Danske Bank A/S : Fitch Upgrades Realkredit Danmarks CC T Covered Bonds to AAA Affirms CC S Covered Bonds at AAA

1/8/2021

Fitch Upgrades Realkredit Danmark's CC T Covered Bonds to 'AAA', Affirms CC S Covered Bonds at 'AAA'

RATING ACTION COMMENTARY

Fitch Upgrades Realkredit Danmark's CC T Covered Bonds to 'AAA', Af rms CC S Covered Bonds at 'AAA'

Fri 08 Jan, 2021 - 6:02 AM ET

Fitch Ratings - Frankfurt am Main - 08 Jan 2021: Fitch Ratings has upgraded Realkredit Danmark A/S's (Realkredit, A/Stable/F1/a) mortgage covered bonds issued out of Capital Centre (CC) T to 'AAA' from 'AA+', and af rmed those issued out of CC S at 'AAA'. The Outlooks are Stable.

The upgrade of CC T re ects the reduced credit loss in the cover pool, stemming mainly from decreased loan-to-value (LTV) ratios, which improves the recovery rates of the residential and commercial pools. The relied upon overcollateralisation (OC) of 6.5% now supports the revised 'AAA' breakeven OC of 6.0%.

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KEY RATING DRIVERS

The covered bonds' ratings for the two programmes are based on Realkredit's Long- Term Issuer Default Rating (IDR) of 'A' and the various uplifts above the IDR granted to the programmes. The covered bonds' ratings also consider OC protection for covered bond holders.

The covered bond programmes are rated ve notches above the bank's IDR. This is out of a maximum achievable uplift of eight notches, consisting of a resolution uplift of zero

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1/8/2021

Fitch Upgrades Realkredit Danmark's CC T Covered Bonds to 'AAA', Affirms CC S Covered Bonds at 'AAA'

notches, a payment continuity uplift (PCU) of six notches and a recovery uplift of two notches.

The Stable Outlook for both programmes is driven by that on Realkredit's IDR and the three-notch cushion against an IDR downgrade.

For the CC S cover pool, which consists of Danish xed-rate residential and commercial mortgages, Fitch gives credit to 5.9% OC. This is the lowest nominal OC observed in the last 12 months and provides more protection than the 4% 'AAA' breakeven OC for the programme.

For the CC T cover pool, which consists of Danish oating-rate residential and commercial mortgages, Fitch gives credit to 6.5% OC. This is also the lowest nominal OC observed in the last 12 months and provides more protection than the 6% 'AAA' breakeven OC for the programme.

Uplifts

Fitch currently does not assign a resolution uplift to Realkredit's covered bonds, as the issuer is a specialised mortgage lender not operationally integrated into a parent bank and the bail-in tool is not applicable to specialised mortgage banks in Denmark.

The six-notch PCU for both programmes re ects the liquidity protection in place for at least 12 months. Of the outstanding bonds in CC S, 99% have a pass-through amortisation pro le and all of CC T bonds have extendible maturity. The remaining bonds of CC S are hard-bullet, whose redemptions are covered by liquid assets for at least 12 months. The six notches also re ect interest payment protection of at least three months in both programmes.

Both programmes are eligible for a recovery uplift of two notches. The combination of 'AA+' timely payment rating and a one-notch recovery uplift results in the lowest breakeven OC supporting the 'AAA' ratings.

OC Protection

The Fitch-breakeven OC has slightly increased for CC S and reduced for CC T. For CC S the Fitch 'AAA' breakeven OC has increased to 4.0% from 3.5%. For CC T the Fitch 'AAA' breakeven OC has decreased to 6% from 7% over the last 12 months.

The 50bp increase in Fitch's 'AAA' breakeven OC for CC S re ects the higher default rates of the commercial pool. This is the result of loans having longer tenors and a slight

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1/8/2021

Fitch Upgrades Realkredit Danmark's CC T Covered Bonds to 'AAA', Affirms CC S Covered Bonds at 'AAA'

increase in the pool correlation regarding industry concentration. Recovery rates have also reduced as the weighted average LTV has increased in the pool.

The 100bp reduction in Fitch's 'AAA' breakeven OC for CC T re ects the decreased weighted average LTV predominately in the residential pool but also to a lesser extent in the commercial pool, which increases recovery rates. The portfolio composition in the share of residential and commercial assets has also remained stable with good residential asset performance.

The breakeven OC for both covered bond programmes remains driven by the credit risk of each pool as Fitch does not model a sale of assets in its cash ow analysis, but considers the possibility of bond re nancing post insolvency or models the pass-through or maturity extension of bonds with these features. The credit loss component of the breakeven OC is 5.6% for CC S and 6.6% for CC T.

For the residential assets, Fitch has derived foreclosure frequency (FF) assumptions based on the analysis of vintage cumulative default data. The expected FF is 1% for the residential assets in CC S and 1.47% for CC T, to which Fitch applied high rating scenario multiples to derive FF in each rating scenarios. This is due to the mild economic environment in Denmark and low cumulative defaults. On recovery prospects, we give full credit to the automated valuation model used for regulatory purposes.

Fitch has analysed the commercial sub-portfolios under the Appendix 10 of its Covered Bonds Rating Criteria (Commercial Real Estate Loans Securing Covered Bonds Analysis), which references Fitch's SME Balance Sheet Securitisation Rating Criteria. There were no material changes in Fitch's assumptions for these assets. Fitch uses its Portfolio Credit Model to derive stressed losses for this segment. The expected average annual default rate (90 days' past due) for the performing commercial mortgage portfolio was set at 1.5%. It was set at 0.5% ( oored at 0.25% for each loan) for the social and cooperative housing segment, given its good historical performance.

We continue to take into account that this segment may gradually reduce over time in both capital centres. We also applied low and high stressed prepayment rates of 0% and 20%, respectively (lower than for residential loans based on historical data), cure rates of 50% in a 'B' scenario and a three-year recovery timing assumption for these loans. The 'AAA' collateral haircuts are 75% for industrial properties and 65% for the other commercial properties. For the social and cooperative housing segments, we applied the residential market value declines that are set out in the Originator-Speci c Residential Mortgage Analysis Rating Criteria.

On the commercial sub-pool analysis, Fitch tested high and low prepayment assumptions in both its portfolio credit and cash- ows models. For CC S, the worst-case

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1/8/2021

Fitch Upgrades Realkredit Danmark's CC T Covered Bonds to 'AAA', Affirms CC S Covered Bonds at 'AAA'

scenario was low prepayments while for CC T, the worst-case scenario was high prepayments. The resulting ALM loss component is -1.5% for CC S and -0.6% for CC T.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

The covered bonds are rated 'AAA', which is the highest level on Fitch's scale. The ratings cannot be upgraded.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

CC S Covered Bonds

The 'AAA' rating of Realkredit's CC S mortgage covered bonds would be vulnerable to a downgrade if any of the following occurs: (i) Realkredit's Long-Term IDR was downgraded by four notches to 'BBB-' or below; or (ii) the level of OC Fitch gives credit to in its analysis falls below the 'AAA' breakeven OC of 4%. Should the relied-upon OC decrease to the legal minimum of 8% (of risk-weighted assets), the covered bonds would be downgraded to 'A+', one notch above the bank's IDR.

CC T Covered Bonds

The 'AAA' rating of Realkredit's CC T mortgage covered bonds would be vulnerable to a downgrade if any of the following occurs: (i) Realkredit's Long-Term IDR was downgraded by four notches to 'BBB-' or below; or (ii) the level of OC Fitch gives credit to in its analysis falls below the 'AAA' breakeven OC of 6%. Should the relied-upon OC decrease to the legal minimum of 8% (of risk-weighted assets), the covered bonds would be downgraded to 'A+', one notch above the bank's IDR.

Pandemic Downside Scenario Stress Sensitivity:

Fitch expects the coronavirus containment measures to negatively impact the performance of Danish mortgage loans. However, the covered bonds' ratings bene t from a cushion between the OC that Fitch relies upon in its analysis and the OC equivalent to Fitch's 'AAA' breakeven OC. In addition, the ratings are well protected by the three-notch buffer against a downgrade of Realkredit.

When Fitch performed downside sensitivity scenario stresses to the programmes by increasing the cover pool's PD assumption and reducing the recovery rates on the

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