The European Banking Authority’s treatment of mortgage assets in capital tests last month betrays a bias against the securities that puts Danish lenders at a disadvantage, according to Europe’s biggest issuer of mortgage-backed covered bonds, Nykredit A/S.
“Credit institutions with very safe mortgage loans have been hit,” Nykredit Chief Executive Officer Peter Engberg Jensen said in an interview in Copenhagen. “It is a strange thing, because it’s not a question of risk. It’s a question of sudden rules being set up because of the crisis in Greece.”
The European Union wants banks to have reserves of 9 percent of their risk-weighted assets by mid-2012. In calculating how much extra capital banks must raise, the EBA assigned tougher risk weights to mortgage debt than Nordic regulators. That tripled Nykredit’s capital requirement, Jensen said. Treating mortgage securities as inherently more risky and less liquid than government bonds makes little sense given the turmoil gripping Europe’s sovereign-debt market, he said.
“It’s difficult not to be affected by what we have seen in the European government-debt market during the last month,” Jensen said in the Nov. 10 interview.
Danish mortgage-backed covered bonds carry higher credit ratings than more than half the sovereigns inside the euro area. Trading in the country’s short-term mortgage bonds rose during the 2008 financial crisis, both in the total value of bonds traded and in the median size of individual trades, according to the central bank.
Lobbying the EU
Denmark has railed against recommendations by the Basel Committee on Banking Supervision to treat mortgage bonds as less liquid than sovereign debt. The Nordic country lobbied the European Commission, the EU’s executive arm, to persuade regulators in Brussels to ease Basel’s liquidity rules.
The EU will probably let banks hold unlimited amounts of mortgage bonds to meet liquidity requirements, compared with Basel’s proposal to cap holdings at 40 percent, Jensen said. Still, the EBA is unlikely to accommodate Denmark’s request that banks also be allowed to hold their own mortgage bonds as liquid assets, he said.
The EBA will be in charge of drafting detailed measures to implement the Basel rules in Europe, once the legislation underpinning Basel III implementation has been agreed by national governments in the region and the European Parliament.
“It will be a little more uphill to convince the commission,” Jensen said.
Avoiding a Sell-Off
While European concessions mean Denmark’s mortgage market will probably avoid the outright sell-off that the central bank, the government and the Association of Danish Mortgage Banks had predicted, there continues to be a bias against the securities that leaves Denmark worse off, said Carsten Wiggers, chief executive officer at Copenhagen-based LR Realkredit A/S, which has about $2.4 billion in assets.
“Most mortgage banks hold their own bonds, and if you can’t do that, it will be a huge problem,” Wiggers said in an interview. “It will, of course, be more costly, and who’s going to pay for it? The borrowers.”
Danish financial institutions held 55 percent of the country’s 2.69 trillion kroner ($495 billion) in covered bonds at the end of September, according to the Association of Danish Mortgage Bonds. Neither the association nor the central bank publishes data on banks’ own holdings of mortgage bonds.
Banning banks from holding their own bonds would cripple Denmark’s mortgage market, said Peter Jayaswal, a deputy director at the Copenhagen-based Association of Danish Mortgage Banks. When homeowners prepay their loans, for example to refinance at a lower interest rate, banks buy back the old bonds, issue new paper and use the proceeds to reimburse themselves.
The Danish market “is very special due to this market-based system,” Jayaswal said. “You know your bonds that have financed your house, and you can buy them back in the market.”
Demand for Danish mortgage bonds has soared since the outbreak of the debt crisis, with Nykredit’s index of the most traded bonds on the Copenhagen stock exchange hitting a 10-year high last week. Foreign investors will buy at least 20 percent of bonds issued by Nykredit in auctions this month and next as it refinances $25 billion in debt, Jensen said.
Denmark is also trying to persuade regulators in Brussels that one-year bonds that fund more than 40 percent of all residential mortgages in the Nordic country constitute a stable funding source and not a refinancing risk. The Basel requirements would prohibit their use to meet its net stable funding ratio requirement.
Stable funds are resources banks can expect to have for at least a year, even in stressed market conditions. The Basel Committee introduced the requirement, which becomes binding in 2018, to avoid a repeat of the mismatch in banks’ funding and lending that exacerbated the 2008 crisis. Basel’s liquidity rules are effective from 2015.
If Denmark’s efforts are rebuffed, the mortgage banks will probably have to issue more costly types of bonds, driving up households’ and businesses’ interest payments, the Association of Danish Mortgage Banks estimates.
“They’re tightening all the rules,” said Wiggers. “If you tighten the rules, if you harmonize across the western world, and if you have a little, small economy like Denmark and a specialized system, it will be crushed.”