Bloomberg News

Danske Bank Says Basel, Moody’s Hurting Danish Covered Debt

June 27, 2011

(Adds background on evolution of mortgage bond market since 1996 in sixth paragraph, updates shares, bond prices in 10th.)

June 27 (Bloomberg) -- Danske Bank A/S said the Basel Committee on Banking Supervision and Moody’s Investors Service don’t understand Denmark’s mortgage bonds and warned their actions may hurt the world’s third-largest covered debt market.

The mortgage unit of Denmark’s biggest bank said last week it will stop paying Moody’s to rate its securities after learning it would lose its AAA credit grade unless it found an extra $6.2 billion in capital. At the same time, Denmark is lobbying the European Union to ease Basel’s liquidity requirements for banks, which it says will penalize the country’s covered bonds and trigger a sell-off.

“It’s obvious that we have a challenge ahead of us in communicating the quality of our product,” said Carsten Noeddebo, chief executive officer at Danske Bank’s Realkredit Danmark unit, in a phone interview out of Copenhagen. “We have both the Moody’s issue and Basel.”

The country’s mortgage bonds, which have never defaulted even when the Kingdom of Denmark went bankrupt in 1813, may encounter refinancing risks because of a surge in adjustable- rate loans being sold to homeowners, Moody’s said on June 10. Criticism of Denmark’s covered-bond market comes as the European Commission decides whether to allow banks to hold more of the securities than Basel recommends. If current liquidity rules aren’t changed, Danish banks will need to sell off the bonds, according to Peter Engberg Jensen, chief executive officer at Europe’s biggest covered-debt issuer, Nykredit A/S.

Moody’s Downgrade

Moody’s, which didn’t respond to e-mails seeking comment, said June 10 it cut the timely payment indicator on some Danish mortgage bonds, including those sold by Realkredit Danmark and Nykredit, because a rise in adjustable-rate loans was infusing the market with risk. Nykredit responded on June 21 by separating financing for the securities from the rest of its business. While the move may result in a lower rating for bonds backed by adjustable-rate mortgages, it should protect the credit grade on the lender’s fixed-rate products, Nykredit said.

Denmark’s mortgage bond market has undergone a number of changes in the past 15 years, moving away from its traditional fixed-rate, callable-option securities into more varied debt instruments. Adjustable-rate mortgages were introduced in 1996. Interest-only loans, which the central bank has criticized for exacerbating volatility in the country’s property market, were sold from 2003. So-called capped floaters, which offer a floating interesting rate with a cap on how high borrow costs can rise, were introduced in 2004.

S&P View

Danske’s Realkredit Danmark unit said last week it was engineering a similar move, as it creates a new capital center for adjustable-rate securities. The bank is in “an on-going dialogue with Standard & Poor’s and feels pretty comfortable” that it will maintain its AAA grade there, Noeddebo said. It may also approach Fitch Ratings to discuss having its debt ranked by that company, he said.

“We fundamentally disagree with Moody’s in their view on Danish mortgage bonds in general and on Realkredit Danmark specifically,” Noeddebo said in the June 24 interview.

Standard & Poor’s is “naturally following everything that’s going on in the Danish mortgage bond sector with interest,” Casper Rahbek, an analyst at the rating company, told Danish newspaper Borsen. “But at the moment we see no reason to change our AAA rating.”

Shares Slump

Danske Bank shares lost 4.2 percent to trade at a two-year low of 89.50 kroner at 2:23 p.m. in Copenhagen. The yield on Realkredit Danmark’s 5 percent bond due 2041 rose 1 basis point to 5.20 percent, set for its highest close since May 19, according to data available on Bloomberg.

Moody’s in its June 10 statement said “the refinancing margins have been increased following the material rise in adjustable-rate mortgage loans in Danish cover pools.”

The rating company said the bonds represent a bigger refinancing risk because they, unlike other Danish covered bonds, don’t match the maturities on the loans linked to them. The adjustable-rate bonds tend to have maturities of one to three years compared with an average loan maturity of 20 to 30 years.

“The issuers’ dependence on regular market access to issue covered bonds has increased with the growing volume of adjustable rate loans,” Moody’s said.

Basel haircut

The outstanding volume of bonds for financing adjustable- rate loans increased to 1.22 trillion kroner ($236 billion) in 2011 from 636 billion kroner in 2008, Moody’s said, citing data from Denmark’s central bank. The bonds now represent about half of all outstanding covered debt in Denmark, it said.

Noeddebo said the criticism is unjustified because “Danish mortgage bonds have performed much better than almost anything else during the financial crisis.” He said that ought to persuade the European Commission to ease liquidity requirements set by Basel that would force banks to restrict their holdings of the securities to 40 percent of easy-to-sell assets. Basel also wants the debt to be booked at 85 percent of its market value, representing a so-called haircut to reflect the perceived liquidity risk relative to government bonds. Government securities face no caps.

“The southern European debt crisis has made it even more evident that government bonds aren’t always superior to covered bonds,” Noeddebo said. “Just look at Greek state debt; that should make it obvious that it’s the quality of the paper, rather than whether it’s state or mortgage, that should count.”

Bank Failures

Moody’s on May 19 downgraded six Danish banks, including Danske, citing an absence of state support following the Feb. 6 collapse of regional lender Amagerbanken A/S. That failure, which triggered a resolution framework that allowed the European Union’s first senior creditor losses, was followed on June 24 by the collapse of Fjordbank Mors A/S. Both banks failed after losing money on loans to the construction industries.

While Denmark expects the commission to soften Basel’s liquidity rules somewhat, the prospect of a haircut is unavoidable, Engberg Jensen said in a June 22 interview. The lender is now trying to double its international investor base to 25 percent of the total to make up for the selloff it expects from local banks. The liquidity requirement is due to take effect by 2015.

Trading in Denmark’s short-term covered bonds -- securities backed by the cash flow from a pool of mortgages -- rose during the financial crisis, both in the total value of bonds traded and in the median size of individual trades, according to a study published last year by the Danish central bank. It was easier to trade short-term mortgage bonds than government notes, the study found.

The European Commission is due to provide an update on how it will implement the Basel rules locally in the middle of July.

--With assistance from Peter Levring in Copenhagen. Editors: Tasneem Brogger, Jonas Bergman.

To contact the reporters responsible for this story: Christian Wienberg at cwienberg@bloomberg.net

To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net


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