Covered Bond Compromise Cuts 20% Off Danish Liquidity Target

Denmark’s biggest mortgage bank said about a fifth of covered bonds in the nation’s $550 billion market can be excluded from the top liquidity status, opening up for compromise in talks with Europe.

Nykredit Realkredit A/S said it would be willing to back down from earlier industry demands that all covered bonds be given the top liquidity designation as the Danish government talks with other European Union member states in an effort to reach an agreement.

“Of course, in theory we would like 100 percent,” Soeren Holm, chief financial officer at Nykredit, said in an interview in Copenhagen. “But if it has to be workable in other jurisdictions than just the Danish, you have to set some kind of barrier.”

The comments mark the first time industry representatives have shown willingness to accept a compromise after condemning a proposal last year by the European Banking Authority to give all covered bonds second-class liquidity status. Denmark is home to the world’s biggest mortgage-backed covered bond market per capita and its banks use the securities to meet more than 70 percent of their liquidity needs.

Smaller Issuers

Eva Kjer Hansen, who heads the Danish parliament’s European Affairs Committee, will lead a delegation to Brussels to meet with Michel Barnier, the European Union’s financial services chief, on March 19. She says Nykredit’s compromise may put smaller issuers at risk.

“This proposal may be fine for Nykredit, as it’ll soften the blow to them,” Kjer Hansen said today by phone. “But then what about the smaller issuers? My concern is what will happen to them and I’ll need to know more about what it’ll do to the smaller bonds and the smaller issuers” before deciding, she said.

The London-based EBA, which is made up of European regulatory heads, published a recommendation in December that would cap banks’ covered bond usage at 40 percent and force lenders to book the bonds at only 85 percent of their market value. It also said all government bonds should get the highest liquidity status, including debt sold by bailed out nations like Greece.

Critical Importance

The European Commission must decide by June whether to adopt the EBA’s plan. Barnier said Jan. 10 the commission is aware of the “critical importance of the covered bond market,” adding it also “recognizes the long tradition and solidity of Danish covered bonds, in particular their good liquidity characteristics.” The comments were made by e-mail through Barnier’s spokeswoman, Chantal Hughes.

Adhering to the EBA’s proposal in its current form would destroy Denmark’s financial “architecture,” Ane Arnth Jensen, head of the Association of Danish Mortgage Banks, said in January.

An empirical study by the EBA last year found that covered bonds sold in issues of 500 million euros ($689 million) or more in principle have the characteristics needed to have an “extremely high liquidity and credit quality.”

Being ‘Greedy’

In January, the Danish Financial Supervisory Authority said the EBA’s liquidity definition could allow Denmark to win the top designation for 80 percent of its covered bond market. FSA Director General Ulrik Noedgaard urged the industry not to be “greedy” and consider aiming for a compromise.

“You can set the threshold at 250 million” euros, Holm said. “500 million euros has also been suggested but 250 million euros could also be just as good if you look at the numbers. That would cover about 80 percent of the market, perhaps more.”

Though Denmark could use the proposal as a negotiating lever, it’s not a sign that the remaining bonds don’t have the characteristics needed to achieve the top rating, according to Nykredit. An October report by the EBA found that covered bonds were as liquid as government bonds. Denmark has argued that the EBA’s recommendation to the European Commission ignores these findings.

“There is liquidity even in the smaller issues in the Danish market, and there are reasons for that,” said Henrik Hjortshoej-Nielsen, Nykredit’s head of treasury. “The mortgage banks are in the market every day because we have tap issuance. The investors are working every day, the traders are working every day, the analysts are working every day.”

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