CREDIT OPINION 5 April 17 DNB Bank ASA Semiannual update following year-end 16 Results Update Summary Rating Rationale We rate Aa the long-term deposits and senior unsecured debt of DNB Bank ASA (DNB). We also assign a long- and short-term Counterparty Risk Assessment (CRA) of A(cr)/ Prime(cr) to the bank. The outlook on the bank s long-term senior ratings is negative. RATINGS DNB Bank ASA Domicile Norway Long Term Debt Aa Type Senior Unsecured - Fgn Curr Outlook Negative Long Term Deposit Aa Type LT Bank Deposits - Fgn Curr Outlook Negative Please see the ratings section at the end of this report for more information. The ratings and outlook shown reflect information as of the publication date. DNB's a baseline credit assessment (BCA) reflects the bank's strong capital and good level of profitability, balanced against weakening asset quality and high reliance on international capital markets, which renders the bank susceptible to investor sentiment. DNB's Aa long-term deposits and senior unsecured debt ratings include a two-notch uplift resulting from our advanced Loss Given Failure (LGF) analysis, reflecting our view that the bank s junior depositors and senior creditors face a very low loss given failure. In addition, our assessment of government support translates into a further two notch uplift included in these ratings. The negative outlook on DNB's senior unsecured debt and deposit ratings reflects our expectation that Norway's slowing growth resulting from low oil prices and reduced oil investments will, over time, have a negative impact on DNB's performance. Exhibit 1 Contacts Alessandro Roccati 44--7776 Senior Vice President alessandro.roccati@moodys.com Louise Lundberg 46-8-55-6568 VP-Sr Credit Officer louise.lundberg@moodys.com Maria Asensio 44--77778 Associate Analyst maria.asensio@moodys.com Jean-Francois 44--777-565 Tremblay Associate Managing Director jean-francois.tremblay@moodys.com Sean Marion 44--77756 Managing Director Financial Institutions sean.marion@moodys.com Rating Scorecard- Key Financial Indicators DNB Bank ASA (BCA: a) Nordic rated peers % 5% % 15% 1% 5%.4% 17.1%.7% 5.4% 7.8% % Asset Risk: Problem Loans/ Gross Loans Profitability: Net Funding Structure: Liquid Resources: Liquid Capital: Banking Market Funds/ Tangible Tangible Common Income/ Assets/Tangible Tangible Banking Assets Assets Equity/Risk-Weighted Banking Assets Assets Solvency Factors (LHS) Source: Moody's Banking Financial Metrics Liquidity Factors (RHS) 45% 4% 5% % 5% % 15% 1% 5% %
Credit Strengths As the leading bank in Norway, DNB has a solid banking franchise and status as the nation's flagship bank Capital is high and leverage compares well with peers DNB reports solid core earnings, and benefits from the relatively strong performance of the Norwegian economy DNB's BCA is supported by its Very Strong- macro profile Our advanced LGF analysis indicates a very low loss-given-failure for long-term deposit and senior unsecured debt ratings, resulting in a two-notch LGF uplift from the adjusted BCA The long-term deposit and senior unsecured debt ratings incorporate a two-notch government support uplift, given size, interconnectedness and partial government ownership Credit Challenges High dependence on market funding, somewhat mitigated by a solid deposit base and good access to local and international capital markets Deterioration in asset quality, mostly related to challenges in the oil offshore portfolio highlight negative pressures on the asset risk profile of the bank Rating Outlook The outlook is negative on all long-term ratings of DNB Bank ASA. Factors that Could Lead to an Upgrade Upward pressure on DNB's debt and deposit rating is unlikely in the near term given the negative outlook. The outlook could return to stable if DNB: (1) further reduces its asset vulnerability, especially in relation to oil-related and offshore exposures as well as to historically more volatile segments, such as shipping and CRE; () maintains strong and stable earnings generation without increasing its risk profile; and () preserves sustained access to international capital markets. Factors that Could Lead to a Downgrade Downwards pressure on the ratings could develop if: (1) DNB's financing conditions were to become difficult; () its asset quality were to deteriorate beyond our expectations and leading to further increase of the bank s credit costs; () its credit profile substantially deteriorates due to adverse developments in the Norwegian oil, offshore and real-estate markets and/or (4) DNB increases its involvement in more risky operations such as capital market activities. (5) government support were to recede due to the implementation of resolution regimes. Key Indicators Exhibit DNB Bank ASA (Consolidated Financials) [1] Total Assets (NOK billion) Total Assets (EUR million) Total Assets (USD million) Tangible Common Equity (NOK billion) Tangible Common Equity (EUR million) 16 15 14 1 1 Avg.,5 46,19 59,7 178 19,567,17 6, 45,57 17 17,964,191 41,45 9,171 14 15,7,46 44,8 7,4 1 14,71,69 81,97 71,75 11 15,.4 -.4-8.64 1.74 6.94 This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history. 5 April 17 DNB Bank ASA: Semiannual update following year-end 16 Results
Tangible Common Equity (USD million) Problem Loans / Gross Loans (%) Tangible Common Equity / Risk Weighted Assets (%) Problem Loans / (Tangible Common Equity + Loan Loss Reserve) (%) Net Interest Margin (%) PPI / Average RWA (%) Net Income / Tangible Assets (%) Cost / Income Ratio (%) Market Funds / Tangible Banking Assets (%) Liquid Banking Assets / Tangible Banking Assets (%) Gross loans / Due to customers (%),68.4 17.1 19. 1.5.6.7 4.7 5.4 7.8 159. 19,515 1.5 16. 1. 1.5. 1. 9.6 4.9 5.4 161. 19,5 1.9 1.7 17.5 1.5.6.9 4. 7.6 9.4 15.4,84. 1..7 1.4..8 46.4 8.. 15.9 19,776. 11. 4. 1.4..6 48.4 4.7 7.8 161. 1.14.5 15.76 19.5 1.55.76.85 4.95 7.95 8.15 157.55 [1] All figures and ratios are adjusted using Moody's standard adjustments [] Basel III - fully-loaded or transitional phase-in; IFRS [] Basel II; IFRS [4] Compound Annual Growth Rate (%). Any interim period amounts presented are assumed to be fiscal year end amounts for calculation purposes [5] Simple average of periods presented [6] Simple average of Basel III periods presented Source: Moody's Financial Metrics Detailed Rating Considerations The financial data in the following sections are sourced from DNB's financial statements and Moody's Financial Metrics. As the leading bank in Norway, DNB has a solid banking franchise and status as the nation's flagship bank DNB's sizeable domestic franchise is a key positive rating driver, supporting the bank's profitability and asset quality. DNB is Norway's largest financial institution, with a dominant and sustainable market share of 9% of domestic gross lending as of end6, according to Finance Norway. DNB achieves stable earnings generation capacity aided by the supportive operating environment, the bank's solid customer base and pricing power, and high brand recognition in Norway. DNB is Norway's most international bank. The loan portfolio of the bank's international units accounted for around.5% of total loans at the end of December 16, thus adding diversification to DNB's earnings and risk. In contrast with European banks that were nationalised during the recent financial crisis, we continue to view DNB as the government's flagship financial institution. The Norwegian government's 4% stake in the bank makes it the largest shareholder and ensures the bank's headquarters remain in the country, so that we view a reduction of this stake as unlikely. In August 16, DNB and Nordea Bank AB (Aa/Aa stable, a) agreed to combine their Baltic operations in a joint venture, which they expect to complete in mid7, subject to regulatory approval. Although the financial effect of the transaction will be limited for both banks, we expect that the merger will create cost and revenue synergies in the bank s sub-scale Baltic operations. Capital is high and leverage compares well with peers At the end of December 16, DNB's common equity Tier 1 (CET1) and total capital ratios according to Basel III transitional rules were 16.% (above the requirement reached one year ahead on plan) and 19.5%, respectively (up from 14.4% and 17.8% respectively, at end5). The increase of common equity Tier 1 capital, was primarily driven by profits generated during the period as well as a strategic reduction in risk-weighted assets relating to large international corporates with low profitability. The group targets a dividend pay-out ratio above 5% from 17. At the end of December 16, a dividend of NOK 5.7 per share was proposed by the Board of Directors, (around 5% pay-out ratio). As a result of different risk weighting among the Nordic banks, it can be difficult to compare reported capital ratios. As an example, in Norway, banks mortgages are subject to both Basel III requirements with a loss given default floor and Basel I requirements subject to an 8% floor, which result in risk-weighting of around 4% on mortgages. In comparison in Sweden, the large Swedish banks apply a mortgage risk-weighting of around 5% to 8% on mortgages in their reported capital ratios but these banks must meet high nominal capital requirements which include a 5% risk-weight on mortgages. Similar considerations apply to the corporate book. DNB's leverage ratio according to Moody s definition (8.7% at end-december 16) compares well against large Nordic and international peers, albeit less so against smaller Norwegian peers (average of 5.4%). 5 April 17 DNB Bank ASA: Semiannual update following year-end 16 Results
DNB reports solid core earnings and benefits from the relatively strong performance of the Norwegian economy We view DNB's core earnings as resilient, supported by DNB's dominant position in the Norwegian market. With around 8% of its loans driven by Norwegian exposures, DNB benefits from the relatively strong performance of the Norwegian economy. We forecast a modest real GDP growth for the total economy (mainland and offshore) of 1.4% in 17. The bank's net income to tangible assets has been steadily increasing over the last years from.6% in 1 to.8% the following year and reaching.7% % in 16. In 16, net interest income, the main driver of DNB's revenues (7% of total revenues on a threeyear average basis), declined by 4% year on year due to higher long term funding costs and a decline in amortisation and fee income; however, the bank was able to reduce expenses by % year on year, mainly supported by the positive impact from recent restructuring initiatives. DNB's cost-to-income ratio remains among the strongest in its European peer group with a three-year average of 4%, reflecting good cost control. During 16, DNB's loan loss provisions more than tripled to NOK 7.4 billion of which NOK. billion on oil and shipping related industries. Despite these challenges, the bank recorded a double digit 1% Return On Equity (ROE) and NOK 19. billion net profit in 16. We expect that spill-over effects from Norway's slowing growth driven by reduced oil investments will continue to put downward pressure on the bank's earnings. DNB's BCA is supported by its Very Strong- Macro Profile DNB's operating environment is primarily influenced by developments in its home market Norway, the EU and through its shipping exposures the rest of the world. Norway, which accounted for 77% of customer loans at end6, carries a Very Strong- Macro Profile, reflecting its solid economic, institutional and government fundamentals, but restrained by Norwegian households' high indebtedness, which renders them sensitive to changes in interest rates. The Norwegian banking market is also highly dependent on market funding and particularly foreign-currency based funding. In terms of industry structure, we view Norway as a favourable banking market with DNB as dominant bank, yielding the bank a certain amount of pricing power. DNB's exposures to Sweden (5% of customer loans) and the UK (1% of customer loans) are also supported by Very Strong- Macro Profiles. Exposures to the EU (7% of customer loans) currently carry a Strong Macro Profile, while the remaining exposures are to a combination of countries to which DNB is exposed mainly through its global shipping operations (6% of lending). Based on a breakdown of total loans and receivables, the weighted average Macro Profile for DNB is currently Very Strong-. High dependence on market funding, but DNB benefits from a solid deposit base and good access to local and international capital markets DNB's funding is underpinned by a solid deposit base, which comprises almost 5% of total funding and 6% of the loan portfolio; the remainder consists of market funding. Interbank funding accounted for 11% of total market funding at year-end 16. Covered bonds have represented a rapidly growing source of funding, and contributed around one third of market funding at year end 16. We note that extensive use of covered bond funding structurally subordinates senior creditors, including depositors. DNB has good access to the capital markets, including extensive use of international funding which contributed 8% of covered bond funding at end6. However, we regard the bank's dependence on market funding - albeit common for Nordic banks - as a risk because, in times of market stress, market funds can become less cost-effective, exerting pressure on banks' net profitability. As reflected in our methodology, we globally reflect the relative stability of covered bonds compared to unsecured market funding through a standard adjustment in our scorecard. A relatively large liquidity buffer of NOK65 billion - 4% of total assets at end6 - supports the bank's liquidity profile. The reserve consists of cash and deposits with financial institutions and central banks (6%), Norwegian bonds and fixed-income securities (18%), shareholdings (%) and the international bond portfolio of the investment bank division (DNB Markets) (%), which includes highly rated non-us residential mortgage-backed securities (RMBS) transactions (14% of the international bond portfolio excluding held to maturity portion), highly rated sovereign bonds (46%) and European covered bonds (4%): all these securities can be repo-ed with central banks. 4 5 April 17 DNB Bank ASA: Semiannual update following year-end 16 Results
Deterioration in asset quality, mostly related to challenges in the oil offshore portfolio highlight negative pressures on the asset risk profile of the bank We view DNB's loan portfolio as well diversified, with 5% of exposures at default (EAD) comprising retail lending at end-december 16 (mainly secured by first-lien mortgages) and the remainder spread across industries. However, shipping and CRE account for 6% and 11% of the bank's EAD, respectively, and we typically view these sectors as more volatile. Exposure to riskier oilfield services and the offshore sector accounts for a sizeable 7% of DNB's EAD which has experienced an increase in losses in the last 1 months. The bank's retail loan book has shown good resilience. While we believe that the high leverage of Norwegian households and elevated house prices create credit risks, the high levels of employment and supportive welfare system partly mitigate these risks. In addition, in our opinion the strong Norwegian operating environment will remain supportive for bank credit quality for the 18 month horizon, despite the reduction in oil-related investments weighing on growth prospects. Exhibit DNB's Problem Loans Relative to Norwegian and European BanksDespite the recent increase in problem loans, DNB is still showing string asset risk metrics compared to most European systems DNB Norway Euro Area 8% 7% 6% 5% 4% % % 1% % 11 1 1 14 15 16 Note: Asset-weighted average for rated banks in the Euro Zone and Norway. Source: Moody's Banking Financial Metrics We view DNB's risk management and systems as robust, but our assessment of the bank's risk practices is constrained by its high borrower concentration. We understand this concentration is partly explained by the fact that DNB is the leading corporate bank in Norway, and in addition that such concentration is a typical feature at many Nordic banks. However, we believe such concentration poses a material risk to DNB's asset quality as it potentially heightens the pace and the extent of any deterioration in asset quality. DNB's problem loans increased to.4% of gross loans at end-december 16, from 1.5% at end5. The deterioration in the bank s asset quality was mostly related to challenges in the oil offshore portfolio, which highlights negative pressures on the asset risk profile of the bank. Non-performing loans in the oil-related industries increased to NOK.6 billion at the end of 16 from zero at the end of 15. Despite the increase, the bank s level of problem loans are low compared to most of its European peers and in line with other rated Norwegian banks (see Exhibit ). In recent years, most of DNB's asset quality risks have been related to its exposures outside of Norway, and we expect the impact of exposures outside of Norway to diminish following the sale of the Polish network and the return of a more stable operating environment in the Baltic States. In addition, the shipping portfolio has required elevated provisioning in the past few years, and shipping and oil-related impairments rose to NOK. billion in 16 (NOK.9 billion in 15). The problem loan coverage decreased to 5% at end-december 16, compared with 49% at end5. DNB is exposed to Eksportfinans (Ba/Not Prime; stable) via a 4% shareholding and a guarantee provided for the institution's liquidity portfolio. 5 5 April 17 DNB Bank ASA: Semiannual update following year-end 16 Results
Notching Considerations Loss Given Failure We expect Norway as member of the European Economic Area to adopt the EU Bank Resolution and Recovery Directive (BRRD). For this reason we apply our Advanced LGF analysis. We assume residual tangible common equity of % and losses post-failure of 8% of tangible banking assets, a 5% run-off in junior wholesale deposits, a 5% run-off in preferred deposits, and assign a 5% probability to deposits being preferred to senior unsecured debt. We apply a standard assumption for the large European banks that 6% of deposits are junior. The bank's Aa deposit takes into account (1) the a adjusted BCA; () a very low loss given failure for these instruments as analysed using our LGF framework resulting in a two-notch LGF uplift; and () our expectation of a high probability of government support. Taking into account the Norwegian government's 4% ownership of the bank, our government support assessment translates into two notches of support uplift. While we expect Norway to introduce bank resolution legislation in the coming years, we believe that Norway, as a non-eu European Economic Area (EEA) member with substantial government wealth, will have more flexibility in dealing with bank resolutions compared with EU states. DNB's Aa long-term senior unsecured debt rating reflects our view that the enhanced volume of senior unsecured debt and underlying subordination, which benefits the position of senior unsecured debt, will be sustainable. For junior securities issued by DNB, our LGF analysis confirms a high loss-given-failure, given the small volume of debt and limited protection from more subordinated instruments and residual equity. We also incorporate additional notching for junior subordinated and preference share instruments reflecting the coupon features. Government Support The expected implementation of resolution regimes has caused us to reconsider the potential for government support to benefit certain creditors. Given DNB's leading market position and partial government ownership, we assess a high probability of government support for DNB's long-term deposits and senior unsecured debt, resulting in a two-notch uplift. For junior securities, we continue to believe that the probability of government support is low and these ratings do not include any related uplift. Junior securities also include additional downward notching from the BCA reflecting coupon suspension risk ahead of a potential failure. 6 5 April 17 DNB Bank ASA: Semiannual update following year-end 16 Results
Rating Methodology and Scorecard Factors Exhibit 4 DNB Bank ASA Macro Factors Weighted Macro Profile Very Strong - Factor Historic Macro Ratio Adjusted Score Credit Trend Assigned Score Key driver #1 Key driver # Sector concentration Solvency Asset Risk Problem Loans / Gross Loans.4% a Quality of assets Capital TCE / RWA 17.1% aa aa Risk-weighted capitalisation Profitability Net Income / Tangible Assets.7% baa baa Return on assets Combined Solvency Score Liquidity Funding Structure Market Funds / Tangible Banking Assets 5.4% ba ba Term structure Liquid Resources Liquid Banking Assets / Tangible Banking Assets 7.8% a a Stock of liquid assets a Combined Liquidity Score Financial Profile Business Diversification Opacity and Complexity Corporate Behavior Total Qualitative Adjustments Sovereign or Affiliate constraint: Scorecard Calculated BCA range Assigned BCA Affiliate Support notching Adjusted BCA baa Balance Sheet in-scope (NOK million) 974,966 945,694 699,814 45,88 198,55,14 9,4 15,95 66,94,1,48 Other liabilities Deposits Preferred deposits Junior Deposits Senior unsecured bank debt Dated subordinated bank debt Junior subordinated bank debt Preference shares (bank) Equity Total Tangible Banking Assets 7 1% 5 April 17 baa a Aaa a-ba a a % in-scope 4.7% 4.4% 1.4% 11.% 8.9%.9%.4%.7%.% 1% at-failure (NOK million) 1,71,47 849, 664,8 184,41 198,55,14 9,4 15,95 66,94,1,48 % at-failure 48.% 8.1% 9.8% 8.% 8.9%.9%.4%.7%.% 1% DNB Bank ASA: Semiannual update following year-end 16 Results
Debt class De jure waterfall De facto waterfall Notching LGF Assigned Additional Preliminary LGF notching Rating Instrument Sub- Instrument SubDe jure De facto notching guidance notching Assessment volume + ordination volume + ordination versus Subordination Subordination BCA Counterparty Risk Assessment.%.%.%.% aa (cr) Deposits.% 5.%.% 1.9% Senior unsecured bank debt.% 5.% 1.9% 5.% 1 1 Dated subordinated bank debt 5.% 4.1% 5.% 4.1% ba (hyb) Non-cumulative bank preference shares.7%.%.7%.% - baa (hyb) Instrument class Counterparty Risk Assessment Deposits Senior unsecured bank debt Dated subordinated bank debt Non-cumulative bank preference shares Loss Given Failure notching 1 Additional Preliminary Rating Notching Assessment - aa (cr) ba (hyb) baa (hyb) Government Support notching Local Currency Rating A (cr) Aa Aa Ba (hyb) Baa (hyb) Foreign Currency Rating -Aa Aa Ba (hyb) Baa (hyb) Source: Moody's Financial Metrics Ratings Exhibit 5 Category DNB BANK ASA Outlook Bank Deposits Baseline Credit Assessment Adjusted Baseline Credit Assessment Counterparty Risk Assessment Senior Unsecured -Fgn Curr Senior Unsecured -Dom Curr Subordinate -Dom Curr Pref. Stock Non-cumulative Commercial Paper Other Short Term Moody's Rating Negative Aa/P a a A(cr)/P(cr) (P)Aa Aa Ba (hyb) Baa (hyb) P (P)P DNB BANK ASA, NEW YORK BRANCH Outlook Bank Deposits Other Short Term Negative Aa/P P DEN NORSKE CREDITBANK Bkd Jr Subordinate Baa (hyb) Source: Moody's Investors Service 8 5 April 17 DNB Bank ASA: Semiannual update following year-end 16 Results
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