As bankers in the world’s biggest mortgage market per capita design debt to meet funding rules set by the Basel Committee on Banking Supervision, Denmark’s largest home-loan provider says the exercise may be a waste of time.
The math behind Basel’s net stable funding ratio suggests even three-year bonds may not be long enough to keep an issuer above water if markets really were to shut down for 12 months, said Soeren Holm, chief financial officer at Copenhagen-based Nykredit Realkredit A/S, Europe’s biggest issuer of mortgage-backed covered bonds.
“It’s not clear whether that’s long enough,” Holm said in an interview. “If you take the very strict Basel math, you have to have quite a long maturity of five or seven years.”
Banks in Denmark’s $500 billion mortgage bond market have been scrambling to adapt to Basel’s funding requirement. The rule threatens to wipe out one of Denmark’s most popular home finance constructions, in which one-year bonds are rolled over annually to fund 30-year mortgages.
The home-loan arm of Danske Bank A/S, Denmark’s biggest bank, has responded by designing a three-year bond with an interest rate that adjusts every six months. Yet according to Holm, whose bank competes with Danske for mortgage clients, swapping one-year bonds for three-year securities will still leave lenders facing a funding gap.
Yields on short-maturity bonds were little changed today in Copenhagen trading. Nykredit’s 2 percent bond maturing April 2014 yielded 0.3 percent, while a similar-maturity bond issued by Danske’s mortgage arm yielded 0.34 percent, according to data compiled by Bloomberg.
Denmark’s mortgage banks, which fought shoulder to shoulder to prevent Basel’s liquidity coverage ratio from destroying their home-loan model, are now split over how to tackle new funding rules. Standard & Poor’s and Denmark’s committee on too-big-to-fail banks also have singled out the nation’s one-year mortgage bonds as a risk.
Eivind Kolding, Danske’s chief executive officer, said Aug. 1 the government may need to ban one-year bonds as banks hesitate to take a first step for fear of losing market share. Both Danske and Nykredit had the outlooks on their issuer ratings cut last month by S&P, which cited the lenders’ funding models. One-year bonds, which were introduced in 1996, now make up more than one-third of all Danish residential mortgage debt.
Danske and Nykredit are among six banks identified by a government committee as systemically important to Denmark’s $355 billion economy. The panel recommended enforcing a national funding rule next year, four years before Basel’s net stable funding requirement is due to take effect.
The Basel committee plans to complete its work on the liquidity rule by “around the end of 2014,” Wayne Byres, its secretary general, said last month. S&P has given banks two years to cut issuance of one-year bonds.
Banks trying to design their borrowing away from one-year bonds in anticipation of new rules risk chasing a moving target, Holm said.
“I think they will have to be changed but I don’t know into what,” he said. “If you look at pure Basel calculations, it’s actually difficult to say.”
While Danish lenders have cut issuance of one-year bonds by about 40 billion kroner ($7.2 billion) since 2012, their use remains too high, the central bank said in June. It advised the industry to cap one-year borrowing at 60 percent of a property’s value, less than the 80 percent allowed by law.
DLR Kredit A/S, a mortgage bank that focuses on farms, is “looking into alternatives,” though it’s finding that “three-year bonds do not seem to be enough,” Pernille Lohmann, investor relations manager at the Copenhagen-based lender, said Aug. 13. DLR probably will wait to see what its bigger competitors do before introducing an alternative, she said.
So far, borrowers have had little incentive to give up the one-year bonds, which the industry estimates have saved them as much as 50 billion kroner since Denmark’s housing market collapsed five years ago. Nykredit sold one-year bonds in auctions that started last week at yields as low as 0.5 percent. That compares with 3.5 percent on fixed-rate loans.
Danske’s mortgage arm, Realkredit Danmark A/S, cautions against a wait-and-see approach. Replacing one-year bonds with three-year borrowing will over time reduce its stable funding gap by two thirds, said Klaus Kristiansen, executive vice president for risk management at Realkredit. The remaining shortfall would be covered by five-year bonds, though for now, those are “too expensive,” he said.
“Introducing three-year funding is an important step in the right direction,” Kristiansen said.
Nykredit, which unlike Danske can’t take deposits, would be short about 80 billion kroner in stable funding each year were it to move all adjustable-rate mortgages to a three-year timetable, Holm said.
“It’s very dangerous to make too fast a decision and to change something that you then have to change again,” he said.