Denmark’s ailing banks need to overcome their fear of stigma and accept a lifeline that will help them offload toxic farm loans, said the head of the bank created by lawmakers to take over the distressed debt.
Landbrugets FinansieringsBank, which parliament created in March, probably faces an uphill battle in persuading lenders of its merits, Chief Executive Officer Jesper Lyhne said. He’s trying to combat resistance by touring the country to explain to management teams how they can use his bank in an effort to demystify the transactions involved, he said.
“We can maybe prevent local banks from being brought to the edge of bankruptcy by taking these loans off their lands,” Lyhne said in a Nov. 14 interview in Copenhagen.
It’s not the first time that Danish banks most in need of aid have shunned it. Use of the central bank’s longer-term refinancing operations in March and September fell as much as 84 percent short of analyst estimates compiled by Bloomberg. Part of the problem is the complexity behind the facilities offered, Lyhne said.
“The banks are open to the idea but it’s a complex proposition and there is arguably an element of stigma,” he said. “You can compare it with the central bank’s LTRO: banks were very eager initially to say they wouldn’t use it, that they didn’t need it.”
LFBank, which is 41.7 percent owned by the financial industry, will take over about 80 of the roughly 160 non-performing farm loans currently held at the state’s resolution unit, Financial Stability, Lyhne said.
LFBank’s model entails buying farm loans from lenders by issuing bonds to them for 85 percent of a loan’s value. The notes can’t be resold, though they can be used as collateral at the central bank, he said. The remaining 15 percent is repackaged as a new loan, which is subordinated to the bond.
“What we’re doing is quite new and untested, so banks are waiting to see how this works before they line up and ask us to take over their loans,” Lyhne said. “We only have about 2 billion kroner ($340 million) in lending capital, so this is not going to be a question of volume coming in to rescue the Danish bank industry.”
Though Denmark’s banking crisis, which pushed losses on to senior bondholders last year, has remained regional in scope, its fallout has sent funding costs higher across the industry. Credit default swaps on Danske Bank A/S, Denmark’s largest lender, trade about 66 percent higher than those on Sweden’s Nordea Bank AB, according to data available on Bloomberg. Danske is rated Baa1 at Moody’s Investors Service, three steps above junk. Nordea enjoys an Aa3 credit grade with the rater.
“You can see that even when a small Danish bank fails, it has quite a ripple effect,” Lyhne said.
Bad agricultural loans, which soured after farmers embarked on a borrowing spree last decade to pay for expansion that left them insolvent as farm property values sank about 30 percent, are adding to losses from Denmark’s housing crisis. Farm loans account for about 7.4 percent of aggregate mortgage and commercial bank lending, with smaller banks having a higher concentration, according to central bank statistics.
The outlook for production and employment growth fell to a record low in August, according to a survey published by the Danish Agriculture and Food Council on Sept. 25. While that adds to pressure on bank loans to the farm industry, lenders may still hesitate to seek help.
“The smaller banks may be afraid of the stigma” associated with using LFBank, said Thomas Hovard, head of credit research at Danske Bank Markets. “Being the first bank to go there could be a big step to take.”
Since the country’s real estate bubble burst four years ago, more than a dozen regional and local lenders have failed, pushing the economy into a recession.
According to Lyhne, banks focused too much on collateral before the crisis and forgot to take cash flows into account. His bank won’t take over loans to farms that don’t have any commercial prospects. Candidates need to meet productivity criteria and show they have the potential to generate cash flows that can pay down their debts, he said.
“It needs to be a good farmer who would be able to thrive once his debt is restructured and made more sustainable,” Lyhne said.
What’s more, bonds sold by LFBank won’t be backed by the state and in principle bondholders can take a loss, Lyhne said.
Three regional banks failed the central bank’s latest stress test, while a fourth bank would be close to breaching capital rules, the bank said on Oct. 25.
Toender Bank A/S, Denmark’s most recent failure, reported a solvency ratio -- a measure of financial strength -- of 17.3 percent at the end of June. Yet an inspection by the FSA last month revealed bad loans almost 10 times as big as those the bank reported, wiping out its equity.
Toender’s collapse “underlines the continued asset and risk management challenges that Danish banks face, even when reportedly profitable,” Oscar Heemskerk, a senior credit officer at Moody’s, said in a Nov. 8 note.
“We hope Toender Bank was an outlier, but there are lots of local Danish banks that we’re aware of that have a much larger exposure to agriculture than Toender Bank had,” Lyhne said. “There are about 10 to 15 banks at least that we can envisage being able to help.”