Fitch Danske Bank Report July 2022

Danske Bank A/S

Key Rating Drivers

Leading Danish Bank: Danske Bank A/S's ratings reflect its strong universal banking franchise in Denmark and, to a growing extent, across the Nordic region, providing stable revenue generation across a wide range of products. The ratings also consider Danske's low risk appetite, stable funding and solid capital buffers built up in the expectation of possible fines related to anti-money-laundering (AML) control deficiencies and operational risk.

Potential AML Fine: At end-April 2022 Danske, began final discussions with the US and Danish authorities regarding the past AML control deficiencies in its Estonian branch, which is likely to result in a fine for the bank. Fitch Ratings expects Danske to maintain at least a EUR3 billion capital surplus until the settlement of the AML issue, which we view as a sufficient loss-absorption capacity to cushion a potentially large fine from the Danish and US authorities.

Solid Capitalisation: Risk-weighted capital ratios compare well with those of international peers. The bank's management has built buffers into its stated target for the common equity Tier 1 (CET1) ratio of at least 16%. In 4Q20, the US authorities cleared the bank of sanctions breaches relating to Estonia. In our opinion, this reduces the risk of a fine of a size that would erode Danske's capital ratios to a level no longer commensurate with its 'a' Viability Rating.

Sound Revenue Generation: Danske's operating revenue has been broadly resilient, despite the cyclical challenges of margin pressure in the highly competitive Nordic markets and the economic downturn. Higher funding costs, partly due to sustained issuance of senior non- preferred instruments, and high expenses related to investments in AML controls, has reduced the bank's cost-efficiency and profitability to levels below those of peers. We expect lower operating profit in 2022 due to normalised credit losses, lower asset-management fees and elevated costs. The net interest income uplift from rate increases will be gradual.

Stable Asset Quality: The bank's impaired loans ratio is weaker than at Nordic peers' but it has been stable since 2018 at about 2%, which is in line with similarly rated international peers. We expect the impaired loan ratio to modestly increase by end-2023 due to the economic slowdown. Danske's direct exposure to Russia, Ukraine and the Baltics is negligible.

Stable Diversified Funding: Danske is reliant on wholesale funding, like most Nordic banks. Its well-diversified funding base has proven resilient to the negative news from the AML investigations and pandemic, enabling the bank to execute its funding plan. The bank's refinancing risk is low and well-managed and the bank maintains ample liquidity surplus.

Rating Sensitivities

Stable Outlook: The bank has sufficient rating headroom to withstand a downward revision of our assessment of asset quality and profitability by one notch that could be triggered by severe delays to the economic recovery. A substantial and durable CET1 ratio erosion below 14% would lead to a downgrade. Such an erosion could be driven by an AML fine considerably larger than the bank's current loss-absorption capacity.

Weakened Capital Surplus: We could revise the Outlook to Negative if we believe the bank's capacity to absorb AML fines is insufficient. This could be triggered if we expect Danske's CET1 ratio surplus over its requirement to decrease materially below 250bp.

Strengthened Financial Profile: An upgrade of Danske would require the completion of AML investigations and clarification of potential fines; an expected CET1 ratio of at least 15% net of AML settlements; a sustainable reduction in impaired loans ratio below 2%; and a successful implementation of the bank's transformation plan. This would have to be demonstrated by a durable recovery in the operating profit/risk-weighted assets (RWAs) ratio to at least 2.5%.

Banks

Denmark

Ratings

Foreign Currency

Applicable Criteria

Bank Rating Criteria (November 2021)

Related Research

Large European Banks Quarterly Credit Tracker (June 2022)

Global Economic Outlook (June 2022)

Potential Material AML Fine for Danske Is Rating Neutral (April 2022)

Fitch Affirms Denmark at 'AAA'; Outlook

Stable (February 2022)

Analysts

Michal Bryks, FCCA +48 22 103 3024 [email protected]

Christian Scarafia

+44 20 3530 1012 [email protected]

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Danske Bank A/S

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Significant Changes

Operating Environment Resilient to the Economic Slowdown

Danske's operations are mainly concentrated in Denmark, but it has also a diversified presence across the remaining three largest Nordic countries. The economic environments and sovereign credit profiles are also strong and structural weaknesses are very limited, which presents very good opportunities for banks to be consistently profitable. Strong levels of employment, savings buffers accumulated through the pandemic, and sufficient fiscal space by Nordic sovereigns mitigates the risk of a sharp economic downturn.

Household debt in the Nordic region is high in an international context, due to high house ownership financed by mortgage loans. The high inflation, rise in long-term interest rates and the projected monetary tightening (started in Norway in late 2021 and in Sweden in April 2022) will dampen real spending power, but should be manageable for Nordic households, which have accumulated sizeable savings.

We expect a moderate rise in bankruptcies in the region largely coming from financially weaker SMEs in the sectors worst-hit by the pandemic, as well as vulnerable to higher commodity and energy prices and the interest rate hike cycle. This should also increase appetite for bank credit, which has been dampened during the pandemic by government liquidity measures and loan schemes. Nordic banks have sufficient liquidity to meet higher corporate loan demand.

Danske, like its Nordic peers, is materially exposed to the real estate market through mortgage loans and lending to property-management companies. We expect a moderate fall in residential property prices from 2H22, which should be viewed as a healthy cool-off after a pandemic- driven surge in prices in 2020-2021 (this was less strong in Finland). This correction should still result in home prices higher than pre-pandemic levels.

We expect the Nordic property management companies to perform well. A large share of this segment is concentrated in residential real estate, which should remain resilient to the economic slowdown. Office and retail spaces remain the most vulnerable segments due to heightened risk of prices falling, but most lending is at low loan/value ratios (LTVs). Refinancing risk at commercial real estate companies is manageable, despite notable widening of funding spreads. Nordic banks are able to temporarily replace short-term borrowing needs.

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Brief Company Summary

Leading Domestic Universal Bank

Danske is Denmark's largest universal bank, with a growing presence in the remaining three largest Nordic countries and a small franchise in NortheIreland. Danske's franchise has been resilient to negative AML news, despite some customer outflows.

Domestic mortgage financing is mainly carried out through Danske's largest subsidiary, Realkredit Danmark A/S (A/Stable/a), which represents about 40% of group loans. Danske also provides investment banking and capital markets, asset management, private banking, real- estate brokerage, and leasing services. It has a significant Nordic fixed income and currency business, in particular in interest-rate swaps, cash management and trade finance. Danske also owns Denmark's second-largest life insurer/pension company.

In October 2021, Danske lowered its 2023 ROE target to 8.5%-9% from 9%-10%, which remains ambitious, as it depends on a sizeable number of structural income and cost initiatives. Reaching the ROE target of its 2020-2023 plan was hamstrung by higher compliance and anti- money-laundering(AML)-remediation expenses, subdued loan growth, competition, margin compression and inflated equity (due to additional AML-related Pillar 2 buffer). Danske maintained its CET1 ratio target above 16%, net of a potential AML settlement.

Diversified Income Streams

Danske's revenue has been broadly stable over time, with the business model focused on traditional, commercial banking, and capturing a larger share of its customers' spending by also offering wealth and life insurance products. The Danish operations generate about a third of revenue, followed by the Nordic personal and business customers and large corporates and institutions. Income for Nordic personal and business customers was particularly resilient during the pandemic due to solid contribution from Sweden and Norway, in line with the bank's strategy to expand into mid-corporate and retail segments across the other Nordic countries.

Conservative Risk Appetite

Danske's underwriting standards focus on cash-flow generation and client selection. The bank has been proactively capturing emerging risks through a more holistic risk management framework, in particular making use of portfolio analysis, stress tests and concentration limits on selected industries. We believe the bank's conservative risk management framework over time will strengthen loan portfolio resilience to a stress scenario. Customer lending is about half of total assets. The rest consists of debt securities (mainly held for liquidity purposes), insurance assets and well-collateralised repo lending and derivatives.

Danske's credit exposure is dominated by the safe retail segment (37% share of credit exposure at end-March 2022) of which about 90% are mortgage loans. Retail lending outside Denmark is mainly via partnerships with labour organisations, targeting mostly well-educated professionals with salaries above the market average rates, which translates into low credit losses.

Commercial property lending is material (12% of credit exposure), but only about a third is in the more vulnerable office and retail segment, for which the bank tightened its underwriting standards in 2020. Office and retail space exposure is concentrated in the largest Nordic cities and so far has performed well.

Danske has a limited exposure to risky sectors, such as agriculture, shipping, or oil and gas - which materially shrank in 2020. The rest of the corporate loan portfolio is well diversified by industry, and Fitch views obligor concentration as satisfactory. Danske also has good and improving geographical loan diversification.

We expect small retail loan growth due to higher rates and lower property prices, but we expect the demand in the non-retail segment, particularly among SMEs, to pick up. Danske's recent loan growth was driven by expansion in the Nordic countries (mainly in low-risk retail and business lending in Sweden and Norway), while the domestic portfolio growth was negatively affected by reputational issues and high competition.

Banks

Denmark

Market Shares

End-March 2022

30

25

20

15

10

5

0

Denmark Finland Sweden Norway Source: Fitch Ratings, Danske

Results Through-The-Cycle

Operating profit/RWAs (RHS)

CET1 ratio (LHS)

Loans by Segments (%)

End-March 2022

Personal customers

- Denmark27

Personal customers

- Nordic19

Large corporates &

institutions16

Source: Fitch Ratings, Danske

Risky Exposures (%)

End-March 2022

Agriculture2.4

Oil-related1.3

Retailing 1.2

Source: Fitch Ratings, Danske