Scope Ratings AG today confirms the Kingdom of Denmark’s long-term local-currency rating at AAA, following the release of its revised sovereign rating methodology, and converts its status from subscription to public. The agency also assigns a long-term foreign-currency issuer rating of AAA, along with a short-term issuer rating of S-1+ in both local and foreign currency. The sovereign’s senior unsecured debt in local and foreign currency was also rated at AAA. All Outlooks are Stable.

Rating drivers

Denmark’s AAA ratings are underpinned by a wealthy and highly competitive economy, which has gradually recovered from the financial crisis of 2008-2009. Recovering private consumption has been the main growth driver, reflecting an efficient labour market, rising house prices and improving confidence. After a slowdown in real growth from 1.6% in 2015 to 1.1% in 2016, Scope expects continued moderate growth of 1.5% and 1.8% in 2017 and 2018, driven by continued strength in private consumption and recovering investment.

Denmark’s public finances are characterized by low deficits and a strong fiscal framework. Denmark benefits from robust public-debt dynamics, which are supported by a low debt stock (of 37.8% of GDP in 2016), recovering economic growth and favourable financing costs, which together more than offset the debt-increasing effect of slightly negative primary fiscal results. It’s Scope’s view that Denmark’s government is making good progress with unwinding the substantial fiscal stimulus provided during the crisis. In 2016, the deficit shrank modestly to 0.9% of GDP. In 2017, Scope expects Denmark to increase the deficit slightly by temporarily loosening its fiscal stance, still complying with both EU Stability and Growth Pact rules and the country’s own budget law while providing space for tax cuts and reform, in line with supporting the pace of the recovery.

The rating is further underpinned by Denmark’s strong external position characterised by large, steady current account surpluses, supported by the considerable earnings on Denmark’s sizeable stock of foreign assets. These assets bolster Denmark’s net creditor position. Owing to its export orientation, Denmark has been running an average current account surplus of 6.2% of GDP annually over the past 10 years, further enhanced by cyclical effects from the financial crisis. In line with a decrease in the current account surplus in 2016 (from 9.2% of GDP in 2015 to 8.1% of GDP), Scope expects this gradual decline to continue, driven by increasing private consumption and domestic investment, and thus higher import demand, and further reductions in North Sea oil and gas revenues. However, Denmark’s external position will remain solid with forecasted surpluses above 5% of GDP over the medium term. Denmark’s sound monetary policy, including the central bank’s prudent interest rate policy and commitment to maintaining the peg of the Danish krone to the euro, further provides the country with an adequate buffer against external shocks.

Denmark’s credit strengths are balanced by challenges in the form of high household debt and sectoral housing market pressures. Although Danish household debt as a percentage of disposable income has declined in recent years, it still remains the highest among OECD countries (at 262% in 2016). Risks surrounding a high private-debt burden are partially mitigated by sizeable household assets in the form of pension savings and housing assets. Moreover, Danish households benefit from a historically low interest burden (of below 5% of disposable income in 2016, which is materially lower compared with a peak around 14% in 2008). Household credit has grown modestly in recent years, but with large regional differences. It’s Scope’s view that current sectoral housing pressures are contained as, in contrast with the pre-crisis period, major increases in house prices and mortgage lending have been concentrated in the wealthy region surrounding Copenhagen recently, reflecting fundamental drivers such as higher salaries and urbanisation.

Denmark’s financial system is large (with assets of about 700% of GDP) and closely interconnected with that of Nordic neighbours. The banking sector is dominated by a few banks and exposed to the domestic housing sector – with real estate lending of mortgage banks amounting to approximately half of total Danish banking sector assets in 2016. In addition, mortgage banks are reliant on mortgage-covered bond funding with Danish pension funds acting as primary investors. The combination of sectoral housing market pressures, high and increasing household debt, and market reliance on continued investment of Danish pension funds into the mortgage covered bond market, poses potential financial stability risks. Furthermore, under Denmark’s implementation of the European Bank Recovery and Resolution Directive, Danish mortgage banks are exempt from having to meet an MREL (minimum requirement concerning the volume of eligible liabilities, i.e. debt that can be converted into equity to bear losses in a resolution situation). In Scope’s view, this arrangement implies a higher probability that the government may need to intervene to rescue mortgage banks in a scenario of difficulties.

Recently implemented macro-prudential measures will help to strengthen credit quality by setting limits on new residential mortgage lending with variable rates, for example. In addition, the level of banking sector earnings has risen substantially over the last three years. Danish banks have been able to compensate for low interest income through increased income from administration margins on mortgage loans, and other fees. Capital adequacy grew significantly to 2013, when the largest Danish banks met the fully-phased-in EU 2019 requirements, and has remained broadly stable since then. While the largest Danish banks have lower capital adequacy than other Nordic banks, their capital adequacy (Tier 1 capital ratio of 17-20% in 2016) is high compared to that of most large banks in Europe. Scope’s public-debt scenario analysis shows that even taking into account potential rescue measures by the sovereign of a sizeable slice of the Danish mortgage banking sector, public debt-to-GDP would remain below the Maastricht threshold of 60%.

Sovereign rating scorecard (CVS) and Qualitative Scorecard (QS)

Scope’s Core Variable Scorecard (CVS), which is based on relative rankings of key sovereign credit fundamentals, signals an indicative “AAA” (“aaa”) rating range for the Kingdom of Denmark. This indicative rating range can be adjusted by the Qualitative Scorecard (QS) by up to three notches depending on the size of relative credit strengths or weaknesses versus peers based on qualitative analysis. For Denmark, the following relative credit strengths have been identified: i) macroeconomic stability and imbalances; ii) public debt sustainability; iii) external debt sustainability. Relative credit weaknesses are not indicated. Combined relative credit strengths and weaknesses indicate a sovereign rating of AAA for Denmark. A rating committee has discussed and confirmed these results.

For further details, please see Appendix 2 of the rating report.

Outlook and rating-change drivers

The confirmation of the Stable trend reflects Scope’s view that risks to the ratings remain broadly balanced.

The ratings or outlooks could be downgraded if: i) structural measures failed to address potential housing risks, leading to markedly higher default rates in the mortgage market and escalating concerns about a build-up of systemic financial stability risks; ii) the Danish government were to intervene in domestic financial markets to support mortgage banks, ultimately leading to increased public debt above expectations; and/or iii) Denmark experienced a protracted period of weak economic performance as a result of an external shock, possibly owing to global protectionism or weaker commodity prices.

For the detailed research report, please click HERE.

Rating committee

The main points discussed during the rating committee were: (1) Economic growth potential and outlook, (2) public finance performance and debt sustainability analysis, (3) external economic position, (4) financial and banking sector performance, (5) banking sector’s reliance on housing market developments, (6) sustainability analysis of private debt, (7) peers consideration.

Methodology

The methodology applicable for this rating and/or rating outlook, ‘Public Finance Sovereign Ratings’, is available on www.scoperatings.com.

The historical default rates used by Scope Ratings can be viewed in the rating performance report on https://www.scoperatings.com/governance-and-policies/regulatory/esma-registration. Please also refer to the central platform (CEREP) of the European Securities and Markets Authority (ESMA): http://cerep.esma.europa.eu/cerep-web/statistics/defaults.xhtml. A comprehensive clarification of Scope’s definition of default and definitions of rating notations can be found in Scope’s public credit rating methodologies on www.scoperatings.com.

The rating outlook indicates the most likely direction in which a rating may change within the next 12 to 18 months. A rating change is, however, not automatically a certainty.

Regulatory disclosures

This credit rating and/or rating outlook is issued by Scope Ratings AG.
Rating prepared by Jakob Suwalski, Lead Analyst
Person responsible for approval of the rating: Dr Stefan Bund, Chief Analytical Officer
The ratings/outlook were first assigned by Scope as a subscription rating in January 2003. The subscription ratings/outlooks were last updated on 05.05.2017.
The senior unsecured debt ratings as well as the short term issuer ratings were assigned by Scope for the first time.
As a "sovereign rating" (as defined in EU CRA Regulation 1060/2009 "EU CRA Regulation"), the ratings on the Kingdom of Denmark are subject to certain publication restrictions set out in Art 8a of the EU CRA Regulation, including publication in accordance with a pre-established calendar (see "Sovereign Ratings Calendar of 2017" published on 21.07.2017 on www.scoperatings.com). Under the EU CRA Regulation, deviations from the announced calendar are allowed only in limited circumstances and must be accompanied by a detailed explanation of the reasons for the deviation. In this case the deviation was due to the recent revision of Scope’s Sovereign Rating Methodology and the subsequent placement of the ratings under review, in order to conclude the review and disclose ratings in a timely manner, as required by Article 10(1) of the CRA Regulation.

Solicitation, key sources and quality of information

The rating was initiated by Scope and was not requested by the rated entity or its agents. The rated entity and/or its agents did not participate in the ratings process. Scope had no access to accounts, management and/or other relevant internal documents for the rated entity or related third party.

The following material sources of information were used to prepare the credit rating: public domain and third parties. Key sources of information for the rating include: the Ministry of Finance of the Kingdom of Denmark, Central Bank of Denmark, World Bank, European Central Bank (ECB), Statistical Office of the European Communities (Eurostat), IMF, OECD, and Haver Analytics.

Scope considers the quality of information available to Scope on the rated entity or instrument to be satisfactory. The information and data supporting Scope’s ratings originate from sources Scope considers to be reliable and accurate. Scope does not, however, independently verify the reliability and accuracy of the information and data.

Prior to publication, the rated entity was given the opportunity to review the rating and/or outlook and the principal grounds upon which the credit rating and/or outlook is based. Following that review, the rating was not amended before being issued.

Conditions of use / exclusion of liability

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