Credit Opinion: Danske Bank A/S

Transcription

1 Credit Opinion: Danske Bank A/S Global Credit Research - 31 Aug 2012 Copenhagen, Denmark Ratings Category Moody's Rating Outlook Stable Bank Deposits Baa1/P-2 Bkd Bank Deposits (ST) --/P-2 Bank Financial Strength C- Baseline Credit Assessment (baa2) Adjusted Baseline Credit Assessment (baa2) Issuer Rating Baa1 Senior Unsecured Baa1 Jr Subordinate Ba1 (hyb) Pref. Stock Ba2 (hyb) Commercial Paper P-2 Other Short Term (P)P-2 Danske Bank A/S (London Branch) Outlook Stable Deposit Note/CD Program (P)Baa1/(P)P-2 Danske Corporation Outlook Stable Bkd Commercial Paper P-2 Contacts Analyst Phone Oscar Heemskerk/London Janne Thomsen/London Simon Harris/London Soline Poulain/London Key Indicators Danske Bank A/S (Consolidated Financials)[1] [2]6-12 [2]12-11 [2]12-10 [2]12-09 [2]12-08 Avg. Total Assets (DKK million) 3,480,722.03,423,662.03,212,645.03,096,966.03,543,695.0 [3]-0.4 Total Assets (EUR million) 468, , , , ,097.3 [3]-0.4 Total Assets (USD million) 594, , , , ,797.7 [3]-2.7 Tangible Common Equity (DKK million) 135, , , , ,773.5[3]14.2 Tangible Common Equity (EUR million) 18, , , , ,717.6[3]14.2 Tangible Common Equity (USD million) 23, , , , ,898.0[3]11.7 Net Interest Margin (%) [4]1.2 PPI / Avg RWA (%) [5]2.1 Net Income / Avg RWA (%) [5]0.4 (Market Funds - Liquid Assets) / Total Assets [4]27.6 (%) Core Deposits / Average Gross Loans (%) [4]44.3 Tier 1 Ratio (%) [5]11.0

2 Tangible Common Equity / RWA (%) [5]9.8 Cost / Income Ratio (%) [4]54.2 Problem Loans / Gross Loans (%) [4]4.7 Problem Loans / (Equity + Loan Loss [4]52.4 Reserves) (%) Source: Moody's [1] All ratios are adjusted using Moody's standard adjustments [2] Basel II; IFRS [3] Compound Annual Growth Rate based on IFRS reporting periods [4] IFRS reporting periods have been used for average calculation [5] Basel II & IFRS reporting periods have been used for average calculation Opinion RECENT CREDIT DEVELOPMENTS On 30 May 2012, Moody's downgraded Danske Bank's standalone rating to C- from C and its debt and deposit ratings to Baa1 from A2. The bank's Prime-1 short term ratings were downgraded to Prime-2. The bank's junior subordinated debt and Tier hybrid ratings were downgraded to Ba1 (hyb) from Baa2 (hyb) and to Ba2 (hyb) from Baa3 (hyb), respectively, reflecting the downgrade of the bank's standalone rating. The downgrade reflected continued pressure on Danske Bank's asset quality, especially regarding its exposures to Ireland, which we expect will continue to undermine the bank's ability to build a solid base for earnings in the short to medium term. In addition, amidst weak economic growth, deflating real estate prices and increased unemployment, we believe the operating environment in Denmark remains difficult and expect it will be challenging for Danske Bank to manage its domestic exposures. We also caution that low interest-rate levels have thus far supported borrowers' ability to repay their debts but loans with variable rates are vulnerable to interest-rate hikes. Another key driver for the rating action was Danske Bank's substantial reliance on market funding, which renders it susceptible to changes in investor sentiment. Even though we recognise that covered bonds have historically been a stable funding source, we note the shift to shorter term instruments has increased refinancing risk. SUMMARY RATING RATIONALE Moody's rates Danske Bank Baa1/P-2/C-. The C- standalone bank financial strength rating (BFSR), which maps to baa2 on the long-term scale, reflects the group's dominant position in the Danish market, paramount Nordic franchise and leading market share in Northern Ireland. It also benefits from the bank's solid customer base on which it can leverage to improve its earnings and its strong capital levels. However, key elements constraining the bank's rating are (i) Danske bank's heavy reliance on market funding, which renders it vulnerable to swings in investor and market sentiment; (ii) its limited net profitability; and (iii) our expectation that asset quality will remain modest in the next couple of years. Danske Bank is part of Danske Bank Group, which also comprises Realkredit Denmark (one of the largest Danish mortgage institutions; not rated) and Danica Pension (a leading Danish life insurance company; not rated). Moody's considers Denmark as a low support country, primarily reflecting the government's willingness to impose losses on senior creditors and depositors in accordance with the bail-in legislation implemented in October 2010 (Bank Package III) and as evidenced by the bail-in of Amagerbanken in February Recognising Danske Bank's systemic importance in Denmark, evidenced by its dominant market shares in lending and deposits and its importance in the Danish payment and clearing systems, Moody's takes into account a one-notch systemic support uplift for Danske Bank's Baa1 long-term GLC deposit rating from its baa2 standalone financial strength. Rating Drivers - Dominant player in Denmark and well-established presence in the Nordic region, Northern Ireland and the Republic of Ireland - Bottom line profits significantly affected by high loan loss provisions - High reliance on market funding

3 - Asset quality under pressure, especially in relation to non-nordic exposure but also to Denmark - Relatively high capital levels Rating Outlook The outlook on all ratings is stable. What Could Change the Rating - Up Rating upgrades are unlikely in the near future, for the reasons described in "Recent Credit Developments". A limited amount of upward rating momentum could develop if Danske Bank substantially improves its credit profile and resilience to the prevailing conditions. This may occur through increased standalone strength, e.g. work-out of asset quality challenges in Ireland and Denmark, improved earnings, unrestricted market access across the liability spectrum, and/or bolstered capital and liquidity buffers. Improved credit strength could also result from increased systemic support, e.g. ownership change or explicit support commitment from the State. What Could Change the Rating - Down While the current rating levels and outlooks incorporate a degree of expected further deterioration, ratings may decline further if (i) operating conditions worsen beyond current expectations, notably if Denmark's sovereign creditworthiness and economic environment encounter material negative pressure, leading to asset quality deterioration exceeding current expectations, and (ii) Danske Bank's market funding access experiences a sharp decline. Recent Results Danske Bank reported pre-tax profit of DKK4.1 billion in H1 2012, up from DKK3.6 billion in H The improvement primarily reflects a positive trend in net interest income, largely as a result of the bank's successful repricing initiatives in 2011 and Profits also continued to be supported by good income from trading and by the bank's insurance business, which benefited from higher investment returns and the partial booking of the risk allowance to income following authorities' easing of the calculation of the discount yield curve. Less positively, loan loss provisions increased by 26% year-on-year to DKK7 billion; according to the bank they mainly related to exposures to commercial property in Ireland and Northern Ireland, households in Ireland and Denmark and shipping. We continue to see asset quality as the main challenge to Danske Bank's earning generation capacity and expect provisioning levels to remain high in the second half of the year. At end-june 2012 Danske Bank reported a Tier 1 ratio of 12.4% including the transitional floor and 16.2% excluding it. We also note that, in June 2012, Danske Bank's mortgage subsidiary Realkredit Danmark repaid the DKK2 billion hybrid capital from the government. DETAILED RATING CONSIDERATIONS Our detailed considerations for Danske Bank's currently assigned ratings are as follows. Bank Financial Strength Rating The assigned rating is in line with the outcome of Moody's bank financial strength scorecard for Danske Bank. -- Dominant Franchise In Denmark And Good Foothold In Other Nordic Countries Danske Bank has commanding market shares in Denmark, reporting almost 30% shares of total lending, deposits, outstanding mortgage bonds and mutual funds. Danske Bank is the only Danish financial institution which successfully achieved a presence throughout the Nordic region, through Sampo Bank in Finland (12% market share; rated A2/P-1/C-), Danske Bank Sweden (6%) and Fokus Bank in Norway (5%). Though we note some correlation across Nordic economies, from a diversification point of view we see positively Danske Bank's sizeable presence in those countries, which have weathered the financial crisis relatively well.

4 The bank has also expanded in Northern Ireland (around 20% market share) and the Republic of Ireland (less than 5%), as well as in Estonia (around 10%), Lithuania (7%) and Latvia (less than 2%). Danske Bank's exposures to those countries, which experienced more severe downturns, weighed on its asset quality and profitability metrics and in turn harmed its franchise value. Whilst Moody's view Danske Bank's dominant franchise in Denmark and its good foothold in other Nordic countries as credit positive, it cautions that Danske Bank's franchise value may yet be undermined by pressures on asset quality and profitability coupled with a deteriorating macroeconomic environment. -- Bottom Line Profit Significantly Below Pre-Crisis Levels Danske Bank's overall profitability has been significantly weakened by asset quality issues in the latest four years; the bank's pre-tax profit averaged around DKK7 billion in , a significant fall compared to an average of DKK19 billion in This reflects the pronounced increase in loan loss provisions which amounted to 25% ( ) to 70% ( ) of its pre-provision profit. Danske Bank's primary source of earnings is net interest income, which accounted for 75% of its operating income at year-end This source of income has been under pressure in 2010 and 2011, primarily due to the lack of volume growth, the low interest rate environment and the high cost of funding. Nevertheless, we positively note Danske Bank successful repricing of loans during the year, which resulted in quarter-on-quarter increases in net interest income throughout The bank estimates that in Q1 2012, repricing initiatives had a positive effect of DKK 0.7 billion on net interest income compared to Q In 2011, income from financial securities and insurance operations added some volatility to Danske Bank's earnings profit was negatively affected by declining profit from the insurance operations due to lower investments returns and the adjournment of the booking of the risk allowance. The bank cautioned insurance profits are likely to remain subdued in Danske Bank managed to keep costs under control over recent years; costs were consistently below 1% of total assets and have been slightly levelling off since However, the bank's cost-to-income ratio at around 60% at year-end 2011 is higher than that of most of its Nordic peers, though we note that the weak metric is largely attributable to reduced income. We see Danske Bank's ability to maintain tight cost control as crucial, especially as we expect its earnings will remain under pressure in the near future. Danske Bank's net profitability compares poorly with that of most of its Nordic peers. An improvement in its profitability stemming from lower loan loss provisions, growing net interest income and good cost efficiency will be clearly credit positive in our assessment of Danske Bank's creditworthiness. However, we believe the bank's ability to do so will be hindered by macro-economic conditions in Denmark, which we expect to remain bleak in the short to medium term. -- Heavy Reliance On Market Funding, Especially Covered Bonds With deposits accounting for 35% of its total funding, Danske Bank relies heavily on capital markets to fund itself. Around two third of market funds were raised from covered bond markets (largely via Realkredit Danmark). We note that this source of funding, which is typically less confidence-sensitive than senior unsecured funds, has been widely used in 2011 when access to capital markets became more restricted for banks across Europe. We view Danske Bank's reliance on market funding - which is a common feature at Nordic banks - as a material source of risk because, in times of market stress, market funding can become more expensive, exerting pressure on the banks' net profitability, or/and restricted. We believe that the usage of Bank Package III on smaller banks in 2011, which resulted in losses for senior bond holders, heightens the fragility of investors' sentiment towards Danish banks. To support banks' financing operations, the Danish Central Bank decided to broaden the existing collateral basis to include good quality loans and, as the ECB, to offer banks loans with a maturity of three years. Danske Bank drew DKK15 billion on this facility in March In addition, it drew DKK11 billion and DKK30 billion on ECB's three-year LTRO in December 2011 and March 2012, respectively. The bank communicated the reason for using these facilities was primarily to take advantage of their more attractive prices. We also note that in July 2012 Danske Bank repaid the last state-guaranteed bonds. While we caution that Danish

5 banks' substantial need for refinancing during the year might result in some overcrowding of the domestic debt market, we take some comfort from Danske Bank's sizeable liquidity buffer, which amounted to almost DKK500 billion or 15% of total assets at year-end The liquidity buffer consisted Danish and Swedish covered bonds, government bonds and bonds guaranteed by central or local government - most of those assets can be repoed with central banks. -- Asset Quality Remains Under Pressure Danske Bank's asset quality metrics compare poorly with those of its Nordic peers. Problem exposures (gross loans subject to individual impairment test) accounted for around 5.9% of the bank's gross loans at year-end 2011 and have been steadily increasing since 2007 when they were less than 1% of gross loans. While we view the bank's weakened asset quality as credit negative, we note as a mitigating factor the good collateral coverage of problem loans (almost half of problem loans were collateralised at year-end 2011). The deterioration of the bank's asset quality continued to stem from operations in the Republic of Ireland (problem loan ratio of 40%) and Northern Ireland (15%), but also increasingly from Denmark (5%). The increasing need for impairments in those countries largely reflects persistently depressed property markets, leading to decreasing collateral values. We expect incremental losses from Danske Bank's activities in Ireland and Northern Ireland (around 9% of credit exposure at year-end 2011) and Denmark, where the exposures related to agriculture, real estate and SMEs are under increasing pressure. In addition, we expect the credit quality of highly indebted households will soften as bleak economic conditions persist. Positively, problem loans in the Baltics (20% of gross loans) and Finland (4%) were further reduced during the year. While we view Danske Bank's risk management and systems as generally good, our assessment of its risk practices is weighed down by the high level of single-borrower concentration - a typical feature at Nordic banks. We believe such concentration poses a material risk to Danske Bank's asset quality as it potentially heightens the pace and the extent of any deterioration in asset quality. -- Relatively High Capital Levels In light of the weakening asset quality, we view Danske Bank's relatively high capital levels as a necessary buffer to absorb potential future losses. The bank's Tier 1 ratio stood at 12.7% (16% excluding transitional floor) at end-march This levels were strengthened by DKK26 billion of hybrid core capital from the Danish state in H and by DKK20 billion capital in a rights issue in Q We understand that Danske Bank will not repay the government hybrid before April Realkredit Danmark repaid the DKK2 billion hybrid capital from the government in June Global Local Currency Deposit Rating (Joint Default Analysis) Moody's assigns a GLC deposit rating of Baa1 to Danske Bank. The rating is supported by the bank's standalone financial strength of baa2 and by Denmark's local-currency deposit ceiling of Aaa. Danske Bank's Baa1 GLC deposit rating includes one notch of systemic support uplift from its baa2 standalone financial strength. Notching Considerations The ratings for the Bank's hybrid obligations are notched off the standalone financial strength according to "Moody's Guidelines for Rating Bank Hybrid Securities and Subordinated Debt" published on 17 November Foreign Currency Deposit Rating The Baa1 foreign-currency deposit ratings of Danske Bank are unconstrained given that Denmark, in common with other EU members, has a country ceiling of Aaa. Foreign Currency Debt Rating The Baa1 foreign-currency debt ratings of Danske Bank are unconstrained given that Denmark, in common with other EU members, has a country ceiling of Aaa. ABOUT MOODY'S BANK RATINGS

6 Bank Financial Strength Rating Moody's Bank Financial Strength Ratings (BFSRs) represent Moody's opinion of a bank's intrinsic safety and soundness and, as such, exclude certain external credit risks and credit support elements that are addressed by Moody's Bank Deposit Ratings. BFSRs do not take into account the probability that the bank will receive such external support, nor do they address risks arising from sovereign actions that may interfere with a bank's ability to honour its domestic or foreign currency obligations. Factors considered in the assignment of BFSRs include bankspecific elements such as financial fundamentals, franchise value, and business and asset diversification. Although BFSRs exclude the external factors specified above, they do take into account other risk factors in the bank's operating environment, including the strength and prospective performance of the economy, as well as the structure and relative fragility of the financial system, and the quality of banking regulation and supervision. Global Local Currency Deposit Rating A deposit rating, as an opinion of relative credit risk, incorporates the BFSR as well as Moody's opinion of any external support. Specifically, Moody's Bank Deposit Ratings are opinions of a bank's ability to repay punctually its deposit obligations. As such, they are intended to incorporate those aspects of credit risk relevant to the prospective payment performance of rated banks with respect to deposit obligations, which includes: intrinsic financial strength, sovereign transfer risk (in the case of foreign currency deposit ratings), and both implicit and explicit external support elements. Moody's Bank Deposit Ratings do not take into account the benefit of deposit insurance schemes which make payments to depositors, but they do recognize the potential support from schemes that may provide assistance to banks directly. According to Moody's joint default analysis (JDA) methodology, the global local currency deposit rating of a bank is determined by the incorporation of external elements of support into the bank's Baseline Credit Assessment. In calculating the Global Local Currency Deposit rating for a bank, the JDA methodology also factors in the rating of the support provider, in the form of the local currency deposit ceiling for a country, Moody's assessment of the probability of systemic support for the bank in the event of a stress situation and the degree of dependence between the issuer rating and the Local Currency Deposit Ceiling. National Scale Rating National scale ratings are intended primarily for use by domestic investors and are not comparable to Moody's globally applicable ratings; rather they address relative credit risk within a given country. A Aaa rating on Moody's National Scale indicates an issuer or issue with the strongest creditworthiness and the lowest likelihood of credit loss relative to other domestic issuers. National Scale Ratings, therefore, rank domestic issuers relative to each other and not relative to absolute default risks. National ratings isolate systemic risks; they do not address loss expectation associated with systemic events that could affect all issuers, even those that receive the highest ratings on the National Scale. Foreign Currency Deposit Rating Moody's ratings on foreign currency bank obligations derive from the bank's local currency rating for the same class of obligation. The implementation of JDA for banks can lead to high local currency ratings for certain banks, which could also produce high foreign currency ratings. Nevertheless, it should be noted that foreign currency deposit ratings are in all cases constrained by the country ceiling for foreign currency bank deposits. This may result in the assignment of a different, and typically lower, rating for the foreign currency deposits relative to the bank's rating for local currency obligations. Foreign Currency Debt Rating Foreign currency debt ratings are derived from the bank's local currency debt rating. In a similar way to foreign currency deposit ratings, foreign currency debt ratings may also be constrained by the country ceiling for foreign currency bonds and notes; however, in some cases the ratings on foreign currency debt obligations may be allowed to pierce the foreign currency ceiling. A particular mix of rating factors are taken into consideration in order to assess whether a foreign currency bond rating pierces the country ceiling. They include the issuer's global local currency rating, the foreign currency government bond rating, the country ceiling for bonds and the debt's eligibility to pierce that ceiling. About Moody's Bank Financial Strength Scorecard

7 Moody's bank financial strength model (see scorecard below) is a strategic input in the assessment of the financial strength of a bank, used as a key tool by Moody's analysts to ensure consistency of approach across banks and regions. The model output and the individual scores are discussed in rating committees and may be adjusted up or down to reflect conditions specific to each rated entity. Rating Factors Danske Bank A/S Rating Factors [1] A B C D E Total Score Trend Qualitative Factors (50%) C Factor: Franchise Value C Neutral Market Share and Sustainability x Geographical Diversification x Earnings Stability x Earnings Diversification [2] Factor: Risk Positioning D+ Neutral Corporate Governance [2] Ownership and Org. Complexity Key Man Risk Insider and Related-Party Risks Controls and Risk Management x - Risk Management x - Controls x Financial Reporting Transparency x - Global Comparability x - Frequency and Timeliness x - Quality of Financial Information x Credit Risk Concentration Borrower Concentration Industry Concentration Liquidity Management x Market Risk Appetite x Factor: Operating Environment B Neutral Economic Stability x Integrity and Corruption x Legal System x Financial Factors (50%) D+ Factor: Profitability D+ Weakening PPI / Average RWA - Basel II 2.24% Net Income / Average RWA - Basel II 0.45% Factor: Liquidity D- Weakening (Market funds - Liqud Assets) / Total Assets 25.68% Liquidity Management x Factor: Capital Adequacy A Neutral Tier 1 Ratio - Basel II 11.84% Tangible Common Equity / RWA - Basel II 10.44% Factor: Efficiency B Neutral Cost Income ratio 52.44% Factor: Asset Quality E+ Weakening Problem Loans / Gross Loans 5.23%

8 Problem Loans / (Shareholders' Equity + Loan 56.69% Loss Reserves) Lowest Combined Financial Factor Score (15%) E+ Economic Insolvency Override Neutral Aggregate Score C- Assigned BFSR C- [1] - Where dashes are shown for a particular factor (or sub-factor), the score is based on non-public information. [2] - A blank score under Earnings Diversification or Corporate Governance indicates the risk is neutral Moody's Investors Service, Inc. and/or its licensors and affiliates (collectively, "MOODY'S"). All rights reserved. CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. ("MIS") AND ITS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND CREDIT RATINGS AND RESEARCH PUBLICATIONS PUBLISHED BY MOODY'S ("MOODY'S PUBLICATIONS") MAY INCLUDE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES. MOODY'S DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL, FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS AND MOODY'S OPINIONS INCLUDED IN MOODY'S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. CREDIT RATINGS AND MOODY'S PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND CREDIT RATINGS AND MOODY'S PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. NEITHER CREDIT RATINGS NOR MOODY'S PUBLICATIONS COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY'S ISSUES ITS CREDIT RATINGS AND PUBLISHES MOODY'S PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE. ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT. All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided "AS IS" without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources Moody's considers to be reliable, including, when appropriate, independent third-party sources. However, MOODY'S is not an auditor and cannot in every instance independently verify or validate information received in the rating process. Under no circumstances shall MOODY'S have any liability to any person or entity for (a) any loss or

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