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Fitch Affirms Danske Bank and Realkredit Danmark at 'A'/Stable
September 18, 2014 / 2:47 PM / 3 years ago

Fitch Affirms Danske Bank and Realkredit Danmark at 'A'/Stable

(The following statement was released by the rating agency) LONDON/PARIS, September 18 (Fitch) Fitch Ratings has affirmed Danske Bank's (Danske) and its mortgage bank subsidiary Realkredit Danmark's Long-Term Issuer Default Ratings (IDRs) at 'A' with Stable Outlooks, and their Viability Ratings (VRs) at 'a'. A full list of rating actions is provided at the end of this commentary. KEY RATING DRIVERS - DANSKE'S IDRS, VR AND SENIOR DEBT The affirmation of Danske's IDRs and VR reflects Fitch's view that Danske's winding-down of non-core assets (mainly in Ireland) is progressing well, and that its improving profitability will enable it to continue to generate capital. Although the bank is addressing its impaired assets, these remain high compared with similarly rated peers. The ratings are underpinned by the bank's strong Danish and Nordic franchise, which provides it with fairly diversified earnings, both geographically across the Nordics as well as by product range. Persistent loan impairment charges (LICs), stemming from Danske's non-core Irish operations combined with the Danish recession, have significantly dented Danske's profitability since 2008, taking up between one-third and three-quarters of pre-impairment operating profits. Until Denmark returns to a firm growth path, helping revenue generation, the bank is making efforts to contain expenses as the portfolio is being worked through. Fitch expects the bank's improving profitability trend in 1H14 will be maintained in 2015, aided by lower LICs. Boosting revenues is likely to remain challenging, although Fitch expects Danske to be well placed to benefit when Danish corporates start to invest again and consumption edges up. Danske's ratings incorporate the bank's gradually improving asset quality, although Fitch expects it will take some time before its asset quality metrics are more in line with those of similarly rated northern European peers. The bank's Irish operations left Danske exposed to the Irish real estate crisis, with Irish real estate lending representing a disproportionally large share of impaired loans. In Fitch's view, downside risk has been diminishing over the past two years as most impaired loans have been provided against. Downside risk to Danske's Danish loan portfolio is also reducing. House prices have bottomed out in most parts of the country, and LICs for SMEs and commercial real estate loans are falling. Danske has a strong management team, in Fitch's opinion, but senior management turnover has been fairly high in recent years. Fitch expects Danske's risk appetite will remain moderate and that management will remain focused on driving profitability via lower costs and without increasing its risk appetite. Similar to most Nordic peers Danske has significant reliance on wholesale funding. Its mortgage lending subsidiary, Realkredit Danmark, largely funds the group's mortgage loan business, exclusively through Danish mortgage bonds. Danske has maintained access to domestic and international funding markets, in particular for its covered bonds, although it would be affected by a prolonged dislocation of debt capital markets. Fitch expects demand for Danish mortgage bonds to remain strong in light of the need from predominantly domestic financial institutions, insurance companies and pension funds to hold highly liquid, high-quality, securities in domestic currency. This is reinforced by the fairly limited outstanding volume of Danish government bonds. Nonetheless, maintaining a significant liquidity portfolio to mitigate any refinancing risk is key to the ratings. Danske's capital adequacy ratios compare well with those of international peers, but lag behind those of some Nordic peers. Limited growth in risk-weighted assets will support the bank in complying with further regulatory requirements, as well as in maintaining investor confidence in light of its reliance on wholesale funding. Leverage is fairly modest in a European context, with tangible common equity/tangible assets at 4% at end-June 2014. RATING SENSITIVITIES - DANSKE'S VR, IDRS AND SENIOR DEBT The Stable Outlook incorporates Fitch's expectation that the bank will continue to improve profitability, strengthening its buffers against LICs, while gradually reducing its volume of impaired loans both in Denmark as well as in its non-core business. The ratings could be downgraded if Danske is unable to competitively access wholesale funding markets, if its Danish business faces a significant deterioration in asset quality that materially affects its capitalisation or if its improving earnings trend reverses, reducing its ability to absorb shocks. An upgrade is currently unlikely given the bank's already high ratings, and earnings and asset quality pressures. In the medium- to long-term, the ratings could be upgraded following significantly improved asset quality metrics, combined with sustainable and solid internal capital generation. KEY RATING DRIVERS - REALKREDIT DANMARK'S VR AND IDRS The affirmation of Realkredit Danmark's IDRs and VR reflects Fitch's view that the mortgage bank's profitability, although moderate, will enable it to absorb unexpected shocks in Denmark until economic growth is firmly back on track in the country. Despite the sharing of some services with its parent bank, the ratings of Realkredit Danmark's are based on its standalone financial strength. Fitch also expects that capital is, to an extent, fungible between Danske and Realkredit Danmark, and thus the VRs are, to a certain degree, inter-connected. The ratings reflect the bank's strong Danish franchise as the second-largest mortgage lender, its solid capitalisation and its strong asset quality. They are constrained by its monoline business model and reliance on wholesale funding, although risks associated with the latter are mitigated by a large, deep and liquid domestic funding market. Realkredit Danmark's assets represent the majority of Danske's mortgage loan exposure and Fitch expects the quality of the mortgage lending to remain strong, supported by a stabilising Danish economy. However, profitability should remain modest, driven by its low-margin mortgage loan business. Realkredit Danmark is by law entirely wholesale-funded, largely by issuance of Danish mortgage bonds. Similar to its domestic peers, around one-third of Realkredit Danmark's bonds mature within a year to match the interest term of the underlying mortgage loan. Generally such dependence on short-term wholesale funding would suggest a lower rating. However, the supportive dynamics of the Danish mortgage bond market are an important mitigating factor for this risk. Realkredit Danmark's move to extend bond maturities and Denmark's new law on mortgage bond maturity extensions will help reduce refinancing risks. Realkredit Danmark's capital adequacy ratios compare well with those of domestic and international peers. Low risk weights on mortgage loans boost reported capital ratios, but leverage is modest in a European context. RATING SENSITIVITIES - REALKREDIT DANMARK'S VR AND IDRS The Stable Outlook reflects Fitch's view that Realkredit Danmark will continue to maintain its focus on asset quality and its adequate earnings to absorb unexpected shocks and to internally generate capital. A rating downgrade would most likely be a result of Realkredit Danmark being unable to competitively access wholesale funding markets or if it significantly increases its reliance on international debt investors that may be less stable during financial stress. A downgrade of Danske's ratings, or reduced focus on liquidity, would also be rating-negative. An upgrade is currently unlikely given the bank's already high ratings and monoline business model. KEY RATING DRIVERS - SUPPORT RATINGS AND SUPPORT RATING FLOORS Danske's and Realkredit Danmark's Support Ratings (SRs) and Support Rating Floors (SRFs) reflect Fitch's expectation that there is an extremely high probability that support would be forthcoming from the Danish authorities if required. This is driven by their importance within the Danish financial sector. In Fitch's view, there is a clear intention ultimately to reduce implicit state support for financial institutions in the EU, as demonstrated by a series of legislative, regulatory and policy initiatives. As an EU member country, Denmark is subject to the requirements of Bank Recovery and Resolution Directive (BRRD). The agency also believes Danske would have an extremely strong willingness to provide support to Realkredit Danmark, although given the relative size and likely correlation in a stressed scenario, Danske's ability to do so may be limited. RATING SENSITVITIES - SUPPORT RATINGS AND SUPPORT RATING FLOORS Danske's SR and SRF are primarily sensitive to the progress made in implementing a resolution regime in Denmark. The BRRD requires 'bail in' of creditors by 2016 before an insolvent bank can be recapitalised with state funds. Fitch expects that the BRRD will be enacted into national legislation in the near term. Although Denmark is not a eurozone country, Fitch believes it will follow a similar agenda to these countries. Fitch expects to then downgrade Danske's SR to '5' and revise its SRF to 'No Floor'. While the BRRD includes some exceptions for non-deposit taking mortgage banks, Fitch believes the Danish state's propensity to support senior unsecured creditors in the large mortgage banks will nonetheless reduce and expects Realkredit Danmark's SR and SRF to follow a similar pattern to that of Danske. The SRs and SRFs are also sensitive to a change in Fitch's assumptions about the ability of the Danish authorities to provide timely support, as reflected in in Denmark's sovereign rating (AAA/Stable). KEY RATING DRIVERS AND SENSITIVITIES - DANSKE'S SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Subordinated debt and other hybrid capital issued by Danske are all notched down from the bank's VR. Therefore, their respective ratings have been affirmed and are sensitive to any change in Danske's VR. The ratings are in accordance with Fitch's criteria 'Assessing and Rating Bank Subordinated and Hybrid Securities', reflecting each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably. Danske's CRD IV-compliant Tier 2 instruments are notched down once below the bank's VR to reflect the notes' higher expected loss severity relative to senior unsecured creditors. The notching also takes into consideration a lack of contractual full write-down or conversion language (which according to Fitch's criteria may be reflected by notching down twice). Fitch rates Danske's other Tier 2 instruments three notches below the VR to reflect loss severity (one notch) and incremental non-performance risk (two notches). The agency has applied additional notching for incremental non-performance risk to legacy issues because of the issuer's ability to defer coupons. The ability to defer interest is the differentiation between the old-style Tier 2 instruments and the new CRD IV-compliant Tier 2 notes. Hybrid Tier 1 securities are rated four notches below Danske's VR to reflect the higher loss severity risk of these securities relative to average recoveries (two notches from the VR) as well as their high risk of non-performance (an additional two notches). Danske's Additional Tier 1 instruments are rated five notches below Danske's VR reflecting the notes' higher expected loss severity relative to senior unsecured creditors (two notches) and higher non-performance risk (three notches), given their fully discretionary coupon payments. Fitch believes Danske's capital buffer being above the 7% CET1 trigger and the minimal capital ratio taking into account the additional buffer on Danish systemically important financial institutions is sufficient to limit the notching for non-performance risk to three (which could otherwise result in wider notching). The rating actions are as follows: Danske Bank Long-term IDR: affirmed at 'A', Outlook Stable Short-term IDR: affirmed at 'F1' Viability Rating: affirmed at 'a' Support Rating: affirmed at '1' Support Rating Floor: affirmed at 'A-' Commercial paper programme: affirmed at 'A'/'F1' Long-term senior debt: affirmed at 'A' Short-term senior debt: affirmed at 'F1' CRD IV-compliant Tier 2 instrument (ISIN: XS0974372467): affirmed at 'A-' Subordinated notes: affirmed at 'BBB' Tier 1 instruments: affirmed at 'BBB-' Additional Tier 1 capital instruments (ISIN: XS1044578273): affirmed at 'BB+' Danske Corporation Commercial paper programme: affirmed at 'A'/'F1' Realkredit Danmark Long-term IDR: affirmed at 'A', Stable Outlook Short-term IDR: affirmed at 'F1' Viability Rating: affirmed at 'a' Support Rating: affirmed at '1' Support Rating Floor: affirmed at 'A-' Contact: Primary Analyst Jens Hallen Senior Director +44 20 3530 1326 Fitch Ratings Limited 30 North Colonnade London E14 5GN Secondary Analyst Olivia Perney Guillot Senior Director +33 144 299 174 Committee Chairperson Cristina Torrella Senior Director +34 93 323 8405 Media Relations: Elaine Bailey, London, Tel: +44 203 530 1153, Email: elaine.bailey@fitchratings.com. Additional information is available on www.fitchratings.com. Applicable criteria, 'Global Financial Institutions Rating Criteria', dated 31 January 2014, are available at www.fitchratings.com. Applicable Criteria and Related Research: Global Financial Institutions Rating Criteria here Additional Disclosure Solicitation Status here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.

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