DBRS Morningstar Downgrades Danske Bank’s LT Issuer Rating to A (low), Trend Now Stable

DBRS Ratings GmbH (DBRS Morningstar) downgraded the Long-Term Issuer Rating of Danske Bank A/S (Danske or the Bank) to A (low) from ‘A’, while the Short-Term Issuer Rating remains at R-1 (low). The trend on the Bank’s ratings is now Stable. The Bank’s Intrinsic Assessment (IA) is now A (low) and the Support Assessment remains SA3. See a full list of ratings at the end of this press release.

KEY RATING CONSIDERATIONS
The downgrade of Danske’s Long-Term Issuer Rating to A (low) reflects the pressure on the Bank’s revenues from expected lower lending volumes amid the COVID-19 pandemic, and the continuation of the ultra-low interest rate environment. DBRS Morningstar also expects profitability to be hindered by higher loan loss provisions in part driven by COVID-19 related asset quality deterioration. As a result, internal capital generation is expected to reduce significantly while risk-weighted assets will likely increase, potentially negatively impacting the Bank’s capital position. DBRS Morningstar also notes that Danske’s capital position remains vulnerable to any further adverse event, including the still potential significant fines related to ongoing investigations over serious AML issues in the Bank’s, now closed, Estonian branch.

The downgrade of the Long-Term Issuer Rating to A (low) also takes into account the issues that have been revealed in Danske’s risk management, internal reporting and controls, particularly after three recent announcements made by the Danish FSA. On 8 June 2020, the Danish FSA commented that Danske’s 2019 provisioning levels could be higher than initially reported. On 9 June 2020, the Danish FSA reported that Danske’s risk practices in relation to the approval of loans to customers owning rental property and property projects in Denmark were not in line with the Bank’s own rules, and deviations from Danske’s credit policy had been approved without the required prior submission to the Bank’s Board of Directors. Furthermore, on 10 June 2020, the Danish FSA filed a criminal complaint against Danske Bank A/S for violations of the Market Abuse Regulation on account of inadequate market monitoring and opposite trades. We recognise Danske has been in the process of addressing shortcomings in its operational risk framework and strengthening its compliance, financial crime and Anti-Money Laundering (AML) activities since 2018. However, we will continue to monitor the potential negative impact on the Bank’s franchise, earnings generation, funding, and capital levels, while taking into account the significant change in management, as well as the important programs of investments aiming to strengthen the Bank’s compliance, and AML systems.

The Stable trend reflects DBRS Morningstar’s view that the ratings are well-placed at the current level. The ratings take into account Danske’s resilient franchise and customer deposit base, along with its good credit metrics. However, a prolonged economic crisis could add further downward rating pressure. As a result, we will continue to monitor the developing situation on revenues, profits, and asset quality, as well as potential funding implications.

RATING DRIVERS
An upgrade of the ratings is unlikely in the near-term, as DBRS Morningstar expects that it will take time for the Bank to improve its earnings generation ability given the economic downturn related to the COVID-19 pandemic, along with the control deficiencies and related potential fines.

A downgrade could be driven by further substantial litigation or reputation issues, including sizeable settlements beyond current expectations, especially if these were to have a material impact on the Bank’s capital position. In addition, a downgrade could be triggered by a prolonged weakening of profitability, an increase in the Bank’s risk profile, or a weakening in investor confidence that would affect access to wholesale funding.

RATING RATIONALE
The ratings take into account the Bank’s strong franchise in Denmark combined with its presence in the wider Nordic region. On the regulatory front, Danske remains under a series of investigations, including by the Danish FSA and US authorities, and there has been a number of changes in Danske’s senior management as a result of the regulatory problems faced by the Bank. However, the impact of these issues on the Bank’s customer base appears limited to date.

DBRS Morningstar views Danske’ ability to generate earnings as weakened. Operating expenses have significantly increased due to the high costs associated with compliance-related activities, in line with what had been announced in 2019. However, DBRS Morningstar now also expects lower revenues due to a combination of ultra-low interest rates, lower business volumes on the back of the COVID-19 pandemic, and tough market conditions, albeit there has been an increase in credit facilities to support the liquidity of corporate clients. In Q1 2020, Danske reported a net loss of DKK 1,289 million compared to a profit of DKK 2,988 million in Q1 2019, due to lower revenues and the significant increase in provisions driven by COVID-19. Danske's loan impairment charges increased significantly to DKK 4,251 million in Q1 2020, well above the Bank’s income before provisions and taxes of DKK 2,842 billion, as a result of both specific and model-driven provisions incorporating updated macroeconomic model assumptions under IFRS 9 and the oil price decline.

Given the economic downturn, DBRS Morningstar expects the cost of risk and asset quality metrics to deteriorate albeit starting from a low point. At end-Q1 2020, non-performing loans (NPLs) as calculated by the Bank were low, accounting for 1.5% of total loans. However, with COVID-19, sector specific provisioning adjustments have increased in sectors most likely to be negatively affected. Overall, Danske reported that its immediately affected segments (oil-related, transportation, hotels & restaurants, and retail) represented 3.3% of its total gross credit exposure at end-Q1 2020, however, we note this excludes commercial property (12.4% of total gross credit exposure), or the automotive sector (2%), which could also be negatively affected in this environment. At this stage, we view that the cumulative impact of COVID-19 and the mitigation of the payment deferral programmes on Danske’s balance sheet will only become apparent over time.

DBRS Morningstar views Danske as having a sound and well-managed funding profile, even though wholesale funding accounts for a higher proportion of total funding than most European peers. 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. Given the balance principle that is applied in Denmark, which is in substance match funding, DBRS Morningstar views the covered bonds as well-aligned with mortgage loans. During Q1 2020, Danske raised DKK 26 billion of wholesale funding, split between DKK 10.11 billion in Senior Non-Preferred, DKK 15.1 billion in covered bonds, and DKK 0.8 billion in senior debt. Liquidity remains solid with the Bank reporting a liquidity coverage ratio (LCR) of 154% at end-1Q20.

DBRS Morningstar considers Danske has adequate capital cushions over regulatory minimum and has enjoyed good access to markets to date. The Bank’s fully-loaded common equity tier 1 (CET1) ratio was 17.4% at end-Q1 2020, implying a capital cushion of 420 bps over the CET1 regulatory minimum of 13.2%. However, DBRS Morningstar notes that the investigation into the AML issues related to its former Estonian branch could result in severe financial penalties.

ESG CONSIDERATIONS
DBRS Morningstar views the Business Ethics ESG subfactor as significant to the credit rating. This is included in the Governance category. There has been a high level of controversies over the Bank’s internal reporting and controls. Most notably, the Bank remains under investigation for deficiencies in its corporate governance and practices, which were identified over substantial AML issues in the Bank’s former branch in Estonia between 2007 and 2015. In addition, the Danish FSA filed a criminal complaint against Danske to the police on 10 June 2020 for violating market manipulation regulations, claiming Danske facilitated so-called wash trades by simultaneously selling and buying the same financial instruments. Adding to controversies over the Bank’s internal reporting and controls, we note the Danish FSA also reported that Danske’s internal auditors had not detected that Danske still needed to implement various parts of the accounting rules and that the credit process for impairment charges contained errors. The Danish FSA also found that internal auditors did not independently address internal issues, while adding it is necessary for the internal auditors to familiarise themselves with the rules so as to have sufficient knowledge when they audit the credit processes.

DBRS Morningstar also views that the Corporate Governance ESG subfactor as significant to the credit rating. This is also included in the Governance category. The Danish FSA recently reported that Danske’s internal reporting and controls should be improved, and this is now reflected in the Risk building block. On 8 June 2020, the Danish FSA reported that, overall, they believe that there is still a need for impairment charges against the largest loans and that this may also apply to small loans. As a result, the Bank’s H1 2020 earnings will show whether impairment charges against those loans are still needed as the Bank was told to take into account the FSA’s comments.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792

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

Notes:
All figures are in DKK unless otherwise noted.

The principal methodology is the Global Methodology for Rating Banks and Banking Organisations (June 8, 2020). https://www.dbrsmorningstar.com/research/362170/global-methodology-for-rating-banks-and-banking-organisations

For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883

The sources of information used for this rating include the Danish FSA website (https://www.dfsa.dk/), the Danish Central Bank website (https://www.nationalbanken.dk/en), Danske Q1 2020 Conference Call Presentation and Factbook, Q1 2020 Debt Investor Update, and S&P Global Market Intelligence. DBRS Morningstar 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.

With Rated Entity or Related Third-Party Participation: YES
With Access to Internal Documents: NO
With Access to Management: NO

DBRS Morningstar 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 Morningstar's outlooks and ratings are under regular surveillance

For further information on DBRS Morningstar 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

The sensitivity analysis of the relevant key rating assumptions can be found at: https://www.dbrsmorningstar.com/research/363593

Ratings assigned by DBRS Ratings GmbH are subject to EU and US regulations only.

Lead Analyst: Arnaud Journois - Vice President, European Financial Institutions, Global FIG
Rating Committee Chair: Ross Abercromby, Managing Director, Global FIG
Initial Rating Date: January 18, 2010
Last Rating Date: October 8, 2019

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