Danske Bank A/S : SP Transaction UpdateDanske Bank AS Cover Pool D Mortgage Covered BondsNov 2023 -November 24, 2023 at 05:22 am EST

Transaction Update: Danske Bank A/S

(Cover Pool D Mortgage Covered

Bonds)

Saerligt Daekkede Obligationer

Primary Credit Analyst:

Andreas M Hofmann, Frankfurt + 49 693 399 9314; [email protected]

Secondary Contact:

Nidhi Nair, Pune; [email protected]

Table Of Contents

Major Rating Factors

Outlook: Stable

Rationale

Program Description

Rating Analysis

Environmental, Social, And Governance (ESG)

Related Criteria

Related Research

Transaction Update: Danske Bank A/S (Cover Pool D Mortgage Covered Bonds)

Saerligt Daekkede Obligationer

Ratings Detail

Major Rating Factors

Strengths

• 
  Very strong jurisdictional support assessment and ‘aaa’ jurisdictional-supported rating level (JRL).
• Liquidity risk is mitigated by the bonds’ soft-bullet repayment profile.
• The program benefits from two unused notches that would protect the ratings on the covered bonds if we were to lower the long-term issuer credit rating (ICR) on Danske Bank A/S.

Weaknesses

• 
  The available overcollateralization is provided voluntarily, reducing the collateral-based uplift by one notch.
• The cover pool includes about 54.9% of second-lien loans that we consider to carry higher risk than first-lien loans.

Transaction Update: Danske Bank A/S (Cover Pool D Mortgage Covered Bonds)

Outlook: Stable

S&P Global Ratings’ stable outlook on its ratings on Danske Bank A/S’ cover pool D mortgage covered bond program and related issuances of “saerligt daekkede obligationer” (SDOs) reflects our view that we would not automatically lower the ratings if we were to lower our long-term ICR on Danske Bank by up to two notches.

We would lower our ratings on the covered bonds if the credit enhancement needed to maintain the ratings were to exceed the available credit enhancement.

Rationale

We are publishing this transaction update following our periodic review of Danske Bank’s cover pool D’s mortgage covered bond program and related issuances.

Our covered bond ratings process follows the methodology and assumptions outlined in our “Covered Bonds Criteria,” published on Dec. 9, 2014, and “Covered Bond Ratings Framework: Methodology And Assumptions,” published on June 30, 2015.

From our analysis of the legal and regulatory framework for covered bonds in Denmark, we believe that the assets in the cover pool are isolated from the risk of the issuer’s bankruptcy or insolvency. This asset isolation allows us to assign a higher rating to the covered bond program than the long-term ICR on Danske Bank.

Danske Bank is domiciled in Denmark, which is subject to the EU’s Bank Recovery and Resolution Directive (BRRD). We consider that mortgage covered bonds have a very strong systemic importance to Denmark. These factors increase the likelihood that the issuer would continue servicing its covered bonds without accessing the cover pool or receiving jurisdictional support, even following a bail-in of its senior unsecured obligations. Therefore, under our covered bonds criteria, we assess the reference rating level (RRL) as the higher of (i) two notches above the long-term ICR; and (ii) the resolution counterparty rating (RCR). Given the RCR on Danske Bank is ‘AA-‘, the RRL is ‘aa’, two notches above its ICR.

Our jurisdictional support analysis determines the JRL of the covered bonds as ‘aaa’. We considered the likelihood of jurisdictional support for mortgage covered bonds in Denmark, which we assess as very strong, resulting in a jurisdictional support uplift from the RRL of up to three notches. Danske Bank’s covered bonds use two notches to achieve a JRL of ‘aaa’.

Following the assessment of the RRL and JRL, we analyze the credit quality of the cover pool and the availability of liquidity support and committed overcollateralization to determine the maximum collateral-based uplift.

The ‘AAA’ ratings reflect our RRL of ‘aa’ and JRL of ‘aaa’, as well as the available overcollateralization of 10.14% as of June 30, 2023, exceeding the 3.14% credit enhancement commensurate with a ‘AAA’ rating, which corresponds to the coverage of ‘AAA’ credit risk.

Lastly, the ratings on the cover pool and related issuances are not constrained by legal, operational, counterparty risks,

Transaction Update: Danske Bank A/S (Cover Pool D Mortgage Covered Bonds)

or country risks.

Program Description

Danske Bank is the leading Danish financial services group. It operates primarily in Denmark, Finland, Sweden, and Norway.

We currently rate categories C, D, and I covered bonds issued under the €30 billion global covered bond program.

Cover pool D comprises only Danish krone (DKK) denominated mortgage loans secured by residential properties in Denmark originated by Danske Bank and the liabilities are currently denominated in euro.

The mortgage covered bonds are senior-secured unsubordinated obligations. They rank pari passu with other obligations in the same cover pool register. If the issuer were to become bankrupt, the C, D, and I cover pools would be separated and independent of each other.

Table 1

Program overview*

Table 2

Program participants

Transaction Update: Danske Bank A/S (Cover Pool D Mortgage Covered Bonds)

Rating Analysis

Legal and regulatory risks

The Danish Covered Bond Act provides the legal framework for the issuance of the Danish covered bonds. It also outlines eligibility criteria for the inclusion of assets in the cover pool. The issuer needs to obtain a general covered bond issuing license from the Danish financial authority.

In our view, the Danish covered bond framework sufficiently addresses the relevant legal aspects of our covered bonds framework criteria and our legal criteria (see “Structured Finance: Asset Isolation And Special-Purpose Entity Methodology,” published on March 29, 2017). This enables us to rate the covered bonds above the long-term rating on the issuer.

Danske Bank adheres to the general balance principle–in contrast to the specific balance principle–in order to manage market risk exposure. The issuer can issue covered bonds that are delinked from the mortgage assets, and the

Transaction Update: Danske Bank A/S (Cover Pool D Mortgage Covered Bonds)

mortgage collateral acts as overcollateralization.

Danske Bank’s cover pool D covered bond investors have a primary secured claim against all assets in the cover pool. The ratings on the covered bonds issued from cover pool D rely on the issuer’s active management of the overcollateralization to support the current ratings.

To become eligible as collateral, mortgage loans must be entered in the Danish land register. The registration is legally binding and will form the basis of any bankruptcy proceedings. If bankruptcy proceedings have been initiated, a trustee appointed by the bankruptcy court will administer the cover pool assets. The trustee is ordered by law to meet all payment obligations as they fall due.

The issuer must maintain an overcollateralization level of at least 2% of covered bonds outstanding on a nominal basis. Banking supervision is carried out by the Danish Financial Supervisory Authority (DFSA, or “Finanstilsynet”). The DFSA can issue an order with which the issuer must comply. In case of severe or multiple breaches, the DFSA may revoke the license.

All Danish covered bonds, which match the maturity of the mortgage, may be extended if a refinancing fails. The issuer or administrator must attempt to refinance such extended bonds annually. For covered bonds without a maturity match (as this is the case in Danske Bank D’s cover pool), the administrator may extend the maturities of the covered bonds.

The legislation to transpose the EU Covered Bond Directive in the Danish legal framework was passed in May 2021 and became effective on July 8, 2022. The amendments are essentially refinements and, given that the Danish legislation was already well aligned to the requirements of the directive, the new legislation does not affect our analysis of the Danish legal framework.

Under Danish law, collateral added to a cover pool less than three months before the bankruptcy of the issuer may be “clawed back” or challenged by other creditors on the basis that the covered bondholders received preferential treatment at the expense of the issuer’s ordinary creditors. If such a challenge were to succeed, fewer assets would be available for covered bondholders from the relevant cover pool. We continuously monitor the transfer of collateral and consider the credit rating on the issuer in determining the size of a potential clawback if Danske Bank becomes insolvent. As Danske Bank has shown it can provide sufficient overcollateralization to maintain a ‘AAA’ rating, any increase of assets in the pool to maintain this rating would likely be considered “ordinary,” and therefore not subject to clawback, in our view.

Operational and administrative risks

In June 2023, we conducted a review of Danske Bank’s origination, underwriting, collection, and default management procedures for the cover pool assets. We also reviewed the cover pool management and administration. We consider that Danske Bank actively manages the cover pool and has adequate underwriting and loan management policies in place. We have not identified any operational or administrative risks that would affect our assessment of the program.

We consider the servicing and origination procedures to be in line with those of other European covered bond issuers, which we have reflected in our originator adjustment.

Transaction Update: Danske Bank A/S (Cover Pool D Mortgage Covered Bonds)

We believe that a replacement cover pool manager would be available if the issuer were to become insolvent. We consider Denmark to be an established covered bond market and believe that the mortgage assets in the cover pool do not comprise product features that would materially limit the range of available replacement cover pool managers.

Our analysis of operational and administrative risks follows the principles laid out in our covered bond ratings framework.

Resolution regime analysis

As part of our covered bonds criteria, our analysis considers the resolution regime in place in Denmark to determine the RRL. The RRL on the issuer, which is the starting point for any further uplift in our analysis, is ‘aa’. We consider the following factors:

• 
  The issuer is domiciled in Denmark, which is subject to the EU’s BRRD. Our very strong assessment of the systemic importance of Danish mortgage covered bonds, which allows for two notches of uplift from the ICR on Danske.

These factors recognize that resolution regimes like the BRRD increase the probability that an issuer could service its covered bonds even following a default on its senior unsecured obligations, because the law exempts covered bonds from bail-in. We consider this an internal form of support because the bail-in of certain creditors does not require direct government support.

Jurisdictional support analysis

The JRL on Danske Bank’s covered bonds is ‘aaa’. Under our analysis of jurisdictional support in our covered bonds criteria, we determine a JRL–which is our assessment of the creditworthiness of a covered bond program–once we have considered the level of jurisdictional support, but before giving credit to the amount of collateral.

In our jurisdictional support analysis, we assess the likelihood that a covered bond program facing stress would receive support from a government-sponsored initiative, instead of from the liquidation of collateral assets in the open market. Our assessment of the expected jurisdictional support for Danish mortgage covered bond programs is very strong.

Therefore, the program can receive up to three notches of jurisdictional uplift from the RRL. Two notches are used to achieve a ‘AAA’ rating, resulting in one unused notch for jurisdictional support.

Collateral support analysis

We base our analysis on the loan-level data and asset and liability cash flow projections provided by the issuer as of June 30, 2023. The cover pool comprises only residential mortgages in Denmark.

Table 3

Cover pool composition

Transaction Update: Danske Bank A/S (Cover Pool D Mortgage Covered Bonds)

Table 4

Key credit metrics

*The effective LTV ratio is the result of the application of our global RMBS criteria, which weight 100% of current indexed whole loan LTV ratio for the WAFF calculation. §Seasoning refers to the elapsed loan term. LTV–Loan-to-value.N/A–Not applicable.

Table 5

Seasoning

Table 6

Current loan-to-value distribution

Transaction Update: Danske Bank A/S (Cover Pool D Mortgage Covered Bonds)

Table 7

Geographical distribution

Table 8

Collateral Uplift Metrics

For the loans in the pool, our analysis estimated the foreclosure frequency and the loss severity and–by multiplying the foreclosure frequency by the loss severity–the potential loss associated with each loan. To quantify the potential losses associated with the entire pool, we calculated a weighted-average foreclosure frequency (WAFF) and a weighted-average loss severity (WALS) assuming ‘AAA’ credit stresses. The product of these two variables estimates the required loss protection, in the absence of additional factors. We assume that the probability of foreclosure is a function of both borrower and loan characteristics and will become more likely–and the realized loss on a loan more severe–as the economic environment deteriorates.

As of June 30, 2023, our WAFF and WALS increased since our previous review as of June 2022. The WAFF increased to 12.4% from 7.36%, mainly due to a higher effective LTV ratio, lower weighted-average seasoning, and a higher share of interest-only loans. The WALS increased to 37.6% from 33.05%, mainly due to a higher current LTV ratio.

By applying our credit and cash flow stresses, we calculate a target credit enhancement of 12.74% (6.37% as of June 2022) and a ‘AAA’ credit risk of 3.14% (2.5% as of June 2022). The higher mortgage assets’ credit coverage and lower excess spread have negatively affected the ‘AAA’ credit risk, while the higher target credit enhancement is further

Transaction Update: Danske Bank A/S (Cover Pool D Mortgage Covered Bonds)

driven by increased asset-liability maturity mismatch.

Our global RMBS criteria identify basis risk relating to standard variable rate (SVR) mortgage loans, given that the lender may change the SVR at any time and for various reasons (for example, changes in the cost of funding or to retain borrowers). As current SVR rates in Danske’s cover pool D reflect a very competitive environment, with spreads at lower levels, we have not reduced the SVR rates in our analysis. However, we may apply a stress as rates change.

Given the JRL of ‘aaa’, under our covered bonds criteria, coverage of ‘AAA’ credit risk or 3.14% of credit enhancement is required to achieve a ‘AAA’ rating, solely based on jurisdictional support.

As the available credit enhancement (10.14%) exceeds the coverage of ‘AAA’ credit risk and 50% of refinancing costs (7.94%), the maximum potential collateral-based uplift above the JRL is two notches. We reduce these two notches by one because there is no commitment to maintain overcollateralization at the current rating level. We make no deductions for the lack of 180 days of liquid assets because the covered bonds soft-bullet maturities satisfy the liquidity coverage requirement under our criteria. Therefore, the maximum collateral uplift above the JRL is one notch.

Counterparty risk

We have identified several counterparty risks to which the covered bonds are exposed. However, these are either structurally addressed in line with our counterparty criteria or taken into account in our cash flow modeling (see “Counterparty Risk Framework: Methodology And Assumptions,” published March 8, 2019). Therefore, we believe that they do not constrain the ratings from a counterparty risk perspective.

Bank account provider

Collections from the borrowers are held in an account with Danske Bank, which exposes investors to commingling risk. However, we consider this risk in our cash flow modeling and therefore believe that it does not constrain the ratings.

We understand that pre-insolvency, principal proceeds are either reinvested or immediately used to repay the bondholders. Post-insolvency, proceeds from the borrowers are identified and promptly segregated for the benefit of the bondholders. We size a small amount to account for the potential disruption that might affect payments above the minimum eligible overcollateralization in a pre-insolvency scenario.

Swaps

Danske Bank is the sole swap counterparty for this program. Hedging addresses interest rate and currency mismatches between the pool’s mortgage loans and the payments due to covered bondholders. To derive the maximum potential rating on the covered bonds under our counterparty criteria, we consider various factors, including whether the counterparties are related to the issuer, the seniority of termination payments, the replacement commitment, and the collateral posting framework.

Danske Bank is a related swap counterparty, and derivative termination costs are not subordinated to payments due to covered bondholders. Because Danske Bank is a related counterparty, we consider the RRL (currently ‘aa’) as the applicable counterparty rating when assessing counterparty risk. According to the swap documentation, Danske Bank has committed to post collateral and to replace itself within 90 calendar days if its RRL falls below ‘a’. We categorize the current collateral-posting framework in the derivative contracts as adequate.