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Morningstar | Anchoring Bias and Lack of Information Drive Danske's Price, but Core Business Remains Solid

After two years of strong returns on equity, 11.7% and 12% according to our calculations, the money laundering scandal in Estonia has caught up with Danske. We believe Danske is a stable and conservatively run bank that follows a sound expansion strategy in the Nordics. However, uncertainties about fines related to the EUR 200 billion of potentially fraudulent transactions that flowed through its Estonian branch from 2007 to 2015 put significant pressure on its share price. We think that the market largely overacts as there is little information to go on, which is typically not well liked among investors. We expect fines by European regulators to come in at about DKK 3 billion, which Danske can absorb with excess capital of about DKK 15 billion on hand. Fines by U.S. regulators are potentially more severe, but also less likely.We expect the underlying business to be little affected by any reputational damages. Danske has built strong and sticky customer relationships that can withstand the negative headlines over the coming couple of years, as we think that the general perception is that this issue is related to a small branch and not reflective of Danske’s general business practices.Despite taking a more bullish view on reputational damages as well as the severity of fines, we believe that the stellar returns of above 11% are not sustainable in the long run. This is largely owed to our assumption that loan impairments will revert closer to midcycle levels from impairment reversal booked currently. We also think that the pendulum will swing back for recently strong trading income. This cannot be fully offset by an improving net interest margin as Danske looks for growth in Sweden, Norway, and Finland. As a result, returns on equity fall to 9.6% on average in our explicit forecast period.