CoCos Allowed for Danish Banks If Triggers Strict: Nordic Credit

Denmark’s financial watchdog will let banks issue new hybrid debt instruments to meet tougher capital demands only if the securities convert into equity early enough to avoid eating into regulatory buffers.

Danish banks can use contingent convertible bonds as long as they convert before capital levels breach core Tier 1 equity thresholds or in the event individual solvency requirements aren’t met, said Anders Balling, head of the Financial Supervisory Authority’s banking analysis division in Copenhagen.

“The crucial thing is that they absorb losses while the bank is still alive,” Balling said in an interview yesterday. “It’s a condition for the whole framework that the capital is loss absorbing, otherwise, the bank couldn’t dig into it and go below their individual solvency requirement.”

The regulator is trying to take a tougher line on banks to avoid another credit-driven property bubble without squashing Denmark’s economic recovery. Bond investors have demanded a premium from Danish banks since the Nordic country in 2011 became the first in Europe to enforce a resolution framework that pushed losses onto senior creditors.

It costs about 48 basis points more to insure against default on senior unsecured notes issued by Danske Bank A/S than it does on similar notes sold by Nordea Bank AB, based in Stockholm.

Exotic Funding

Denmark is exploring the option of allowing more exotic funding vehicles to help banks build their capital buffers as the government commits to its goal of protecting taxpayers from bailouts. Even banks deemed too big to fail won’t get state support, Benny Engelbrecht, head of parliament’s business committee overseeing banks, said this week. Instead, the onus will be on systemically important financial institutions to increase their capital reserves, he said.

“It’s of principle importance to this government to protect taxpayers,” Engelbrecht said.

Five-year credit default swaps on Danske’s debt traded at 127 basis points yesterday, versus 74 basis points on Nordea’s notes, according to data available on Bloomberg.

‘Rough Ride’

“In Denmark, bank debt has had a rough ride because of the bank failures,” said Per Jensen, vice president of debt origination at Danske, the country’s largest lender. “You don’t have to go past last year’s failure of Toender Bank, which had issued some instruments just a few months prior.”

Toender Bank A/S, a regional bank near the German border, declared bankruptcy on Nov. 2 after an FSA inspection revealed impairments big enough to wipe out its equity. Ulrik Noedgaard, the FSA’s director general, defended his agency’s handling of the bank and said at the time its management was guilty of “massive misrepresentation.”

Since Denmark’s property bubble burst in 2008, the nation’s bank resolution agency has taken over a dozen lenders while the industry has absorbed another dozen.

The FSA won parliamentary approval last month to give banks that fall below their individual solvency requirements more time to recapitalize. The compromise was struck after the agency tightened its rules.

Sifi Panel

A lawmaker-appointed panel is due to present its recommendations on Denmark’s systemically important banks by March. The proposals will include a list of which banks should be deemed too big to fail and how much extra capital they must hold. It will also address the need for living wills that would work as roadmaps for orderly resolution.

Danish banks already face new requirements to hold as much as 18 percent of risk-weighted assets, including capital conservation and countercyclical buffers, according to the FSA. Soeren Holm, the chief financial officer at Europe’s biggest issuer of covered bonds backed by mortgages, Nykredit A/S, said this month he expects Sifi banks to be required to hold as much as 3 percentage points in additional capital.

Nykredit, which isn’t listed, is looking into issuing debt instruments that mimic the characteristics of CoCos, Chief Executive Officer Peter Engberg Jensen said in November.

“We think CoCos can fulfill our aim of having loss-absorbing capital if designed the right way,” Balling at the FSA said.

Banks are struggling to build equity amid higher writedowns and a negative central bank deposit rate, and have improved capital ratios in part by limiting growth in lending, putting an economic recovery at risk. Gross domestic product shrank 0.4 percent last year, according to government estimates.

Impairments Rise

Industry-wide impairments climbed 51 percent in the six months through June compared with the same period a year earlier, the FSA said in a December industry analysis. The jump followed the FSA’s tightening of write-down procedures. Lending grew by 0.3 percent to 1.89 trillion kroner ($338 billion), while banks raised core capital levels to an average of 14.99 percent from 14.61 percent in the same period a year earlier.

Banks deciding to use CoCos to meet stricter capital requirements may find buyers among investors seeking higher returns after AAA rated Danish government and mortgage bond yields hit record lows, Jensen at Copenhagen-based Danske said.

“The Danish krone market is starved for high-yield opportunities” so “the underlying dynamics are in place for good demand should new bank debt offerings come to market,” he said. Success will depend on who’s offering, he said.

The instruments are similar in some ways to debt that banks already issue, with the main difference being “the trigger in the future might be set at a higher level, enabling the bank to survive the trigger event,” according to Torben Jensen, chief dealer at debt capital markets at Copenhagen-based Nykredit A/S.

While pricing probably will be difficult, “I don’t see why investors would not buy them,” he said.

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