Investors in Swedish Bank Bonds Told to Stop Misreading Signals

As Sweden prepares new bank requirements to protect taxpayers, the agency in charge is telling investors that a number of their assumptions may be wrong.

The prospect of a so-called MREL buffer, which Sweden wants to coordinate with the rest of the European Union, has been read by the market as a sign banks will need to issue new kinds of capital. But that’s not necessarily the case, according to Tom Andersson, a resolution expert at Sweden’s National Debt Office. He also questioned assumptions that all such debt would need to be subordinated.

A Breakdown of Nordea’s Debt

“We haven’t expressed a preference, though some in the investor community tried to read into the proposal that we have a preference for contractual subordination,” Andersson said by phone. “We are a little bit cautious, not doing something before we see what the EU legislation is going to be.”

Disappointed Investors

“The investor community seems a bit disappointed that we weren’t more detailed on the subordination or on the type of subordination we want, but that’s one of the issues we will come back to,” Andersson said. “We need to do a more thorough assessment.”

Sweden, like the rest of Europe, needs to implement the Bank Recovery and Resolution Directive as the region puts in place rules that allow banks to collapse without disrupting the economy. Shareholders and then debt investors would be the first to absorb losses, with subordination specifying the order to minimize disruptions.

Sweden says its four biggest banks face a minimum requirement for own funds and eligible liabilities, or MREL, of about 32 percent of risk-weighted assets as a buffer. That’s roughly equal to a requirement of 8 percent of gross balance sheets being discussed in Europe. About two-thirds should be debt, and at least some of that must be subordinated, the debt office said in April.

Decision Delayed

But the office delayed until next year decisions on amounts, deadlines and how banks are to achieve subordination, setting off a wave of speculation among investors and analysts.

Nordea Bank AB, Svenska Handelsbanken AB, Swedbank AB and SEB AB may have to issue as much as $72 billion in new debt instruments if Sweden opts for contractual subordination of the entire debt requirement, according to Moody’s Investors Service. That’s about half the banks’ outstanding senior unsecured debt, according to Danske Bank analyst Lars Holm.

“Given how they have implemented BRRD and basically done everything possible to avoid bailing in senior unsecured, I believe the banks will be required to go for subordinated seniors for the entire amount,” Holm said. That’s particularly so “given that structural subordination would be difficult and costly for them, in my view, and statutory doesn’t seem to be on the agenda.”

Tier 3?

In addition to including provisions in contracts, subordination can be achieved by legislative fiat or by issuance through a holding company. Swedish banks don’t typically have holding companies. Nordea is considering whether to issue Tier 3 securities.

Banks face an insignificant shortfall in meeting MREL now but that expands when the subordination requirement is imposed, Andersson said. “Then it becomes more challenging for the Swedish banks,” he said. “It will have consequences for the Swedish banks that need to be considered carefully.”

It’s possible that only a portion of the debt will need to be subordinated, because of the high level at which MREL is being set, Andersson said. Sweden wants “the flexibility to restore capital to current levels, post resolution,” he said. “In the light of this, a policy choice that still has to be made is whether subordination is needed for all eligible debt.”

Sweden’s cautious approach in part reflects the lack of consistency in how BRRD is being implemented in Europe, Andersson said. Germany, France and Italy have created different insolvency hierarchies in the course of adopting the directive, causing fragmentation and increased complexity for investors, according to Moody’s.

“We could do what other countries have done, but it’s still uncertain where the EU will go on this issue and then we might have to revise our proposal once again,” Andersson said. “We see no need to rush into the subordination issue until we have more clarity.”

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