Nykredit A/S, Europe’s largest issuer of covered bonds backed by home loans, says the Basel Committee on Banking Supervision is likely to give in to Danish pleas to adjust a stable funding rule the bank says will kill short-term mortgage bonds.
“I think they will listen, and I have the feeling they are listening,” Soeren Holm, Nykredit’s chief financial officer, said in an interview. “We feel that the adjustable-rate mortgage loans are going to continue.”
That’s why Nykredit has no plans to abandon its one-year notes, used to finance mortgages as long as 30 years, he said. The Copenhagen-based bank says the securities will constitute the “main part” of 136 billion kroner ($24 billion) in bonds it plans to sell in refinancing auctions starting next month.
Basel, which wants banks to move away from such short-term funding, has excluded liabilities with effective maturities of less than one year from its definition of stable funding. The Danish central bank and Moody’s Investors Service also argue the securities pose a refinancing risk to Denmark’s $496 billion mortgage bond market, which is the world’s third largest after the U.S. and Germany. Nykredit fired Moody’s in April, citing disagreement over its methodology.
Denmark’s next-biggest mortgage lender after Nykredit, Danske Bank A/S unit Realkredit Danmark A/S, isn’t taking any chances over Basel’s net stable funding rule. The bank is weaning borrowers off adjustable-rate loans funded by one-year bonds by charging higher fees and through advertising campaigns. The Basel proposal is under review by the European Commission and due to be enforced in 2018.
More than half of all outstanding household mortgage debt in Denmark is financed by adjustable-rate bonds, according to the Association of Danish Mortgage Banks. The share of adjustable-rate notes, which also come in maturities of three and five years, rose 9.1 percent in the second quarter to 55 percent, it estimates.
The Basel proposal requires that 65 percent of a loan’s funding comes from sources defined by the committee as stable, said Peter Jayaswal, deputy director at the association. Deposits are deemed stable funding, even though they can be withdrawn at any time, he said.
“It makes no sense,” Jayaswal said in an interview. The association is submitting trading data as part of the European Commission’s rule review in the hope a graduated approach to weighing the bonds will be adopted. That would find the notes stable when issued and add haircuts as they near maturity.
“We have the evidence that they are 100 percent stable,” Jayaswal said.
According to Holm at Nykredit, international regulators will recognize that Denmark’s mortgage system is supported by domestic institutional buyers such as pension funds. Local investors held 86 percent of Danish mortgage bonds at the end of August, central bank data show. That ownership provides stable funding, Holm said.
Homeowners have tapped the adjustable-rate loans as investor demand for assets out of AAA rated Denmark drove interest rates to record lows. The central bank cut its lending rate to 0.2 percent in July, and brought its deposit rate to an unprecedented minus 0.2 percent in an effort to keep capital out and protect the krone’s peg to the euro.
Investors seeking refuge from Europe’s debt crisis have been undeterred by Denmark’s housing and regional banking crises, focusing instead on the country’s stable public finances. Property prices have sunk about 25 percent since their 2007 peak, and will decline 3.5 percent on average this year, the government estimates.
If investors change their view on Denmark and interest rates start to rise, homeowners relying on adjustable rates become more vulnerable, the central bank warns.
Moody’s cut Nykredit’s issuer rating on May 30 by three steps to Baa2, with a negative outlook. The ratings company, which chose to publish its views even though the bank had terminated its contract, also downgraded Nykredit’s covered bonds, saying the maturity mismatch between the securities and the loans added “very significantly” to refinancing risks.
Nykredit has an A+ rating from Standard & Poor’s and is graded A at Fitch Ratings, both with a stable outlooks.
“I know Moody’s has a different opinion,” said Holm. “But still, it’s been confirmed by two and it’s my belief that actually the European Commission and other bodies think that it’s a relatively good way of doing things that we have in Denmark.”
Nykredit has made some adjustments to accommodate the concerns. The bank this year began limiting the use of adjustable-rate bonds to cover the first three-quarters of a loan. The rest is financed using long-term, fixed-rate bonds, which don’t require the bank to provide supplementary collateral if house prices fall. The industry’s shift toward spreading auctions over a calendar year, instead of a single December refinancing, has also reduced risks, Holm said.
Danish banks and the government are also lobbying to prevent Basel from reclassifying mortgages as traded assets, which would require them to set aside additional capital. Basel’s liquidity coverage ratio proposal will probably be eased to accommodate most of Denmark’s demands, Holm said.
“I’m not that pessimistic,” he said.