Moody’s positive on Danish bill, Nordea covered

A bill providing for the conditional maturity extension on certain Danish covered bonds removes refinancing risk for covered bond issuers and will have a “marked” credit positive impact on Nordea Kredit covered bonds, said Moody’s on Monday.

The bill is an amendment to Denmark’s covered bond act and was passed by the country’s parliament last Tuesday (11 March), according to Moody’s, which said it is overall credit positive for Danish mortgage credit institutions and covered bond-issuing banks, and Danish covered bonds.

The rating agency expects the bill to come into force on 1 April, at which point it would immediately apply to bonds issued after that date with a maturity of up to and including 12 months. For maturities of more than 12 months and up to and including 24 months, including for bonds issued by banks rather than mortgage credit institutions, the bill is expected to come into effect on 1 January 2015.

The amended legislation was one of the drivers of an improvement in the outlook on Nykredit Realkredit’s and Nykredit Bank’s ratings last Friday. Moody’s continues to rate Nykredit despite it terminating its relationship with the rating agency in 2012 and therefore no longer participating in the ratings process. A spokesperson for the rating agency said that it “may continue to maintain a rating as long as it has access to enough information to make an accurate and robust rating assessment”.

Moody’s rates Nykredit Realkredit and Nykredit Bank at Baa2, and said that it lifted the outlook because the refinancing bill “removes a historically significant credit driver for the group” and because it considers that the operating environment in Denmark, while still challenging, is stabilising.

Nordea Kredit continues to work with Moody’s, and the rating agency on Monday highlighted an expected “marked” credit positive impact on covered bonds sold by the issuer, mainly those issued out of Capital Centre 2.

The rating agency said that once implemented, the amended act would lead to a “substantial” reduction in the overcollateralisation (OC) consistent with the prevailing Aaa rating of Nordea Kredit’s covered bonds, from 11% to 4.5%. It would also increase the Timely Payment Indicator (TPI) leeway from three to four notches.

Nordea Kredit’s covered bonds are the only covered bonds issued by a Danish mortgage credit institution that Moody’s rates, after several mortgage banks in 2012 ceased working with the rating agency due to a disagreement over the rating agency’s approach to rating covered bonds that finance adjustable rate mortgages (ARMs).

For most Danish financial institutions the credit positive change stemming from the new legislation is not in itself sufficient to lead to outlook or rating changes, according to Moody’s.

“In particular, it does not affect the risks we continue to see relating to the high level of household debt in Denmark, or our assessment of a still challenging operating environment in Denmark,” said Kim Bergoe, vice president, senior credit officer at Moody’s.

The new bill introduces a maturity extension mechanism for certain newly issued Danish covered bonds that are exposed to refinancing risk, which Moody’s noted is significant because these bonds account for about 55% of the Danish covered bond market.

The main features for bonds issued under the new framework is that maturing bonds will be extended in the event of a failed refinancing auction or if an auction results in interest rates that are more than 500bp higher than the level a year before the auction. An interest rate cap would also apply.

The rating agency said that the bill reduces refinancing risk in the Danish mortgage system by transferring it from covered bond issuers to investors in the form of extension risk. The extension of a bond maturity in certain stressed situations “provides a framework for dealing with refinancing risk” and, together with the cap on interest rates, “adds to general financial stability”, according to Moody’s.

However, it said that the bill does not address the underlying issue of large maturity mismatches between lending and funding.

“The shift from issuers to investors could even negatively impact the mortgage credit institutions’ efforts in recent years to extend their financing maturity,” said Bergoe.

While the bill protects issuers against a failed auction and certain borrowers against interest rate increases above 500bp, the impact on investors is negative, according to Moody’s.

“The ‘interest rate trigger’ implies that existing investors who own bonds that fail to be refinanced will, for at least one year, receive lower interest payments than they would have otherwise demanded in order to invest in the new bonds,” said Bergoe. “Similarly, the ‘failed auction trigger’ implies that some investors will, for at least an additional year, hold an instrument that they would not otherwise have bought.”

The rating agency noted that investors’ collective decisions on whether to take on these risks, and at what price, creates uncertainty over the first bond sales due after the bill takes effect.

However, a relatively captive investor base mitigates these risks in Moody’s view.