Danske Shrinks FICC Portfolio to Meet Equity Returns Target

Declining revenue triggered by turbulent markets is forcing Danske Bank to find new ways of squeezing its struggling fixed income, commodities and currency operations so they’re not a drag on financial targets.

Chief Executive Officer Thomas Borgen says the bank can’t afford to get out of the business, because it’s too vital to clients. So Danske is targeting positions again, only this time rather than firing people, it’s shedding securities.

The bank has cut its trading portfolio assets by 25 percent in the past year, selling off enough bonds in the third quarter to reduce credit exposure from trading and investment activities by 17 percent. Less exposure means less capital, less capital means better returns.

“We have taken down quite considerably the capital consumption to bring down the volatility and make sure that we have an acceptable ROE,” Borgen said in an interview following the release of the bank’s third-quarter earnings.

Tighter regulations and falling revenue from fixed-income trading are forcing banks to review operations. Credit Suisse Group last week said last week in a surprise announcement it would no longer make a market in European government bonds.

Danske aims for a return on equity of at least 12.5 percent by 2018 at the latest, to catch up to its Swedish rivals. The figure stood at 11.5 percent as of Sept. 30.

The stock fell more than 7 percent on Thursday after a 10 percent drop in total revenue cast doubt on the lender’s ability to meet its targets. Negative rates in Denmark and Sweden are forecast to last longer amid the prospect of more European Central Bank stimulus, adding to concerns about Danske’s revenue prospects.

“We’ll see earnings per share estimates coming down for 2016 and 2017, there will be a de-rating,” said Karl Morris, an analyst at Keefe, Bruyette & Woods. “It’s an uninspiring report especially since Danske has been a darling. It’s been one of the best performing.”

Danske has consistently outperformed the Bloomberg Europe 500 Banks and Financial Services Index since Borgen become CEO two years ago. Still, the spread widening began reversing for the first time last month and is now at its lowest in about three months.

Danske reported net income of 3.67 billion kroner, 12 percent up on a year earlier, but below the 3.84 billion-krone estimate in an analyst survey compiled by Bloomberg. Net interest income fell 7 percent, while trading income plunged 36 percent.

“Trading income was disappointing,” said Thomas Eskildsen, an analyst at Jyske Bank. The result is the main reason the bank downgraded its total income forecast to be in line with last year’s figure, compared with an increase before, he said.

Borgen said the bank’s trading results reflect what’s happening in the broader market, and that Danske will “work on the costs if we’re getting more pressure on net interest income.”

ATP said on Thursday it will adjust its portfolio to insulate Denmark’s largest pension fund against sudden liquidity droughts in debt markets.

Nordic banks find themselves increasingly squeezed between record low interest rates and property markets that have become dangerously inflated by cheap loans. Denmark’s Financial Supervisory Authority warned Danske earlier this month to reconsider its expansion plans in Sweden, where the property market is overheated.

Banks’ reliance on fee income, a bright spot until the third quarter, has revealed the industry’s exposure to volatile markets. Nordea, the region’s biggest lender, said on Oct. 21 its profit fell 17 percent last quarter after both net interest income and revenue from fee missed estimates.

But Danske has no option but to stick with markets exposed to low interest rates, Borgen said.

“The FICC business, being in the Nordics, is important for us, it’s important for all our clients,” Borgen said. “We’re adjusting the business model but not exiting. No.”

Before it's here, it's on the Bloomberg Terminal.