Danske Bank A/S : Fitch Realkredit Danmark Report July 2022

Realkredit Danmark A/S

Key Rating Drivers

Strong Credit Profile: Realkredit Danmark A/S's ratings reflect its low risk appetite and strong asset quality metrics, which balance its monoline business model and undiversified, though stable, earnings. They also consider Realkredit's well-entrenched mortgage lending franchise in Denmark, strong capitalisation and well-managed reliance on wholesale funding. The bank's IDRs are also underpinned by potential parental support from Danske Bank A/S (A/Stable/a).

Capital Fungibility Constraints VR: Realkredit's Viability Rating (VR) is rated in line with that of its parent as Fitch Ratings believes there is a high correlation between the two VRs because of a high level of capital fungibility. Consequently, we are likely to retain Realkredit's VR within one notch of that of its parent, unless the fungibility of capital decreases.

Strong Asset Quality: Realkredit's asset quality is a rating strength. Credit risk exposure solely comprises mortgage lending, the tight underwriting of which is underpinned by conservative Danish covered-bond and mortgage-lending legislation. Realkredit's loan book is geographically concentrated in Denmark and strongly linked to the performance of the Danish economy. We expect asset quality to hold up, despite the economic slowdown and the impaired loans ratio should not increase materially above 2%.

Undiversified but Stable Earnings: Realkredit's profitability is weaker than that of similarly rated peers as its income is solely reliant on its lending activity. Realkredit's lack of revenue diversification is offset by low credit losses and robust cost efficiency.

Strong Capitalisation: Realkredit's capitalisation is underpinned by its low-risk business model and solid capital surplus over regulatory minimums, giving the bank a sufficient cushion to absorb potential credit losses and risk-weighted assets (RWAs) inflation. Realkredit is subject to standalone capital requirements, which underpins our view of its capitalisation.

Solely Wholesale Funded: Realkredit relies extensively on wholesale funding because mortgage lending is, by law, entirely funded by covered bonds in Denmark. We believe the risk of Realkredit not being able to access the covered bond market is low due to strong demand for these bonds from Danish financial institutions, insurance companies and pension funds. Refinancing risk is also mitigated by the bank's good liquidity buffer and potential ordinary support from Danske if needed.

Rating Sensitivities

Revised Support Assessment: Realkredit's IDR could be upgraded if Danske's IDRs are upgraded, assuming it retains its core role within the group. In addition, a downgrade of its parent's VR by more than one notch could lead to a downgrade of Realkredit's ratings, given the high correlation we believe exists between the two ratings.

Eroded Capitalisation: We would downgrade Realkredit's VR if we expect it will not be able to maintain its common equity Tier (CET1) ratio above 14% or restore it to that level within a short time. This could be due to significantly higher-than-expected loan impairment charges (LICs) driven by a prolonged recession, high unemployment and a material property price correction.

Constrained Funding Access: An adverse change in investor sentiment requiring extraordinary support from the parent, due to a material weakening of Realkredit's ability to access competitively priced covered bond funding, would be negative for the bank's VR. An increased reliance on international debt investors who could prove less stable during financial stress would also put pressure on ratings.

Banks

Retail & Consumer Banks

Denmark

Ratings

Foreign Currency

Long-Term IDR	A
Short-Term IDR	F1
Viability Rating	a
Support Rating	1

Sovereign Risk

Long-Term Foreign- and Local-	AAA
Currency IDRs
Country Ceiling	AAA

Outlooks

Long-TermForeign-Currency	Stable
IDR
Sovereign Long-Term Foreign-	Stable
and Local-Currency IDRs

Applicable Criteria

Bank Rating Criteria (November 2021)

Related Research

Danske Bank A/S (July 2022)

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 [phone] [e-mail]

Christian Scarafia

[phone] [e-mail]

Rating Report │ 8 July 2022

fitchratings.com

1

Banks

Retail & Consumer Banks

Denmark

Ratings Navigator

Realkredit Danmark A/S	ESG Relevance:

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Significant Changes

Resilient Danish Operating Environment

Realkredit's operations are concentrated in Denmark, which presents very good opportunities for banks to be consistently profitable. The economic environment and sovereign credit profile are strong and structural weaknesses are very limited, underpinned by strong levels of employment and a healthy sovereign fiscal position. We expect real GDP growth of 2.4% in 2022, down from our 3.1% expectation at the beginning of the year, which is in line with Denmark's pre-pandemicfive-year average growth rate. The economy will decelerate after a recent post-pandemic cyclical upswing driven by high levels of domestic and foreign demand, expansionary fiscal and financial conditions and a pronounced recovery of the labour market.

Danish household indebtedness 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 will dampen real spending power, but should be manageable for Nordic households, which have accumulated sizeable savings during the pandemic.

We expect a moderate rise in bankruptcies largely coming from financially weaker SMEs in the sectors worst-hit by the pandemic, as well as from those 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 support measures and loan schemes. Banks in Denmark have sufficient liquidity to meet higher corporate loan demand.

Banks

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Viability Rating	Institutional	Issuer Default
Support	Rating
aaa	AAA	AAA	Stable
aa+	AA+	AA+	Stable
aa	AA	AA	Stable
aa-	AA-	AA-	Stable
a+	A+	A+	Stable
a	A	A	Stable
a-	A-	A-	Stable
bbb+	BBB+	BBB+	Stable
bbb	BBB	BBB	Stable
bbb-	BBB-	BBB-	Stable
bb+	BB+	BB+	Stable
bb	BB	BB	Stable
bb-	BB-	BB-	Stable
b+	B+	B+	Stable
b	B	B	Stable
b-	B-	B-	Stable
ccc+	CCC+	CCC+	Stable
ccc	CCC	CCC	Stable
ccc-	CCC-	CCC-	Stable
cc	CC	CC	Stable
c	C	C	Stable
f	NF	D or RD	Stable

Realkredit Danmark A/S
Rating Report │ 8 July 2022	fitchratings.com	2

Banks

Retail & Consumer Banks

Denmark

Institutional Support Assessment

Institutional Support				Value
Parent IDR				A
Total Adjustments (notches)			+0
Institutional Support:				A
Support Factors (negative)	Equalised	1 Notch		2+ Notches
Parent ability to support and subsidiary ability to use support
Parent/group regulation	✓
Relative size		✓
Country risks	✓
Parent Propensity to Support
Role in group	✓
Potential for disposal	✓
Implication of subsidiary default	✓
Integration	✓
Size of ownership stake	✓
Support track record	✓
Subsidiary performance and prospects	✓
Branding		✓
Legal commitments			✓
Cross-default clauses			✓

We believe there is extremely high probability that Realkredit would be supported, if ever required, by its parent. Danske has strong incentives to provide extraordinary support as we consider Realkredit a core and integral part of the group. Danske originates all mortgage loans in Denmark via Realkredit and overall mortgage lending represents the majority of all domestic lending. Any required support for Realkredit would likely be manageable relative to the ability of Danske to provide it.

Realkredit's management and corporate culture are highly integrated into Danske's and Realkredit shares some central functions and distribution channels with its parent bank, which we regard as ordinary support. Realkredit also benefits from shared risk management practices within the group.

Realkredit Danmark A/S
Rating Report │ 8 July 2022	fitchratings.com	3

Brief Company Summary

Second-Largest Mortgage Bank in Denmark

Realkredit is a wholly-owned mortgage bank subsidiary of Danske (the largest financial institution in Denmark) and the second-largest specialist mortgage bank in Denmark, with a market share of about 25%. Realkredit serves all customer segments in Denmark (where the vast majority of credit exposure resides), while the strategy in Sweden and Norway is to serve large commercial and residential real estate companies.

Realkredit's business model is monoline, but it balances low-risk appetite and stable income. Realkredit has been less vulnerable to negative interest rates than commercial banks because of the mortgage financing pass-through model in Denmark. Mortgage lending is, by law, financed through covered bonds and Realkredit is a large issuer of these securities internationally.

Mortgage loans for private individuals and SMEs are distributed through Realkredit's own real estate agency chain and Danske's branch network. The largest customers in Denmark, Norway and Sweden are served by a dedicated unit specialised in property mortgage advisory.

Low Risk Appetite

Realkredit observes tight underwriting standards for mortgage loans. These are underpinned by the conservative Danish covered bond legislation and regulatory constraints set by the Danish FSA. Realkredit applies a loan/value (LTV) regulatory cap of 80% for most mortgage loans and 60% for riskier lending, such as financing agricultural, office or retail properties.

At end-March 2022, the average LTV ratio was 51% compared with 60% at end-2020. Since 2H12 average LTVs have gradually declined across all customer segments, driven partly by conservative underwriting standards and partly by increasing property prices. We expect a moderate fall in residential property prices from 2H22, which we view as a natural cool-off after the pandemic-driven surge in prices in 2020-2021. Between March 2020 and May 2022 the prices of single-family homes and apartments grew by 23% and 30%, respectively, and we expect prices to remain above the pre-pandemic levels.

Realkredit's principal segment is residential mortgage loans (owner-occupied housing and holiday homes). The remaining segments are residential and commercial real estate and agriculture. We do not expect the bank's segment mix to change in the foreseeable future.

The share of fixed-rate residential mortgage loans increased materially in 2019 and 2020, driven by low rates and high re-mortgaging activity. This trend abruptly reversed in 1H22 as customers switched to variable-rate loans (which will likely to continue), due to a sharply steepened yield curve. The lower fair value of fixed-rate mortgage debt due to higher interest rates incentivises borrowers to refinance their loans, using a new variable rate loan.

At end-March 2022, the back book was evenly split between fixed-rate(10-30 years) and variable-rate mortgage loans. During the underwriting of long-term loans with an interest rate fixed for a short period (such as five years), the bank stress tests borrowers' repayment capacities. It assumes there will be a 30-year amortising loan with a materially inflated interest rate of at least 4%.

Realkredit's recent lending growth has been modest. The contraction in the loan portfolio in 1H22 reflects fair-value adjustment, while the underlying growth was broadly stable. We expect annual credit expansion to remain below 2%.

Realkredit's market risk exposure is low. The structural interest rate risk in the banking book is insignificant because there is no interest rate mismatch between mortgage loans and covered bonds, and both are carried at fair value.

Banks

Retail & Consumer Banks

Denmark

Results Through-The-Cycle

		Operating profit/RWAs (RHS)
		CET1 ratio (LHS)
(%)		Impaired loans ratio (RHS)	(%)
50									5
40									4
30									3
20									2
10									1
0			FY15				FY19		0
FY12	FY13	FY14	FY16	FY17	FY18	FY20	FY21
Source: Fitch Ratings, banks

Loans by Segments (%)

End-2021

Residential	55
mortgage loans

Residential real

estate25

Commercial real

estate15

Agriculture 5

Source: Fitch Ratings, Realkredit

LTV Split (%)

End-2021

0-20%

44

20-40%33

40-60%17

60-80% 4

>80% 2

Source: Fitch Ratings, Realkredit

Realkredit Danmark A/S
Rating Report │ 8 July 2022	fitchratings.com	4

Banks

Retail & Consumer Banks

Denmark

Summary Financials and Key Ratios

	31 Dec 21			31 Dec 20	31 Dec 19	31 Dec 18
	Year end	Year end	Year end	Year end	Year end
	(USDm)	(DKKm)	(DKKm)	(DKKm)	(DKKm)
	Audited -	Audited -	Audited -	Audited -	Audited -
	unqualified	Unqualified	unqualified	unqualified	unqualified
Summary income statement
Net interest and dividend income	956	6,285	6,496	6,905	7,008
Net fees and commissions	-19	-127	-21	-528	-617
Other operating income	-29	-191	-296	336	58
Total operating income	908	5,967	6,179	6,713	6,449
Operating costs	151	995	864	812	703
Pre-impairment operating profit	756	4,972	5,315	5,901	5,746
Loan and other impairment charges	41	269	335	265	196
Operating profit	715	4,703	4,980	5,636	5,550
Tax	157	1,034	1,097	1,240	1,213
Net income	558	3,669	3,883	4,396	4,337
Other comprehensive income	2	13	14	-18	-13
Fitch comprehensive income	560	3,682	3,897	4,378	4,324
Summary balance sheet
Assets
Gross loans	123,725	813,477	819,827	805,858	799,386
- Of which impaired	2,607	17,139	11,925	10,732	11,879
Loan loss allowances	446	2,930	2,801	2,736	2,792
Net loans	123,279	810,547	817,026	803,122	796,594
Interbank	2,277	14,969	24,993	53,772	21,285
Derivatives	6	40	39	128	66
Other securities and earning assets	7,062	46,435	47,187	52,363	51,158
Total earning assets	132,624	871,991	889,245	909,385	869,103
Cash and due from banks	559	3,674	52	54	161
Other assets	203	1,334	1,971	3,109	1,953
Total assets	133,386	876,999	891,268	912,548	871,217
Liabilities
Interbank and other short-term funding	304	2,000	2,000	4,003	778
Other long-term funding	124,861	820,950	835,217	853,479	815,043
Trading liabilities and derivatives	2	16	17	5	68
Total funding and derivatives	125,168	822,966	837,234	857,487	815,889
Other liabilities	694	4,561	4,444	5,068	5,413
Total equity	7,524	49,472	49,590	49,993	49,915
Total liabilities and equity	133,386	876,999	891,268	912,548	871,217
Exchange rate		USD1 =	USD1 =	USD1 =	USD1 =
		DKK6.5749	DKK6.1138	DKK6.6759	DKK6.5194

Source: Fitch Ratings, Fitch Solutions, Realkredit

Realkredit Danmark A/S
Rating Report │ 8 July 2022	fitchratings.com	5