Danish Banks Cornered Without Funds to Pay Subordinate Debt

Denmark’s regional banks face a repayment deadline on subordinated debt sold before the financial crisis that now threatens to leave them insolvent unless they deleverage or divest.

“The central bank can’t give them capital,” Torben Jensen, chief dealer at debt capital markets at Nykredit A/S in Copenhagen, said in an interview. “They have three options: reduce their balance sheets, merge or make more money. But that’s probably the hardest option.”

Banks need to refinance about 400 billion kroner ($66 billion), with maturities concentrated in 2012 and 2013, the financial regulator estimates. About 12 percent of that is subordinated debt. Refinancing is unlikely to be an option for a number of banks as capital markets roll over only the safest credit, said Kristian Vie Madsen, deputy director general at the Copenhagen-based Financial Supervisory Authority.

“The market is not very friendly to issuing new subordinated debt,” Vie Madsen said in an interview. “At the same time, it’s also not the right way to go ahead, in light of new regulations.”

Denmark’s regional banks are still struggling to emerge from a funding crisis spawned by Europe’s toughest resolution laws, which require senior creditors to share losses in the event of insolvency. The industry is also fighting to recover from a burst housing bubble and a recession that caused two thirds of the country’s medium-sized banks to lose money last year, central bank data show.

Padding Buffers

“Earnings haven’t been high, so many of them need to be refinanced and they’re coming up now,” Jensen at Nykredit said. “It’s not a good time. The appetite for risk is a lot smaller than it used to be.”

Investors buying subordinated debt from Danish lenders had been accustomed to getting the loans repaid after five years, three years before the standard maturity expires, according to Thomas Hovard, head of credit research at Danske Bank A/S. (DANSKE) Now, banks are holding on to the loans to pad their capital buffers, he said.

“It is a trend that some smaller Danish banks are not calling subordinated debt, in order to protect capitalization,” Hovard said in an interview.

Repayment Cliff

The repayment cliff won’t hurt the country’s largest lenders including Danske Bank A/S, the FSA estimates. Danske, which this week reported a 27 percent surge in second-quarter net income, said Aug. 7 it issued 20 billion kroner in junior covered bonds in the first half, in addition to 17 billion kroner in senior debt and 39 billion kroner in covered bonds. Danske would be able to continue its operations even if it were cut off from capital markets for more than 12 months, it estimates.

Danske reduced the amount of outstanding subordinated debt on its balance sheet by 13 percent last quarter to 62.6 billion kroner from a year earlier.

“We have a divided market,” Vie Madsen said. “The large banks can issue both senior and subordinated debt when the European markets are open. For the smaller banks, it’s in general probably harder to issue both.”

Danske also borrowed 24 billion kroner in subordinated debt from the Danish state in May 2009.

State Loans

The refinancing pressure that banks face doesn’t include such state-held debt, which is classed as hybrid tier 1, Vie Madsen said.

“The state-held hybrid does not expire as it is perpetual, there is therefore no need to refinance it,” he said. “It should however be noted that if the Capital Requirement Regulation is agreed, this type of government owned capital cannot be counted after 2018.”

Banks looking for ways to refinance subordinated debt can’t tap the central bank’s liquidity facility, which doesn’t provide loans to replenish capital buffers.

The central bank offered its first three-year loans in February, with banks taking a total of 19 billion kroner, 15 billion kroner of which went to Danske Bank. A second offering is due next month. The facility was designed to help lenders ease liquidity strains as they repay about 118 billion kroner in state-guaranteed unsecured debt through 2013.

“Refinancing of long-term market debt remains a risk factor,” the central bank said in a June report.

Sub-Zero

Adding to financial industry woes are negative central bank rates. Nationalbanken Governor Nils Bernstein lowered the seven- day deposit rate by a quarter point to minus 0.2 percent on July 5 as his bank tries to counter a capital influx that’s putting pressure on the krone’s peg to the euro.

Official rates below zero are credit negative for Danish banks, and may cost the industry as much as 315 million kroner annually, making bank bonds unattractive to investors and driving up funding costs, Moody’s Investors Service said Aug. 6.

The industry faces a particular “challenge” as capital requirements are toughened, Vie Madsen at the FSA said. Banks may need as much as 39 billion kroner in fresh capital, according to the central bank.

“The smaller banks are approaching a situation where they, to a large extent, are funded by deposits and a large part of the capital is based on core equity,” Vie Madsen said. “Still, they’re in a transition period. There are some banks that will have to explain to us what they’re planning with their capital which will have to be repaid.”

To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at fschwartzko1@bloomberg.net

To contact the editors responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net; Christian Wienberg at cwienberg@bloomberg.net