Danske Bank has tools to reach 2023 target despite market skepticism

Analysts are unconvinced Danske Bank A/S will reach its return on equity target of 9% to 10% by 2023, but they say it is not an impossible mission for Denmark's largest lender, which has multiple tools available to change its current course.

Even if the bank falls short of its goal, its stock could still gain, according to one analyst.

This comes as Danske Bank is due in the coming quarter to present an updated plan on how it will boost its ROE — which measures a corporation's profitability in relation to shareholders' equity — toward 2023.

Analyst consensus currently predicts Danske Bank will achieve an ROE of just 7.5% by 2023, far below its target, according to an average of 12 estimates provided to S&P Global Market Intelligence.

Yet analysts speaking to Market Intelligence do not dismiss the possibility the bank could present a plan that will see those estimates change. Among Danske Bank's tools to boost ROE are lowering compliance costs, growing fee income and expanding negative interest rates, or it could carry out share buybacks to reduce its high capital reserves.

"Based on the initiatives that Danske Bank has already launched, it does not seem realistic that it will reach its goal. Is it impossible? No, I do not think so either. The bank may have planned initiatives that we analysts don't know about," said Mikkel Emil Jensen, equity analyst at Sydbank, who estimates Danske Bank will achieve an ROE of 8.0% in 2023.

Even if Danske Bank were to downgrade its 2023 target, Jensen believes there is still potential for share price gains amid low market expectations for the bank's ROE performance.

"According to my calculations, the current share price reflects a significantly lower ROE than what the bank promises it can deliver. There will still be share price potential if the bank reached above 8%, in my view," Jensen said.

Danske Bank has a "large toolbox" of initiatives available to raise its ROE, said Mads Thinggaard, an equity analyst at ABG Sundal Collier, though "not all instruments are equally shareholder friendly."

For example, Thinggaard explained, Danske Bank could write down the value of intangible assets, an accounting technique that it has used before, or it could negotiate a settlement with authorities investigating its involvement in a €200 billion money laundering scandal in Estonia. Both moves would help to lower Danske Bank's equity base, but neither would provide any shareholder value, Thinggaard said. Danske Bank currently has 10 billion kroner set aside in capital to cover the fallout of the scandal.

While share buybacks would be welcomed by investors, they are unlikely to happen as long as the bank faces a money laundering fine, Thinggaard said. The analyst predicts Danske Bank's ROE will land at 8.0% in 2023.

"There are a lot of elements in play" that could help Danske Bank achieve its goal, but it may take beyond 2023 to do so, Thinggaard said. "If we look at those instruments that make sense, then it may be more logical for the bank to postpone the targets until 2025," the analyst said.

New initiatives needed

Danske Bank, continuously questioned by skeptical analysts over the mismatch in expectations, remains persistent. During its second-quarter earnings call, CEO Carsten Egeriis emphasized that the bank is "heading in the right direction," promised to update the market in the next quarter on how it plans to meet its objective and reiterated that the ROE target will not be adjusted.

Danske Bank has already made significant progress on this measure, recording an ROE of 7.0% in the first half of 2021, up from 0.9% a year earlier.

As part of its transformation program, the bank has launched significant cost-cutting initiatives and changes to its organizational structure, including a plan to discontinue approximately 1,600 positions.

But more is required, and Danske Bank will need to present new and "convincing" initiatives to persuade the market that it will be able to achieve its objective, said Sydbank's Jensen.

Compliance expense is one post where Danske "may surprise" by delivering on its target to bring such costs down to between 1.5 billion kroner and 1.7 billion kroner in 2023, from a peak of 4.1 billion kroner in 2020, according to Thinggaard. The analyst's estimate for 2023 includes compliance costs at 2.35 billion kroner.

Danske Bank also has room to grow its fee income, Thinggaard said, adding that the bank could be inspired by Danish peers such as Sydbank A/S, which earlier this year introduced a monthly fee for customers with a business volume of less than 300,000 kroner.

Danske Bank could boost income by expanding its negative interest rate regime to cover more depositors or lowering the interest it charges in order to reinstate a positive margin on deposits, said Sydbank's Jensen. Such moves could also encourage customers to move toward the bank's more profitable investment products, Jensen added.

Furthermore, Danske Bank's ability to keep loan loss provisioning levels low will be "a decisive factor" for ROE, Jensen said. The analyst assumes a normalized cost of risk level of between 10 bps and 15 bps in 2022 and 2023, saying there is a risk of a "COVID-19 hangover" that will see bankruptcies rise once government support packages end.

"But it may well be that Danske Bank, based on the credit quality it currently sees, expects loan losses to be lower in the coming years than they have historically been," Jensen said. "If the economy is strong and there is good volume growth, and it gets a financial boost over the coming years in the wake of COVID-19, then it may help it to meet these goals."

Danske Bank had a cost of risk of 6.6 bps in the first half of 2021, according to Market Intelligence data.

The bank does not comment on specific analyst opinions, Danske Bank's head of investor relations, Claus Ingar Jensen, said in an email, but he noted that deviations between external estimates and Danske Bank's own plans are "not uncommon," as 2023 "is far away." Estimates gathered by Danske Bank itself include "a fairly big range for net profit — and thereby ROE," Ingar Jensen said.

Without going into further detail, Ingar Jensen said the bank expects both higher income and lower costs to support it in realizing its ROE target. "And remember that the size of the capital base is also an important component for the ROE," he added.

As of Sept. 1, US$1 was equivalent to 6.28 Danish kroner.