under Basel III.

Danske has taken noteworthy steps to improve its risk profile, and this is highlighted by the steep decline in credit costs and provisions in 2013. On an overall basis, DBRS calculates the Bank’s ratio of gross impaired lending (both not in default and defaulted) to total lending at 4.35% at end 2013 which is a marked improvement from the higher levels of nearly 6% for 2012 and 2011. Nonetheless, levels remain relatively high and may help to highlight the still lacklustre performance of the Danish economy relative to more buoyant conditions in neighboring Sweden and Norway.

DBRS views the Bank’s capital as solid and expects that Danske is well positioned to meet future capital requirements. The Group is designated as a SIFI (systemically important financial institution) under Denmark’s pending Bank Package 6 legislation and this will require an incremental capital buffer of 3% for Danske’s Core Tier 1 (CT1) ratio and raise the minimum CT1 capital level for the Bank to 13.5% under fully phased in Basel III norms. As of year-end 2013, the Bank’s pro-forma Basel III ratio stood at 12.8%, reflecting capital reductions for Danica Pension, as well as other risk weighted asset effects. The Bank has been strengthening its capital position in recent years via a combination of capital issuance and retained earnings, as well as via deleveraging. Core Tier 1 was reported at 14.7% at year-end 2013, with total capital ratio of 21.35%.

Notes:
All figures are in Danish Krone (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: Support Assessment for Banks and Banking Organisations and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities. These can be found can be found at: http://www.dbrs.com/about/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 is an unsolicited rating. This credit rating was not initiated at the request of the issuer.

DBRS does not audit the information it receives in connection with the rating process, and it does not and cannot independently verify that information in every instance.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period. DBRS’s outlooks and ratings are under regular surveillance

For further information on DBRS historic default rates published by the European Securities and Markets Administration (“ESMA”) in a central repository, see:
http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml.

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

Lead Analyst: Peter Burbank
Rating Committee Chair: Roger Lister
Initial Rating Date: January 18, 2010
Most Recent Rating Update: October 4, 2013

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