Biggest EU Mortgage Bank Sets Up $1.8 Billion Risk-Weight Hedge

Nykredit Realkredit A/S, Europe’s biggest issuer of mortgage-backed covered bonds, is setting aside as much as $1.8 billion in anticipation regulators will step up risk-weight requirements.

Nykredit aims to hold equity capital of at least 15 percent of risk-weighted assets, equivalent to 63 billion kroner ($11.5 billion), by 2019. In addition to that, the lender will set aside up to 10 billion kroner to gird for new demands from regulators that may force banks to assume higher loss probabilities.

“Our risk-weighted assets can be adjusted by the Danish regulator as well as the European one, independently of what we think,” Soeren Holm, chief financial officer at Nykredit, said in an interview in Copenhagen. “That’s a new uncertainty facing the industry; we expect these provisions to be used.”

Regulators are scrutinizing the calculations banks use to determine how risky their assets are amid concern internal models may understate the likelihood of losses. Danske Bank A/S was told in June to add about $18 billion to its risk-weighted assets after the Financial Supervisory Authority found Denmark’s biggest bank had understated its loss probability. The FSA said last month it may ask banks to provide more details on how they arrive at their risk-weight estimates.

CoCos, Hybrids

The heightened vigilance by regulators is adding to banks’ reserve requirements and putting pressure on unlisted companies in particular to find new ways to issue capital.

Nykredit has asked the government to let it sell preference shares to help the closely held lender gain access to a new investor group. Nykredit’s main shareholder is a cooperative owned by borrowers. The bank has received signals from lawmakers its request will be approved, helping it sell hybrid capital and contingent convertible bonds, Holm said.

“Preference shares will be a fairly expensive tool as we will have to guarantee a certain dividend,” he said. “It’ll mainly be used when the property market soars, however we do plan to issue a small number of shares as soon as we can, to get the legal conditions for issuing in place.” The bank won’t sell preference shares until European Union rules on dividends are set, due to happen in 2016, Holm said.

Nykredit plans to “remain well north of equity making up 15 percent of risk-weighted assets,” he said.

EBA Battle

Denmark’s $550 billion mortgage market, which is dominated by Nykredit and the mortgage arm of Danske Bank, faces a regulatory crackdown on several fronts. The European Banking Authority said last year mortgage-backed covered bonds should be treated as second-class assets in banks’ liquidity management, a proposal Denmark is battling by lobbying the European Commission. The European Union’s executive arm is due to decide in June.

Inside Denmark, legislators and regulators are also putting pressure on the industry. Lawmakers agreed last week to the most sweeping regulatory overhaul to affect mortgage bond issuance in at least a decade after Standard & Poor’s said the industry had grown too reliant on short-term funding.

The changes are transforming Denmark’s two-century-old home finance system, which is the world’s biggest per capita. Starting in April, investors will face a 12 month maturity extension on mortgage bonds if refinancing auctions fail or if interest rates jump 5 percentage points. Banks are responding by adjusting their lending patterns.

“In 10 years, Danish mortgage lending will move closer to how property loans are funded elsewhere in Europe,” Holm said. “Denmark having one-year bonds has been a special case arriving from special Danish regulation that once made that product attractive.”

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