Basel Seen Rotten in Denmark as Banks Bypassed
Danish bankers are learning the hard way it pays to have a seat at the table.
The Basel Committee on Banking Supervision, which brings together regulators from 27 nations including the U.S and China, last month expanded the range of easily sold assets banks must have on hand to weather a month of market turmoil. While policy makers approved company debt and equities, they kept limits on covered bonds, mortgage-backed securities that fund almost all Danish home purchases, and are rated higher than the sovereign debt of Japan, Italy and Spain.
Denmark, which doesn’t have a representative on the committee, has more of the securities outstanding per capita than any other nation, with its banks holding more than half of the 3.3 trillion-krone ($600 billion) market. Unless revised, lenders will have to find alternatives to fulfill the liquidity requirements at the same time Denmark is shrinking its issuance of government debt. Interest rates for Danish homeowners, the world’s most indebted, may also climb, creating reverberations throughout the economy, said Steen Bocian, chief economist for Danske Bank A/S, the country’s largest lender.
“The thing that keeps us still breathing” is the expectation the European Commission “will implement Basel in a pragmatic manner,” said Jesper Berg, head of regulatory affairs for Nykredit A/S, Europe’s biggest issuer of mortgage-backed covered bonds. The Copenhagen-based lender estimates Danish banks will face an asset shortfall of almost 200 billion kroner.
“The covered bond issue is not really the big issue for the countries that participate in the discussion,” Berg said.
That’s likely to have negative consequences for the Danish economy, which is struggling to emerge from the fallout of a property bubble that burst in 2008. Growth will suffer as homeowners, confronted with higher rates, rein in spending, Bocian said.
“Denmark is more interest-rate sensitive than most other countries because the financial gross indebtedness is higher,” Bocian said. Greater use of adjustable-rate loans and an increase in household debt since the financial crisis erupted have worsened the situation, he said.
Household debt is about three times disposable income, and most of it is in mortgages financed by covered bonds, a form of bank financing backed by mortgages, creating Europe’s second- largest residential covered bond market after Spain. Danish banks held mortgage bonds valued at 1.52 trillion kroner, or 46 percent of the 3.3 trillion kroner outstanding, in December, the central bank said Jan. 25.
Foreclosures rose 18 percent in January from a month earlier, to 425, the Danish statistics agency said today on its website. They’ll probably stay around this level into 2014 as the labor and housing markets remain sluggish, according to Danske Bank.
Denmark isn’t alone in opposing rules that have been four years in the making and are designed to apply global banking standards to prevent a repeat of the 2008 global financial crisis. Basel III also penalizes the 262 billion euros ($347 billion) market for Dutch residential mortgage-backed securities because their loans allow for up to 95 percent of a home’s value. Basel will only categorize securities as liquid assets where the loan-to-value ratios are less than 80 percent.
The Basel Committee expanded the range of assets that banks may use to meet liquidity requirements after a sampling of 209 banks found stricter rules led to a shortfall of $2.4 trillion. The committee also gave lenders four more years to meet the requirements to avoid a credit crunch.
Soros a Fan
What’s irksome for Danes is that the country’s two- century-old mortgage market is touted by billionaire financier George Soros as a model to be replicated; it has attracted Pacific Investment Management Co, the world’s biggest bond fund; and it withstood the financial crisis while Europe’s sovereign turmoil has tested confidence in government debt, which will count the most for liquidity purposes.
It “shows how you can become victim to what is politically expedient,” said Berg.
Investor demand drove interest rates on bonds financing loans that adjust yearly as low as 0.42 percent in December and November auctions, according to the Association of Danish Mortgage Banks. The Nykredit index of the market’s most traded bonds hit a record last month, and closed yesterday less than 1 percent below that high.
Basel has categorized government debt as level 1, allowing banks to fulfill 100 percent of their liquidity requirements with the assets. Mortgage-based debt is considered level 2, so there are caps on their use as liquid assets. Covered bonds will have a 40 percent ceiling, while securitizations can’t count for more than 15 percent of a lender’s liquidity buffer.
‘Safe as Gold’
“The key assumption made in late 2009 was that government bonds are as safe as gold, and time has not been kind to that assumption,” Berg said. Still, “it’s bad timing to raise doubts about that now. If the committee had gone more fundamental, the whole liquidity coverage ratio would have died.”
Top ranked benchmark Danish mortgage securities are, on average, as liquid, or as easy to buy and sell, as the nation’s AAA rated government debt, even in periods of market stress, the Danish central bank said in a Nov. 22 working paper. The study confirmed a 2010 finding.
The Basel changes “don’t address our main concern that mortgage bonds should be considered highly liquid,” said Jan Knoesgaard, the mortgage association’s deputy director. “We’ll still have to follow through in the European Union for some time now.”
The commission is working on legislation to implement the recommendations, and agreed last year to submit assets to a battery of tests to determine liquidity, rather than relying on asset classes.
Denmark’s financial regulator told banks last year to ignore the Basel rules. The Financial Supervisory Authority said in December that, in expanding the pool of banks required to report liquidity levels, it would allow banks to consider mortgage bonds as liquid as sovereign assets after “objective criteria” showed a “large part” are.
Still, Benny Andersen, Denmark’s executive director at the IMF, said conclusions that the European Commission would address Denmark’s concerns “seem premature” as Basel still gives preferential treatment to government debt.
“This poses a challenge for jurisdictions with low public debt,” Andersen wrote in response to an IMF country review completed in December. “More importantly, the current euro debt crisis has revealed the inappropriateness of this approach.”
Danish banks face a shrinking pool of Danish government debt, which is about half that of Europe’s average.
The debt office plans to issue 75 billion kroner in bonds this year, down from just more than 100 billion kroner last year, after taking advantage of record low rates in 2012 to prefund the government’s financing needs.
That issuance may decline further after the government last year said capital pension holders cashing in policies this year will get a lower tax rate, 37.5 percent compared with 40 percent. The government has estimated it may collect an additional 5 billion kroner in revenue this year. The debt office said in December the amount could run much higher, and the “extraordinary large revenue” would be used to reduce bond issuance in 2014 and beyond.
Yields on 2-year government notes were below zero for almost half of last year as investors fled Europe’s debt crisis for the safety of top-ranked Danish assets. Mortgage rates fell to less than 0.5 percent in auctions to refinance adjustable- rate loans and on the secondary market.
The low rates have helped ease the effects of a recession, enabling households to continue paying their mortgages even as unemployment rose and house prices continue to slide. The government estimates that gross domestic product shrank 0.4 percent last year.
House prices have dropped more than 20 percent since their 2007 peak, and the length of time properties are on the market before a sale has grown steadily. Last month, the average time climbed an annual 5 percent to 231 days, Boligsiden.dk, a real estate agent-owned website that tracks the market, said today.
“It is still extremely important for us to have covered bonds as high quality liquid assets,” Karsten Beltoft, director of the Danish Mortgage Bankers’ Federation, said. “To have covered bonds qualified as highly liquid assets will be stamp of approval that will be important for us in many circumstances.”
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