Swap Use Probed in Sweden as Nordea Finalizes $9.5 Billion Deal

Sweden’s financial regulator is taking a closer look at an instrument that cuts bank capital requirements and which Scandinavia’s biggest lender is offering investors.

The Financial Supervisory Authority in Stockholm says it’s reviewing how synthetic securitizations affect capital adequacy as Nordea Bank AB gets close to completing its first deal. The Stockholm-based agency, which has imposed some of Europe’s toughest requirements, expects to let banks know in coming months how it will treat such instruments in the so-called supervisory review and evaluation process.

“We are looking at various aspects of the impact of such transactions on banks’ capital and liquidity positions,” said Peter Svensson, spokesman for the Stockholm-based agency. The FSA expects “to publish our thoughts about how this is to be reflected in the SREP process later in the autumn.”

Nordea plans to transfer the credit risk on 8.4 billion euros ($9.5 billion) of corporate loans to investors, at an annual cost to the bank of 30 million euros. The credit default swap the bank is using for the transaction will lower its risk-weighted assets and shave 30 basis points off its regulatory capital requirement. The assets themselves will remain on Nordea’s books. The intention is to raise returns, the bank said.

Rodney Alfven, Nordea’s head of investor relations, has underscored the instrument’s transparency. “There is a very clear risk that investors can judge and price,” he said.

Nordea expects to have to meet a minimum requirement of common equity Tier 1 capital of 17 percent, after the FSA imposed tougher rules on the risk weighting of corporate assets. The bank’s capital by that measure was 16.8 percent at the end of June.

“This makes sense for Nordea, but I’m also quite convinced that it wouldn’t have done it if it hadn’t been for the pressure on meeting capital requirements,” said Lars Holm, a credit analyst at Danske Bank A/S. “Although it seems rather harmless it still has a negative ring to it, which I believe will make most Nordic banks not consider this. They also generally don’t need to free up capital.”

The product doesn’t require the FSA’s approval, but the agency needs to verify that the risk has actually been transferred, Svensson said. “Capital relief is conditional on the FSA confirming that commensurate risk transfer has taken place,” in keeping with guidelines from the European Banking Authority, he said.

According to S&P Global Ratings, such transactions are at the very least credit neutral and may be credit positive, because investors would absorb any losses in the underlying loan portfolio. That’s the case even though S&P halves the corporate exposures that are hedged using credit derivatives, to reflect the new counterparty risk, according to Alexander Ekbom, a credit analyst at S&P Global Ratings.

“The risk of both the underlying corporate exposure and the buyer of risk (through the instrument) would have problems at the same time is less likely than just the underlying borrower running into problems and therefore this should be a positive for the risk in the bank,” Ekbom said.

The practice of securitization -- the repackaging of assets, including both actual loans and risk, 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 safe versions with the aim of enabling banks to grant more credit especially to small businesses.

So far, synthetic securitizations like the default swap Nordea is issuing have yet to win preferential regulatory treatment because of their complexity. But the European Commission and the European Banking Authority have signaled some instruments, namely those like Nordea’s that transfer credit risk, could be eligible if they meet specific criteria.

Global regulators have been more tentative. The Basel Committee on Banking Supervision said in June such transactions can reduce a bank’s capital charges without making the lender safer, which essentially undermines rules put in place since the financial crisis. The committee urged regulators to carefully scrutinize the products to ensure banks still have enough capital.

Since the financial crisis, issuance has been mostly between banks and their investors and hasn’t involved rating companies, the EBA said in December. It’s still working with the industry to collect more information.

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