Basel Rules Force Nykredit to Seek China, Mideast Investors

Nykredit A/S Chief Executive Officer Peter Engberg Jensen
Nykredit A/S Chief Executive Officer Peter Engberg Jensen. Source: Nykredit A/S via Bloomberg

Europe’s biggest issuer of covered bonds backed by mortgages said it will double the international holders of its securities as a result of global liquidity rules forcing local banks to sell the debt.

Nykredit A/S will approach investors in China, the Middle East, Europe and the U.S. to bring foreign ownership of its mortgage-backed bonds to as much as 25 percent, Chief Executive Officer Peter Engberg Jensen said.

“We need to reach that in a few years and have to make a big effort to get there,” Engberg Jensen, 58, said in an interview in Copenhagen yesterday. International investors today account for about 12 percent, he said.

Denmark is leading efforts to persuade the European Union to ease liquidity rules set by the Basel Committee on Banking Supervision that the Nordic country says penalize the world’s third-largest mortgage-bond market. While the EU has signaled it may accommodate some of the demands, standards scheduled to take effect by 2015 are still likely to treat covered bonds as less liquid assets than government debt, Engberg Jensen said.

“I don’t think we can totally avoid a haircut” on how banks treat covered bonds in their liquid assets, he said. “I don’t think that we’ll end up with rules where covered bonds and government bonds are equal.” This means “we need to find a broader investor base. We want to be stronger in Europe and we have also started in the Middle East and the Far East. We’ve had investors for many years in the U.S. and Europe.”

Ratings Cloud

Nykredit will rely on international investors to step in as Moody’s Investors Service warns Denmark’s mortgage-bond market may be exposed to refinancing risks on securities carrying adjustable rates. Moody’s on June 10 lowered the so-called timely payment indicator to “high” from “very high” and raised refinancing margins, citing a “refinancing risk and the issuers’ dependence on regular market access.”

At the same time, Denmark’s central bank has recommended phasing out interest-only mortgage debt, arguing the securities exacerbate swings in the property market. The bank’s concerns were echoed by the European Commission in a June 7 report.

Nykredit has since announced it will keep funding for adjustable-rate mortgage loans separate from other securities to protect its fixed-rate business from any rating cuts.

‘Significant Weakness’

Basel’s liquidity coverage ratio, designed to ensure banks hold enough easy-to-sell securities to survive a 30-day credit squeeze, requires lenders to limit so-called Level 2 assets, including covered bonds, to 40 percent of liquid assets. It places no cap on government debt. The Basel committee also wants Level 2 assets to be listed at 85 percent of their market value.

Danish mortgage bonds returned 0.8 percent this year, not including re-invested interest, according to Nykredit’s Index of the securities. That compares with a 1.25 percent loss in the same period for German government debt, according to Merrill Lynch prices.

“As far as the Basel rules on liquidity are concerned, all government bonds are as good as each other,” Danish central bank Governor Nils Bernstein said in a June 20 interview. “This, in my view, is a significant weakness in the rules. We’re still working hard to ensure that Danish mortgage bonds can be used as a liquidity instrument to fulfill the liquidity coverage ratio set by Basel.”

The European Commission is due to provide an update on how it will implement the Basel rules locally next month.

China, Mideast

“If we get the new rules, most Danish banks will have to restructure to sell mortgage bonds and buy government bonds,” Engberg Jensen said.

While Danish banks have relied on the country’s covered bonds to generate liquid assets, lenders in Germany and Asia have room to purchase the securities without breaching Basel’s 40 percent limit, Nykredit estimates. The company wants to sell its bonds to banks in those regions to make up for the selloff it expects to see in Denmark, Nykredit Group Managing Director Karsten Knudsen said in the same interview.

“Over time we’ll have a larger proportion of fixed-interest rate loans in our portfolios and then the traditional big investors in continental Europe will come in,” he said. “It will be the big German investors, pension funds, the Middle East. And we recently got on the approved list of the central bank of China. We see a lot of possibilities and we know these people already.”

Nykredit announced in May it set up a fixed-income unit in Sweden. That move gave the company pan- “Scandinavian access to European and international bond markets,” Engberg Jensen said.

‘Not Right’

Trading in Denmark’s short-term covered bonds -- securities backed by the cash flow from a pool of mortgage loans -- rose during the financial crisis, both in the total value of bonds traded and in the median size of individual trades, according to a study published last year by the Danish central bank. It was easier to trade short-term mortgage bonds than government notes, the study found.

“It is about having something liquid to sell if needed,” Engberg Jensen said. “That’s what it should be about. I know it’s much easier to say covered bonds only account for 40 percent and government bonds 100 percent, but it’s not the right thing to do.”

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