Merrill Lynch Banking and Insurance CEO Conference Peter Straarup CEO and Chairman of the Executive Board, Danske Bank
October 4, 2007
SPEECH
platform supports our activities in Denmark, Sweden, Norway, the UK, Ireland, Germany, Poland and Luxembourg.
Peter Straarup - Danske Bank - CEO
These business units are fully integrated on our platform, and we use the same concepts all over the group. This provides our units with strong systems, superior products and excellent services.
Thank you for giving me the opportunity to talk about Danske Bank. It is a pleasure once again to stand before this very knowledgeable audience.
Our platform is an ongoing project. We have invested a lot in the past four years: in new banks, in new branches and in integration of our business units. Right now, investment expenses are peaking. This also because we are presently bringing Sampo Bank on to our platform. Fortunately, at the same time that investments are peaking, we can show the first results in terms of improved profitability.
The environment for our industry at this years conference is a bit different compared to previous years. Our sector is going through a period of uncertainty in the international markets, with declining prices and high volatility. Turbulence is never attractive. However, we feel that Danske Bank is well positioned to deliver stable earnings, irrespective of the turmoil.
It is worth mentioning that since 2004 Danske Bank has invested more than 45 billion kroner in new banks, new branches and integration costs but we have issued new shares for only 15.5 billion.
In Danske Bank we focus our activities on good old-fashioned banking traditional retail banking. In our opinion, retail banking will most likely be the segment in the financial industry that is the least affected by the current environment.
I think it is relevant to give you an update on our franchises, our investments and a few comments on what you can expect in the coming years. Let us start in our home market.
My presentation will include the following subjects: • •
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Retail Banking in Denmark Our retail bank in Denmark is still the largest entity in the group. The bank is characterised by being a market leader with a very high profitability. Measured before credit losses and tax, the return is normally above 40 percent. This high return provides the bank with strong cash flows to finance dividends and cash flow for profitable investments outside the Danish market.
A review of Danske Banks retail activities, our investments and their potential An overview of our funding structure, liquidity policy and off-balance-sheet commitments which I find important to touch upon because of the situation in the money market And finally a summary of our geographical distribution of income and our potential for enhancing earnings
Still, we are also investing in Denmark. As you may know, we decided to merge our two Danish brands, BG Bank and Danske Bank in April this year. The merger will create synergies of 300 million kroner once it is completed. It will reduce the number of branches by 15 to 20 percent and will also reduce the number of staff.
Map of Danske Banks presence No bank is unaffected by the present situation. But our decision to shut down our New York branch, exit from corporate banking in the UK, and close our Hong Kong and Singapore branches, has significantly reduced our presence in the wholesale market.
New product offerings in Denmark We decided to use the amounts we have saved to introduce new concepts in Denmark. We have recently launched a new internet-based banking package. The product makes day-today banking free of charge and thus closes the door to competition from mono-line product offerings on the internet. The obvious attraction is that when customers need advice in a more complex financial product, they are welcome to visit their branch and avail themselves of the financial advice they need. We call the new concept 24/7, and it was an instant success. The inclusion of a competitive internet product has vastly improved Danske Banks strategic platform in our home market.
Instead, we focus on the markets close to us. On these markets we conduct retail banking operations. Our activities are based on our core concept and vision: One platform exceptional brands. Danske Banks vision/mission During the last couple of years, we have created a unique platform for offering our retail bank services across borders. Our IT systems are multi-currency and multi-lingual. We strive to use the same tools across borders. We have developed our platform to a scalable and resilient low-cost functionality. This has made it possible to absorb new franchises at low marginal cost. Presently, our single IT
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Starting new business relationships through lending products means that it will probably take a couple of years before the positive ROE development really takes of. But I invite you to follow our progress.
Let us take a closer look at some of our international investments, beginning in Sweden and Norway. Sweden, 10 years of high growth Our presence in Sweden since 1997 has been a story of growth. We have brought our market share up from 1.5 percent to 6 percent, measured on total lending.
We believe that all our retail banks can achieve a return on allocated capital before credit losses and tax of at least 25 percent. Let us go to Norway.
One thing is growth in terms of volume and market share. Another is to make this growth profitable. Our retail banking model is the tool which ensures profitable growth.
Norway: J-curve is also kicking in Developments in Norway are not much different from those in Sweden. But the starting point was a bit lower. The bank had a number of difficult years in a turn-around period turnaround in terms of product quality, staff education and geographical presence. As in Sweden, we increased the number of new branches by 25 per cent, mainly in the largest cities. At the same time some branches in rural areas were closed or sold.
Sweden: New branches and improved profit. Still sustainable growth requires investments. From 2004 to 2006 we expanded our presence in Sweden by increasing the number of branches by 25 percent. This investment is an important component of our lending growth during the last couple of years.
The financial numbers tell more than many words. The cost/income ratio was an unhealthy 75 in 2004 but has now dropped close to 60. Return on allocated capital has shown even stronger improvement and is now above 20 percent.
It takes time before a new branch reaches break-even. Usually about two years. And it takes another couple of years until the investment has been repaid. Only after about seven years will most branches have reached their full earnings power and become mature.
60 percent of the best branches earn close to 100 percent of profits. 13 branches showed a deficit in the first half of 2007. This means that the potential for enhanced profitability in Norway should be the same as in Sweden.
In Sweden, 60 percent of our branches are currently mature, and these branches account for more than 90 percent of profits. If you assume that the remaining 40 percent have the equivalent earnings potential as the 60 percent, our future profitability is substantially higher. We can already see where we are heading.
The conclusion is that our Swedish and Norwegian entities are currently improving according to expectations and that we expect that there will be more to come.
Sweden: J-curve is now kicking in
Lets turn to the two Irish banks we acquired in 2005. Let us start in Northern Ireland.
Looking at a few key figures, you can see the improvement in recent years. Our cost/income ratio has dropped from 62 to
Northern Ireland In Northern Ireland our results before credit losses have not yet shown significant improvement. The result for the first half of 2007 was only at break-even.
54 since 2004 and return on equity has increased from 16 to 20 percent. To understand the life of a newly established branch and the expansion of a franchise, it is essential to remember that
We think we have a good explanation for this. Integration costs and amortisation of intangibles have depressed results. Also, it has been quite cumbersome to change many processes from manual handling to electronic handling. It has also been cumbersome to turn around the retail bank to focus on customers rather than products. But, we are now in the final stage of this process. And what is more important: the expensing of take-over costs will be completed for all practical purposes from March 2008 when the three-year amortisation period is over.
lending is often the door opener to new customers. Moreover, in many cases, price is the most important parameter to a new customer. And lending consumes capital. Later on, returns will increase through sales of less capital-consuming products. Product offerings And here Danske Bank has a unique offering. Our offering includes state-ofthe-art cash management services and business online systems, which enhance efficiency both for our customers and for us. The systems include a wide array of trading possibilities.
On this slide we illustrate the potential of our results by deducting total integration costs from the half-year result. This alone will improve the cost/income ratio by more than
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And on that single other platform we only have to pay marginal IT production costs. We expect that Sampo Banks total IT costs will be reduced by close to 50 percent.
30 points and return on allocated capital to a very healthy 38%. Going forward - we should add the full impact of the synergies.
IT costs are not the only area which will create synergies, but this is the area where our strategy and platform are outstanding compared with those of most other banks.
Our conclusion is that Northern Bank will shortly become a very profitable part of the group. The fact that developments in Northern Ireland have increased the prospects for general growth in the community has only made our franchise more attractive. Let us look at Ireland.
So also in Finland and the Baltics, Danske Bank has good reason to expect strong improvements in return on capital. Total integration costs and synergies After this tour of our main retail banking units I hope you have got an insight into where we currently stand in each of the projects. To sum up, you will see that our franchises are all in a very good position.
Ireland National Irish Bank is in a similar situation when it comes to the integration process. By March 2008 almost all costs will have been booked, and then we will focus entirely on developing our activities.
Looking at total integration costs and amortisation of intangibles, we can summarise the numbers like this. Our expenses will peak in 2007 at around 2.3 billion and gradually decline by 1.8 billion to half a billion in 2010. And this half billion is a non-cash charge. In addition, the announced synergies should tick in by around 1 billion annually in the same period.
The results so far show a clear improvement since 2005, but return on equity excluding integration costs is still below 20 percent. Strong growth in lending and hence allocated capital is the main reason. But here we establish the basis for future growth in returns. Even though the strong market growth in Ireland is replaced by more normal rates, we expect to continue to invest and show strong growth. We will invest in branches as we have done in the Swedish market.
Disregarding IT integration costs, we have very cost efficient use of IT. In 2006, our total IT costs amounted to some 15 percent of our total costs. This is at the low end compared with other European banks, which normally spend between 15 and 20 percent on IT costs. More important, we use almost half of our IT costs to develop the bank. According to Datamonitor, an IT consultant, this is one of the very highest among European banks. It means that our IT production costs are very low, and when we have finished our current integration projects our overall IT costs should come down below the 15 percent we had last year.
Our strong product offering should provide for a quicker penetration of non-capital binding products and thus quickly enhance returns. Competitive offerings such as our loan-tovalue mortgage loans, Irelands technologically most advanced online bank and cash management systems which have functionalities way beyond any of our peers form a solid foundation for this expectation. So also here Danske Banks expects to deliver growth as well as increasing returns.
All this should be a very solid foundation for future earnings growth. A foundation for growth that we see very few other banks having the potential to deliver.
Finland and the Baltics Some comments about our newest investment, Sampo Bank, which includes one of the leading banks in Finland and gives us some exposure to the three Baltic countries. Our strategy is the same as for our other acquisitions. We want the new banks fully integrated in our group, using our IT platform and all the other concepts we currently use throughout the group.
Now coming back to the theme for this conference; delivering growth in a riskier world. The financial sector has without any doubt become more risky in recent months. Will that affect our retail banking operation? Not directly, as most of this business is predominantly local business without much contact with the international wholesale markets.
We will begin with Finland, which has the biggest cost base. The Finnish operation will be converted to our IT platform at Easter 2008. Our Baltic banks will wait until Easter 2009.
Indirectly, it is possible that there could be some impact in terms of lower GDP growth and higher volatility in the markets.
We expect to achieve cost synergies of as much as 18 percent. How is this possible, you may ask? The main reason is that we will replace one platform with another platform.
Increasing spreads on risk are another issue. If the current situation persists for a longer period, one should expect that corporate spreads will change. Funding costs might also
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bonds in the market and only then passes the proceeds to the borrower. The duration of the bond is equal to the duration of the loan. The interest payment is determined by the market when we sell the bonds. This means that we do not have any liquidity or interest rate risk at all. We only retain the credit risk on the debtors. And in Denmark the maximum loan to value at origination is 80 percent. At the end of the second quarter of 2007, our average LTV was a healthy 53 percent.
increase. This development could eventually improve our lending margins. I think, however, that it is too early to party on that. Short term, most banks will probably be hit by higher funding costs how much depends on the structure of the bank. Liquidity and funding of Danske Bank Danske Banks has a cautious policy when it comes to our liquidity. Our main objective is to have positive liquidity at any time for three weeks ahead, without any management intervention. This is based on different scenarios including worst case. Our liquidity reserves include 13 percent of our total committed lines at any time. So far, we have not deviated from our policy in 2007.
This tells you that the Danish mortgage market is fundamentally different from many others, including the American market. Conventional mortgage bonds are rated all triple A, and, as I mentioned earlier, the only risk the bank holds is the credit risk on the debtor. A low risk supported by collateral. Our expected credit loss ratio over the cycle is a very modest 2-3 basis points. It needs to be said that the bonds in the Danish market are not carved up into a number of tranches.
Furthermore, we have a 12-month positive liquidity, using Moodys scenario, which includes some intervention but no use of capital markets. This means no refinancing of debt to credit institutions, issues of bonds and certificates.
In Denmark, new covered bond legislation has made it possible for banks to issue covered bonds for loans. Here the loan-to-value ratio will be 70%. Danske Bank expects covered bonds to become an additional and very dependable source of funding supplementing conventional mortgage bonds. Covered bonds will also be rated triple A.
Owing to the very good market conditions in the spring, we raised a significant proportion of our total funding need for 2007 then. In June, we raised more than 26 billion of new medium and long-term funding. Debt maturing in 2007 This means that Danske Banks need for making new issues for the remaining of 2007 is very little in absolute terms as well as relative to our European peers. This slide gives you a good view of our current strong position.
Wholesale Funding As mentioned, only 20 percent of our funding is coming from the wholesale market. A fairly low proportion compared with many other banks. A closer look at our wholesale funding shows that of the 20 percent, 14 percent have a duration at origination of at least two years, whereas the short-term funding only accounts for 6 percent or some 160 billion kroner.
Debt maturing in 2008 Next year, our funding need will be higher, but in an European context our 20 per cent debt maturing is comparable with the majority of peers. Due to our very low funding requirement this year I would expect us to be at the low end of debt maturity scale when entering 2008.
Our funding strategy including liquidity management is published in detail on our Web site. The overall purpose of our strategy is to monitor and control developments in the banks short-term and long-term liquidity and to ensure that the bank always holds a liquidity buffer.
Furthermore, our total proportion of funding in the capital market is very small. Funding structure of Danske Bank Today, only 20 percent of our funding comes from issued bonds and subordinated loans, whereas more than a quarter comes from our deposits and a similar amount comes from the Danish mortgage market.
We are using a variety of funding sources ranging from a short-term cp programme over medium-term note programmes to long-term bond issues. Our funding sources also include subordinated loans and hybrid capital. Due to lack of understanding, among other, of the structure in the Danish mortgage market, our observation is that some market participants have been arguing that Danske Bank has a weak funding structure and a stressed liquidity. I hope that I have shown you that this is not the case and that our positions are very strong in all respects.
A few words on the Danish mortgage market, since mortgage bonds these days seem to have caused some angst in the financial markets. Danish mortgage market Our main mortgage activities are founded on a solid concept. It is worth noticing that the Danish mortgage market is a pass-through system, in which the bank, as a provider, sells
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Enough of that. I hope to have conveyed to you that also in this field, the risk is limited and our platform a solid one. But let us start wrapping up.
Danske Markets The growth in Danske Banks franchise has also meant good growth in Danske Markets. Danske Markets has a number of functions. It handles capital market activities and it is also responsible for the operational management of Danske Banks day-to-day liquidity. It provides all our retail franchises with capital market activities. And it has developed a profitable business co-operation with international financial counterparties.
Nordic Banks business mix I started by mentioning that Danske Bank is predominantly a retail bank, and this slide shows that around 80 percent of our revenues originate from our retail banks, including our Danish mortgage finance company.
Through Danske Markets we have also provided a number of back-up facilities, which these days have come to the attention of many observers.
In a period where higher risk is coming into wholesale and capital market operations, we see conventional retail banking as a more safe haven if like us you operate in markets
Therefore, I find it pertinent to give you some information about Danske Banks position in this market.
where the underlying economies are healthy with good economic growth, low unemployment rates, sound budgets and a positive current account. And this goes for most of
Committed line to conduits etc. First a few facts. Today, Danske Bank has committed lines to ABCP conduits and SIVs of a total of 61 billion kroner, of which our own sponsored Polonius accounts for 19 billion. This is equal to 2 percent of our total assets.
Danske Banks home markets. Geographical distribution of income In the first half of 2007, 42 percent of our income from retail banking came from outside Denmark, more than twice as much as in 2004. With the expected growth in the coming years, we believe the 50 percent mark will be reached within the next few years through organic growth.
Polonius has been fully consolidated since IFRS accounting began, whereas the other lines amounting to 42 billions are off balance until lines are drawn. At this point in time, some 14 billion have been drawn, of which half is coming from
We see our Danish operation as the cash generator of the bank, which should finance our organic growth in our other home markets.
Polonius. This means that almost 25 percent of the total amount is now drawn. And this has not changed our strong liquidity position which I described a few minutes ago.
Danske Bank has unique and multiple EPS enhancers I would like to conclude this presentation with a brief sum-up.
Asset quality Asset quality within Polonius is very strong as 97% is rated Triple A and the rest Double A or Single A. Also the other conduits have very strong ratings, as the slide shows, with no exposure to assets with a rating below Single A.
The investments we have made in recent years will begin to pay-off and be more visible in our accounts. In Sweden and Norway several years of high income growth is now to a larger degree feeding through to the bottom line and the already achieved high return ratios should be improved further.
It should be noted that we do not carry out any mark to market valuation of these exposures, but we have to do impairment tests. In recent weeks we have gone through our exposure and looked at the assets in cooperation with the rating agencies, and we have not found any need for impairment charges. Therefore, if any of the assets come on our books, our current assessment is that no charges will have to be made.
Lower integration costs and higher synergies will be the main drivers for improved earnings in Northern Bank and National Irish. The same will be the case in Finland and the Baltics, but one respectively two years ahead. On top of this, we expect continued strong top line growth in Ireland and in the Baltics.
Geographical /Asset type distribution The distribution of the assets geographically and by asset types in Polonius can be seen on this slide. It should be noted that some of the CDOs are protected by received credit default swaps.
In Denmark, our focused strategy and the brand merger will secure high returns and enhance our growth. All these issues are specific for Danske Bank. Our capital management has not been in focus in this presentation. We are just a few months away from our
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entrance into Basel II. We still expect that we will be recognised as an advanced bank in most cases, and the expectations are that this will be positive for our capital position. However, we do not know the details yet, as we are still discussing specifics with the Danish FSA. Until then, we can only repeat our old statement that our goal is to run the bank with the necessary capital, not more not less. Given our strong funding structure, we expect that we can deliver good growth in the coming years, even though the world has become riskier. Many thanks for your attention. If you have any questions, I will be happy to answer them.
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