Exotic Capital Deals Fed by Stricter Bank Rules in Scandinavia

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New rules that may force Scandinavian banks to use tougher risk models could fan the proliferation of a securitized product that’s too complex for many investors.

After becoming the region’s first bank to achieve capital relief through a so-called synthetic securitization, Nordea Bank AB is now predicting that stricter risk-weight requirements may prompt others to follow. The deals involve investors taking on some credit risk in a portfolio, in exchange for a cash flow, while banks keep the loans on their balance sheets. That’s in contrast to traditional securitizations, in which banks move assets off their balance sheets and into special purpose vehicles.

“Are we likely to see other banks in Northern Europe executing synthetic as well as true-sale securitizations -- in line with U.K., French and German banks? Yes, I believe we will,” said Tom Johannessen, Nordea’s head of group treasury and asset liability management. The scenario becomes more likely if European regulators heed the advice of the Basel Committee on Banking Supervision and impose tougher rules on how lenders calculate risk weights, he said.

“With the Basel Committee’s challenging proposals regarding risk weights, banks will want to be pro-active in managing their capital through these types of transactions in order to continue supporting the real economy by lending,” Johannessen said.

Nordea’s transaction, done using a credit default swap and completed on Aug. 24, pays investors an undisclosed coupon to cover the junior risk on an 8.4 billion-euro ($9.4 billion) portfolio of corporate and small business loans. Investors agreed to absorb the first losses in the portfolio, or up to 420 million euros. By transferring the risk, Nordea expects to shave 30 basis points off its capital requirement and improve its returns.

Banks may be enticed to buy capital relief if stricter rules are imposed. The Swedish Bankers’ Association says a plan to curb the use of internal risk models to determine capital levels will cost as much as 365 billion kronor ($43 billion) in additional buffer requirements. The group cites a report by Oliver Wyman, commissioned by the industry. Sweden’s regulator has questioned the calculations.

Given the regulatory environment, Johannessen says he would be surprised if Scandinavian banks don’t follow Nordea in turning to synthetic securitizations for capital relief. Nordea is already “aware of other banks in the Nordics that are working on their own transactions,” he said.

To be sure, Nordea is under more pressure than its Nordic peers to improve its capital ratio. The bank expects to face a minimum requirement of common equity Tier 1 capital of 17 percent of risk-weighted assets, as the Financial Supervisory Authority phases in tougher rules on corporate loans. The bank’s capital by that measure was 16.8 percent at the end of June.

Lars Holm, a credit analyst at Danske Bank A/S, said last month that the capital relief deal made sense for Nordea but is less likely to attract more lenders. “Although it seems rather harmless, it still has a negative ring to it,” he said.

Nykredit Realkredit A/S, A Danish mortgage lender that ranked weakest in the Nordic region in European Banking Authority stress tests published in July, has said it isn’t looking into issuing synthetic securitizations to achieve capital relief.