Banks Defer CoCos in Denmark as Beating EU Proves Pointless

As Denmark sets some of Europe’s first rules to guide its banks through contingent convertible debt sales, lenders are hesitating to issue the securities until other countries commit to similar standards.

Denmark said this month banks can use CoCos to fill individual solvency requirements, provided the securities live up to national standards set by the financial regulator.

“We still need to know what is going on in Germany, in France, and in the rest of Europe,” Jan Kondrup, director of Denmark’s Association of Local Banks, said in an interview. “Right now we are unsure of what the other countries will do.”

The logjam suggests national efforts to move fast and help banks build capital risk being thwarted. Denmark’s Financial Supervisory Authority is allowing banks to use CoCos if the securities convert or absorb losses when a 7 percent core equity threshold of risk-weighted assets is breached, matching standards in Switzerland and the U.K.

“Our hope is that the rest of Europe will also implement 7 percent so there is a broad market,” said Kondrup, whose association represents 70 community banks in Denmark.

Under European Union regulations adopted earlier this year, banks can meet a minimum requirement for additional Tier 1 capital of 1.5 percent using CoCos if the securities convert once core equity drops below 5.125 percent. National regulators are free to decide whether the instruments can be used to fill other capital requirements and to set their own conditions.

Crisis Management

Conflicting rules, lack of clarity about regulatory treatment and incomplete credit ratings are limiting the market’s growth, the Bank for International Settlements said yesterday in a report. Sales total $70 billion since 2009, compared with $550 billion for other subordinated debt, according to Basel-based BIS, which acts as a central bank for the world’s monetary authorities.

In Scandinavia, Denmark’s banks are set to become the main source of CoCos, according to Thomas Hovard, head of credit research at Danske Bank A/S.

Denmark may also let its too-big-to-fail banks use CoCos to fill a crisis management buffer of 5 percent of risk-weighted assets that a government-appointed committee recommended in March. Using the instruments would cap a systemically important bank’s equity requirement at 10.5 percent, compared with 12 percent in Sweden, according to the March proposal.

There will be “quite a lot of supply,” Hovard said. “Especially in Denmark it will be a significant market. I would be surprised if we don’t see the first one this year.”

Sweden, Norway

Denmark’s government-backed committee on systemically important financial institutions has recommended that the nation’s six biggest lenders face a trigger of 10.125 percent of total capital, or 5.125 percent of equity, to convert hybrids used to fill a crisis management buffer.

Sweden will consider whether to let banks use CoCos to fill individual solvency requirements after completing the implementation of the new European capital requirements later this year, Jonatan Holst, a spokesman with the FSA in Stockholm, said by e-mail. Norway has “no immediate plans” to introduce the securities, Kjetil Karsrud, an FSA spokesman, said by e-mail.

Danish banks, led by Danske Bank, have welcomed the option of issuing convertible debt to build up reserves while arguing in favor of lower triggers. The industry says Denmark’s decision to set a higher trigger than the 5.125 percent put forward in the EU directive puts Danish banks at a disadvantage.

“A 5.125 percent threshold is too low for it to kick in,” Anders Balling, head of banking at the FSA in Copenhagen, said in an interview. “You have to get the loss absorption earlier to get time to work on recovery.”

Pricing Struggle

Denmark’s first CoCo is likely to come from a lender that isn’t subject to too-big-to-fail conditions. The owners of privately held DLR Kredit A/S, Denmark’s fifth-largest mortgage bank, earlier this month approved a board proposal allowing the lender to issue convertible instruments. Jens Moeller, DLR’s managing director, said in April the bank would seek Sifi designation. Lawmakers are due to decide in coming weeks.

Banks are struggling to price the securities to make them a feasible alternative to equity in building capital. Worldwide, 90 CoCos have been issued since 2009 to meet a variety of capital requirements, according to data compiled by Bloomberg. Average coupons span from a low of 2.24 percent in Japan to a high of 12 percent in Sweden. Banks in the Netherlands and Ireland also have sold CoCos.

Issuers “have to be very well capitalized to get cheap funding,” Hovard said.

Return Expectations

Equity investors want a return of at least 10 percent, while yields as low as 6 percent for CoCos filling individual solvency requirements, and as low as 8 percent for instruments filling Tier 1 requirements, may satisfy creditors, he said.

Core capital ratios for Danish banks, including hybrids, climbed more than 2 percentage points in each of the years since 2008, according to the FSA. Core capital rose to 19.19 percent of risk-weighted assets last year from 10.69 percent in 2008.

“Banks need both Tier 1 and Tier 2” capital, Steen Blaafalk, Danske’s head of group treasury, said in an interview. “Capital issues are probably going to take off this fall. We’ll see more banks coming out. The environment is good for it.”

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