DBRS Confirms Danske Bank A/S at A, Trend Revised to Stable

DBRS Ratings Limited (DBRS) has confirmed the ratings of Danske Bank A/S (Danske or the Bank) at ‘A’ for the Long-Term Issuer Rating, and Long-Term Debt and Deposit Rating, and R-1 (low) for the Short-Term Issuer Rating and Short-Term Debt and Deposits rating. The Intrinsic Assessment (IA) for the Bank is ‘A’, resulting in the Bank’s final ratings being positioned in line with its IA. The trend was reversed to Stable. Please see the table at the end of the press release for full list of ratings.

KEY RATING CONSIDERATIONS
The confirmation of the long-term ratings reflects Danske’s capacity to generate strong and resilient earnings along with its improving asset quality, reflecting the ongoing winding-up of the Non-Core unit and good macroeconomic conditions. It also incorporates a well-managed funding profile and strong capital levels, including the forthcoming impact relating to regulatory capital developments.

In reversing the trend to Stable, DBRS takes into account that recent investigations led by local and Danish regulators have revealed serious shortcomings in governance in Estonia over money laundering issues during the 2007-2015 period, and more generally weaknesses in risk management. DBRS notes that at this point further clarification is needed regarding the full extent of the breakdown in risk control and how this will impact the Bank.

RATING DRIVERS
Positive pressure on the ratings would result from (i) addressing identified shortcomings in risk management as and when required by the Danish FSA, while maintaining (ii) solid profitability and (iii) strong capitalisation levels.

Negative pressure on the ratings would likely be driven by (i) a significant deterioration in profitability or (ii) capital levels, or (iii) a weakening in investor confidence that would affect access to wholesale funding.

RATING RATIONALE
In confirming the ratings, DBRS recognises Danske’s very strong domestic franchise, and this remains a key factor underpinning the ratings. The leading market position in Denmark is complemented with meaningful market shares in Sweden, Norway and Finland as well as a strong presence in Northern Ireland. DBRS also notes that the winding-up of the Bank’s Non-Core, consisting now primarily of personal and business Baltic exposures, continues. Effective April 1, 2018, the activities of Business Banking customers in the Baltics who do not have business interest in the Nordics have been transferred to non-core as Danske is re-focusing its strategy towards customers operating in the Nordic region, reflecting the Bank’s ambition to become the “Nordic Integrator” in the financial sector along with management’s decision to close down the non-residents portfolio in light of serious anti money laundering issues encountered in Estonia.

DBRS considers Danske’s capacity to generate earnings as strong and resilient. Despite the pressure from the negative interest rate environment, Danske’s net interest income has remained largely resilient while the Bank has managed to grow the contribution of net fee income to its revenues in recent years. Also, the earnings generation ability is supported by strong level of efficiencies with a cost-to-income ratio in the 50% range (1H18: 51%; 2017: 47.2%, 2016: 47.2%; 2015: 50.9%). Impairment charges continued to trend downwards with the Bank reporting net reversals of DKK 433 million in 1H18, compared to reversals of DKK 1,582 million in 2017. As a result, in 2017, the Bank reported net profit of DKK 20.9 billion. However, net profit in 1H18 was down to DKK 8.8 billion, compared to DKK 10.3 billion in 1H17 (IFRS figures), as the pressure on margins remains offset by increased lending volumes and reversals of impairments but was impacted by lower trading income.

Asset quality indicators generally improve on the back of good Nordic macroeconomies. However, operational risk challenges have become evident. DBRS notes that recent investigations revealed weaknesses in risk management in Estonia in all three lines of defence (the business, the risk management and compliance function, and the internal audit department). While Danske is cooperating with the relevant authorities and has announced that final conclusions of the internal investigation are to be presented by the Bank in September 2018, DBRS remains cautious until the conclusion is known.

With regards to credit risk, the Bank’s largest exposure remains towards personal customers, and accounted for DKK 899.7 billion at end June 2018, or 34% of the total net credit exposure, with the majority of it being mortgage loans granted through Realkredit Danmark, Danske’s domestic mortgage subsidiary. While the Danish housing market shows a strong recovery since 2012, there are also some signs of overheating in large cities. At present, DBRS views this as manageable given stricter regulatory requirements on mortgage lending since 2015, as well as the fact that the average loan-to-value for residential mortgages was 62.8% at end-June 2018. Overall, as calculated by the Bank, NPLs in core segments accounted for just 1.3% at end-June 2018, stable from end-June 2017 and below 2.5% at end-2014.

In DBRS’s view, Danske’s funding is sound and well-managed, and liquidity is ample. As per Danish regulation, mortgage lending is exclusively financed by covered bonds. As a result, Danske relies to a higher degree than other European banks on capital market funding due to its significant usage of covered bonds. As a result, wholesale funding represented approximately 57% of total funding at end-June 2018 (DBRS calculation), with covered bonds accounting for half of this amount. Given the balance principle that is applied in Denmark, which is in substance match funding, DBRS views the covered bonds as well-aligned with mortgage loans. Customer deposits, which represented 43% of total funding at end-June 2018, have been relatively stable in the last 5 years. DBRS views Danske’s deposit base as providing a solid foundation to the funding profile. Liquidity remains ample with the Bank reporting a liquidity coverage ratio (LCR) of 142% at end-June 2018.

DBRS views Danske’s capital position as strong. There are a number of challenges ahead with regards to regulatory capital and risk-weighted asset (RWA) requirements, but DBRS considers the Bank to be well placed to manage the impact given current buffers over regulatory minimums, the Bank’s track record for strong internal capital generation, and flexibility to access markets. Illustrating this is the Bank’s Common Equity Tier 1 (CET1) ratio, under Danish transitional rules, of 15.9% at end-June 2018 (net of full share buy-back and the short-term effect of SEB Pension Danmark acquisition), compared to 17.6% at end-2017. This represents a capital cushion of 360 bps over the 12.3% CET1 minimum requirement, including a 1.4% Pillar 2 CET1 requirement (or a capital cushion of 170-270 bps over Danske’s CET1 target of 14-15%). The leverage ratio stood at 4.2% at end-June 2018 under fully phased-in rules.

DBRS notes that mortgage banks are not subject to bail-in tools under the Danish version of EU’s BRRD (Bank Recovery and Resolution Directive). However, the Danish authorities have required mortgage banks to maintain a buffer of 2% of unweighted assets in addition to their capital requirements, and DBRS understands that their mortgage bank, Realkredit, is already able to meet the requirement using excess shareholders’ equity - not requiring any additional funding.

The Grid Summary Grades for Danske Bank A/S are as follows: Franchise Strength – Strong; Earnings – Strong; Risk Profile – Good; Funding & Liquidity – Strong/Good; Capitalisation – Strong.

Notes:
All figures are in DKK unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations (May 2017). This can be found at: http://www.dbrs.com/about/methodologies

The sources of information used for this rating include SNL Financial, Finanstilsynet (Danish FSA) and Company Documents. DBRS considers the information available to it for the purposes of providing this rating to be of satisfactory quality.

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

This rating included participation by the rated entity or any related third party. DBRS had no access to relevant internal documents for the rated entity or a related third party.

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 historical default rates published by the European Securities and Markets Authority (“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 and US regulations only.

Lead Analyst: Vitaline Yeterian, Vice President, Global FIG
Rating Committee Chair: Elisabeth Rudman, MD – Head of EU FIG, Global FIG
Initial Rating Date: January 18, 2010
Last Rating Date: August 08, 2017

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