Crisis-Era Swaps Return as Nordea Finds New Way to Remove Risk

Scandinavia’s biggest bank is issuing its first credit default swap to reduce its capital requirement and improve returns.

After more than a year of preparations, Nordea Bank AB is now in the final stretch of selling swaps on $9.4 billion of its corporate exposures to select investors, Rodney Alfven, head of investor relations, told Bloomberg. The bank may sell more, he said.

Nordea, which is based in Sweden, says the swap is a far cry from the kinds of products that obfuscated risk and fueled the financial crisis in 2008. “This is nothing close to the deals that you saw pre-financial crisis, in the early part of the century,” Alfven said. “There is a very clear risk that investors can judge and price.”

The practice of securitization -- the repackaging of assets into new marketable products -- has been tainted because of its association with the slicing and dicing of loans that drove the subprime mortgage bubble. But Europe is now working to create a safe version of a financial process that officials hope will provide credit to small businesses. The idea is to free up more bank capital for lending.

Nordea’s primary concern is raising its return on equity, Alfven said. The process “is ROE-enhancing,” he said. “There is no shortage of capital in the Nordics.” Small and medium sized businesses “that want to borrow can do that.”

The transfer of risk will shave 30 basis points off the common equity Tier 1 that Nordea is required to hold, as a share of risk-weighted assets. The bank said last month it expects its regulatory CET1 minimum requirement to be at least 17 percent, after Sweden’s financial regulator imposed tougher rules on the risk weighting of corporate assets. Nordea’s CET1 ratio was 16.8 percent at end-June.

The bank’s return on equity, excluding non-recurring items, fell 1.7 percentage points at the end of June, to 11.4 percent. “It’s a matter of returns,” Alfven said. Efforts to improve profitability include divesting assets, he said.

So far, so-called synthetic securitizations like the default swap Nordea is selling have yet to win preferential regulatory treatment because of their complexity. But the European Commission and the European Banking Authority have signaled some instruments could be eligible if they meet specific criteria.

Synthetic securitizations only transfer credit risk to investors. The actual assets remain on the bank’s balance sheet. Regulators divide them into two categories: 1) those created to bet on credit spreads, and 2) those, like Nordea’s, designed to manage credit risk and gain capital relief. These so-called balance-sheet transactions performed just as well during the crisis as traditional securitizations, according to the EBA.

In fact, balance-sheet instruments may offer a better way to stimulate lending to SMEs than traditional securitization, according to a working paper published in May by the European Parliament’s Committee on Economic and Monetary Affairs.

Spain’s Banco Santander and CaixaBank earlier this year did two synthetic deals in what Moody’s Investors Service said “could be seen as a marker for a shift to use securitization as a tool to strengthen capital, rather than just to raise funding.” Northern European banks, especially those in the U.K., Germany and Austria, have so far dominated the market, the ratings company said.

Nordea is betting the Nordic region’s strong economic growth will soothe investor unease over the design of its swaps. The bank is also keeping the product simple, with a single tranche, to boost its appeal.

“This is a very specific risk that you buy as an investor,” Alfven said. “There are no hidden risks, and they have done very thorough due diligence of every single credit risk.”

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