DBRS Confirms the Kingdom of Denmark at AAA, Stable Trend

DBRS Ratings Limited (DBRS) has today confirmed the long-term foreign and local currency ratings of the Kingdom of Denmark at AAA, and the short-term foreign and local currency ratings at R-1 (high). All ratings have a Stable trend.

The Stable trend reflects DBRS’s baseline scenario in which the country’s credit metrics remain strong. Downward pressure on the ratings could occur if several of the challenges faced by Denmark prove to be structural, or if domestic or external shocks materially impair the downward trajectory of the country’s public debt ratio. The ratings could also come under downward pressure if a migration of liabilities from the financial sector onto the sovereign balance sheet substantially increases the debt stock, thereby undermining the credibility of the current resolution framework for banks.

The AAA ratings of Denmark are underpinned by sound public finances, which are characterised by low structural deficits and a moderate debt burden. In addition, the ratings benefit from Denmark’s net creditor position vis-à-vis the rest of the world, a wealthy and resilient economy, and a reliable and transparent institutional framework. The main challenges faced by the economy are related to (i) the domestic financial sector that remains in recovery mode and is vulnerable to shocks, (ii) the weaknesses in the financial position of the domestic private sector, and (iii) the slow recovery in employment.

Denmark’s ratings benefit from a sound fiscal framework based on a countercyclical fiscal stance and a moderate public debt burden. The fiscal strategy of the government is to maintain public finances within the limit of annual deficits not exceeding 0.5% of GDP in structural terms. Given that the recovery is gaining traction, and that forecasts for public finances already indicate full use of this fiscal space over the coming years, DBRS does not anticipate additional fiscal easing ahead of the elections expected for next year. The government deficit in 2013 was small at 0.9% of GDP, but it was positively affected by one-off factors, including the reclassification of capital pension schemes and high receipts from the pension yield tax.

As these receipts are not expected to persist over the medium term, the headline deficit will rise to 1.4% and 3.0% of GDP in 2014 and 2015, respectively. In addition, the fiscal space is constrained as government finances are expected to remain in deficit until at least 2020, largely as a result of the fiscal strategy adopted to counteract the crisis. However, DBRS judges this strategy to be sustainable, as gross government debt stood at a moderate 44.5% of GDP in 2013. Also, the deficit is expected to not increase the borrowing cost of the government, which is low at 3.3% of total government revenues in 2013.

On the back of accommodative monetary and fiscal policy and resilient net exports, the Danish economy is gradually recovering. GDP is set to expand by 1.6% and 1.9% in 2014 and 2015, respectively, driven by domestic consumption and renewed investment activity. The contribution from net trade is expected to remain positive, but become less significant over time as higher investment activity translates into stronger imports of machinery and other equipment, of which Denmark is a net importer.

In spite of these strengths, several challenges weigh on the ratings. The Danish financial sector, although better capitalised than before the crisis, is only partially benefitting from the economic recovery. While it returned to profitability in 2013, the industry remains large and exposed to an evolving regulatory environment and higher capital needs. In particular, the implementation of the Basel 3 framework in Europe via the Capital Requirements Directive IV (CRD IV) and the Capital Requirements Regulation (CRR) over the coming years, together with the Danish Bank Rescue Package 6, will likely materialise in a gradual but potentially large cost to the country’s lenders, both in terms of higher capital requirements and higher liquidity ratios. Adding to the regulatory uncertainty, Danish authorities have not yet decided whether or not the country will join the European Banking Union. Finally, the European Commission has postponed its final ruling on the treatment of mortgage bonds under the Liquidity Coverage Ratio (LCR) indicator, which was expected by June 2014.

Overall, DBRS expects the Danish banking sector to be impacted by the changing regulatory environment over the coming years, potentially in the form of reduced risk appetite, lower credit growth and limited earnings generation. However, DBRS expects profits to benefit from lower impairments as the economic recovery boosts asset quality. Impairment charges at systemic banks were 0.5% of loans in 2013, down from 0.9% in 2012. In addition, DBRS considers that although regulatory changes may impact on short-term profitability of banks, they will be beneficial to the country’s banking industry over the medium term, leading to more robust capital and liquidity positions, and enhanced resiliency and transparency.

A second challenge faced by Denmark relates to the country’s high private sector gross debt, estimated at 258% of GDP in 2013. While early signs of deleveraging observed at the beginning of 2013 have persisted throughout the first half of 2014, the highly leveraged structure of the Danish economy is unlikely to change substantially over the medium term, primarily as a consequence of the limited incentives currently in place to reduce the private sector debt stock. This will likely represent a challenge when interest rates rise, although DBRS considers this scenario unlikely in the near term. Over the coming years, though, the stock of 30-year mortgage loans with possibility of a 10-year interest-only period, introduced in 2003 will reach maturity. These loans represent half of loans to households, whose ability to repay the principal is somewhat constrained by a limited buffer of household’s liquid assets and by house prices being 15% lower than the pre-crisis peak. As a result, some households may experience problems in managing their own debt burden.

Finally, the Danish economy is challenged by a labour market that continues to be strained, with job losses since the beginning of the crisis having been only partly recovered. Employment in the first quarter of 2014 was still 9% lower than the peak reached in the third quarter of 2008, and the employment rate, at 74.4%, is 6.2 percentage points below the peak. Raising the employment rate will be crucial to achieve the long-term economic growth rate of 1.7% per annum, 24% of which is expected to come from growth in the labour supply.

Notes:
All figures are in Euros (EUR) unless otherwise noted.

The principal applicable methodology is Rating Sovereign Governments, which can be found on the DBRS website under Methodologies. The principal applicable rating policies are Commercial Paper and Short-Term Debt, and Short-Term and Long-Term Rating Relationships, which can be found on our website under Rating Scales.

These can be found on www.dbrs.com at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include Ministry of Finance of the Kingdom of Denmark, the Ministry of Business and Growth of the Kingdom of Denmark, Danmarks Nationalbank, Danmarks Statistik, European Commission, European Central Bank, Statistical Office of the European Communities, IMF, OECD, BIS, and Haver Analytics. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

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.

Information regarding DBRS ratings, including definitions, policies and methodologies are available on www.dbrs.com.

This is an unsolicited credit rating. This credit rating was not initiated at the request of the issuer.

Generally, the conditions that lead to the assignment of a Negative or Positive Trend are resolved within a twelve month period, while reviews are generally resolved within 90 days. 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: Claudio Columbano
Initial Rating Date: 20 September 2012
Rating Committee Chair: Roger Lister
Last Rating Date: 28 February 2014

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