Morningstar | Danske Closes Turbulent 2018, but We Do Not See a Deteriorating Business
Danske reported DKK 14.7 billion in net profit for full-year 2018, which came as no surprise after its recently revised outlook. The largest factors impacting the bottom line this year have been donations related to the Estonia case as well as weaker equity markets negatively impacting trading markets. More importantly, however, we do not see a structural decline in Danske’s business. We plan to update updated our model for 2018 financials but do not anticipate a material change to our fair value estimate of DKK 210 per share and narrow moat rating.The loss of about 11,000 core Danish retail customers on a net basis over the full year can easily be construed as evidence of a deteriorating business in Denmark, however, we would point out that this constitutes only 0.8% of Danske’s Danish retail customer base and commercial customers have remained flat. We would expect a more meaningful customer flight in the case of brand damage as a result of the Estonian case. On the other hand, lending volumes have been up slightly in Denmark (1%), while loans in the other Nordic regions (up 5%), Northern Ireland (up 8%), and the Wealth Management segment (up 4%) drove total volumes growth of 3% compared with 2017.
Danske remains well capitalized with a common equity Tier 1 ratio of 16.8% versus a requirement of 14%. This gives Danske about DKK 21 billion in capital buffers for potential fines. To put this into perspective, in our base case, we anticipate another DKK 1.9 billion in fines after the donations booked in 2018, while we expect about DKK 15.4 billion in total in our bear-case scenario.
We would highlight that at current prices, Danske trades below our bear case fair value estimate of DKK 155 per share, which, next to worse operating performance assumptions, pencils in significantly higher fines. In our bear case we assume Danske to pay 8 times gross profits gained from its Estonia non-resident portfolio, which can be split into about 2 times gross profits for European and 6 times gross profits for U.S. fines, or DKK 3.8 billion and DKK 11.5 billion, respectively. We believe the market is putting undue weight on the possibility of the U.S. Department of Justice banning Danske from having its transactions cleared in U.S. dollars. While this would likely bring an end to Danske's operations, and we do not argue that it is not a possibility, we do disagree with the likelihood the market puts on this scenario.
Danske Bank is a diversified financial services firm. Through its subsidiaries, Co.'s activities include the provision of banking, mortgage finance, insurance, real estate brokerage, asset masnagement and trading in fixed income products, foreign exchange and equities. Co. operates international retail bank operations in 15 countries, with an emphasis in the Nordic region. Co. divides its operations into five segments: Banking Activities, Danske Markets, Danske Capital, Danica Pension and Other Activities. As of Dec 31 2011, Co. had total assets of DKK3,424,403,000,000 and total deposits of DKK848,994,000,000.
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