Banks, Estonia, Financial Services

 The transaction will be finalized in the autumn of the current year, when the final scope and price of the transaction will also be determined. Prerequisites for finalizing the transaction are getting permission from the Competition Authority and raising additional capital for LHV Group. The transaction is not to be considered a transaction with related parties, LHV Group, parent group of LHV Pank, told the stock exchange.

LHV Pank and Danske Bank have agreed on the price of the transaction, according to which a discount of 39 mln euros will be subtracted from the volume of the portfolio at the moment of the transaction. The estimated price of the transaction will be around 410 mln euros.

The volume of the loan portfolio of the unit as of the end of February is 470 mln euros, about 97% of which are home loans. According to LHV's assessment, this is a well-guaranteed strong credit portfolio. Whereas the interest rates of granted home loans were essentially near cost price, the transaction is only possible due to the discounted sale of the portfolio.

It is presumed that the volume of the portfolio will decrease to 450 mln euros by the moment of the transaction. The balances and settlements of clients will not transfer with the unit when making the transaction. At the same time, the unit is accompanied by a few employment contracts, the specific number of which will be determined by the moment of making the transaction.

With the transaction, LHV Pank will take over serving about 10,800 private customers. According to LHV's settlement analysis approximately 80 % of these are new customers for LHV.

Current loan customers of Danske Bank do not have to change anything in their activities, and they will be provided with more specific instructions as soon as the transaction is finalized in the second half of 2019. LHV intends to automatically open a personal account for loan servicing at LHV bank for every client and formalize amendments to contracts so that all that the clients have to do is redirect loan payments to their new bank account. The current loan terms will not change with the automatic transfer of loans, unless clients themselves wish to amend the contracts.

The intended transaction will have a significant impact on the financial situation of LHV. As of the end of April 2019, the loan portfolio of LHV Pank amounted to 1.016 bn euros. By acquiring the unit, the loan portfolio of LHV will grow by about 450 mln euros. In addition to the existent deposits, LHV will raise a total of 280 mln euros of new financing in order to finance the transaction.

In the short term, LHV Pank will finance the added volume of loans with deposits taken from Estonia and foreign markets. The deposits of Estonian clients have grown faster than planned. If this trend continues, it is possible to finance the transaction to a significant extent through local deposits. The rest of the financing will be involved through deposit-taking platforms where the international deposit platform Raisin will be the main partner.

Through the latter, deposits will be taken from German, Austrian, Dutch and Spanish private persons. Still, this is a source of financing that is on the more costly side, which is why LHV Pank intends to finance the home loan portfolio in the long term through issuing covered bonds.

From 2021, the additional income from the portfolio will be 4 mln euros per year. On average, the transaction will improve the return on equity (ROE) of LHV Pank by 0.4 percentage points per year. By that time all one-off expenses will have been made and the expensive short-term deposits raised for the transaction will have been replaced with more favorable covered bonds.

Additionally, the financial plan takes into account that the discount included with the transaction will be reflected in accounting through interest income over the life of the portfolio. In case of significant change or termination of loan contracts, the discounts related to the contracts will be included in income at the same time.

In 2020, the additional profit from the transaction will amount to 1.7 mln euros. The financial results will then be still affected by the costlier short-term deposits, which are planned to be replaced with more favorable covered bonds in 2020.

Since the loan portfolio will be acquired in the autumn of 2019, the transaction will predominantly add costs this year. According to LHV's assessment, in 2019, the transaction will bring LHV a loss of 2.7 mln euros, 1.05 mln euros of which originates from net interest income, 1.54 mln euros from the provision accompanying the portfolio, and 0.12 mln euros from additional administrative cost.

LHV Group will update their financial plan after the transaction has taken place. Subject to the timing of the transaction, updating of the financial plan may occur in the beginning of 2020 in the course of regular updating of the financial plan.

In order to acquire the unit of Danske Bank involved with the loan portfolio of Estonian private clients, LHV Group will have to raise additional capital, which the group will use to increase the capital of its subsidiary, LHV Pank. To finance the loan portfolio to be acquired, LHV Group requires 27 mln euros of own funds, at least 16 mln euros of which are tier 1 own funds and 11 mln euros of which are tier 2 own funds.

"This is an important event for us. LHV's loan portfolio will increase by 40% as a result of the transaction taking place, and the importance of retail banking in LHV's business will increase dramatically. This event can also be considered significant in Estonian banking since a bank based on Estonian capital intends to take over the business of outgoing foreign capital and considerably increase its market share in a strategically important sector," Madis Toomsalu, CEO of LHV Group, said. 

"LHV has indeed grown to become the largest domestic financial group, but the success of the transaction requires us to take on over half a billion euros of deposits and, considering the growth of existing business volumes, raise capital to the extent of about 50 mln euros through three different capital instruments. The latter is divided between bonds and share capital," Toomsalu said .

"The transaction is built on the principle that in addition to using the deposits of Estonian clients, we will temporarily finance ourselves with deposit-taking platforms. Next year, we hope to issue long-term covered bonds which will make the financing cost more favorable. With this transaction, the formulating of provisions, re-registering of guarantees and other one-off costs must be taken into account at the beginning. The regular effect without one-off factors of the portfolio to be acquired will be revealed on the income statement in 18 months, also increasing the return on equity of the whole bank compared to the current financial plan," Erki Kilu, chairman of the management board of LHV Pank, said.

"After the transaction is finalized, we will certainly invite new loan clients to use all other LHV services as well. We can serve the new clients in the best possible way -- we offer all banking services, the best service in Estonia, a network of ATMs across Estonia, and an extremely comfortable internet and mobile bank," Kilu added.

The Estonian Financial Supervision Authority on issued a precept to Danske Bank in February prohibiting the branch of the bank from operating in Estonia. 

The bank must cease its activities in Estonia within eight months from receipt of the precept, and it must consider the interests of its current customers in doing so, the financial watchdog said.

Nothing changes at this moment for customers of Danske Bank's Estonia branch, and all customer contracts continue to be in force. The reorganization of customer relationships will be carried out gradually over the next eight months. The bank will return all customer deposits in full. However, it may not force current borrowers to terminate their loan agreements or repay their loans to the bank early only because of the precept.

Danske Bank must transfer all the loan contracts of its branch within eight months to some other unrelated bank or entity that is authorized to operate in Estonia and that will continue to serve those loans, or if it cannot do so after reasonable attempts, it will find another lawful solution for how those loan contracts may continue to be served, provided that customer interests are adequately protected. At the end of 2018, the branch had around 14,700 depositors in Estonia and 12,300 borrowers.

Last September, an independent investigation ordered by the bank's board of directors revealed that more than 230 billion US dollars in suspicious transactions passed through the Estonia branch from Russian sources. The report found that Danske's senior leadership had known of the problem as far back as 2013, but failed to make appropriate disclosures even after the laundering was confirmed in 2014. Investors accuse Danske Bank of engaging in a concerted cover-up to keep the findings as well as the magnitude of the laundering from investors and financial regulators in Estonia and Denmark.

After having conducted on-site inspections at the bank and carried out in-depth analysis of the information provided by the Estonian Financial Intelligence Unit, the Estonian Financial Supervision Authority concluded that Danske Bank must close its operation in Estonia.

Some 200 bn euros, the bulk of which appears to have come from uncertain sources, was channeled through Danske's Estonian branch between 2007 and 2015.

Thomas F. Borgen, then CEO of Danske Bank, in September of 2018 decided to resign from his post due to the bank's money laundering scandal. In addition, rules and control mechanisms pertaining to the financial sector have come under closer scrutiny in many places across the European Union.

Due to the money laundering scandal, Danske is under investigation in Denmark, Estonia, France, Germany, the United Kingdom and the United States.