Nordic supply dynamics to change in 2013

The past year has offered both issuers and investors quite a few surprises, writes Robin Bagger-Sjöbäck, Nordic FIG DCM Origination, Crédit Agricole CIB. European banks were given an early Christmas gift by the European Central Bank when the first three year LTRO was announced in December 2011, only to be followed by a second longer term refinancing operation in February, with a combined take-up of more than Eu1,000bn.

Robin Bagger-Sjöbäck

As a consequence of the additional liquidity injected into the euro banking system early in the year, 2012 new issue supply forecasts generally overshot, leaving many cash rich investors on the sidelines as funding requirements diminished. Looking back at 2012, another surprise to market participants was that senior unsecured funding came back into fashion, becoming the number one financing tool for banks: year-to-date issuance in euros stands at Eu116bn versus Eu100bn in covered bond format.

In the Nordic region similar supply dynamics have been observed as Eu22.5bn of senior funding was not part of many supply forecasts for 2012, let alone less than Eu20bn of euro benchmark covered bonds. However, on a country basis we find different factors, including regulatory statements, expensive cross-currency basis swaps, etc, driving new issue supply and choice of format from the region’s banks in 2012. For example, Norwegian issuers have been very active in the euro covered bond space with Eu11.7 of benchmark supply, while Swedish borrowers have preferred the senior unsecured format to the tune of Eu15.1bn.

Looking into 2013, there are reasons to believe that the supply dynamics will change, at least on a country basis. The Norwegian FSA, Finanstilsynet, declared in October its discomfort over current asset encumbrance levels among a number of supervised banks. As a result, the FSA highlighted that a policy response in one form or another on a bank specific level intended to curb covered bond issuance is not improbable in the future. The announcement followed only days after the Swedish regulator and the Riksbank called for more transparency regarding encumbrance levels among Swedish lenders.

The Swedish FSA, Finansinspektionen, presented a new regulatory policy on November 26, stipulating the amount of capital banks need to hold against Swedish mortgages. Historically, risk weights on mortgages among Swedish banks have averaged below 10%, while the new rules being implemented specify a floor of 15%. In the short term, the new risk weight floor may to some extent impact the profitability on banks’ mortgage business, while in the longer term the banking system will be regarded as more resilient and better equipped to face future economic slowdowns. Eventually, such stabilisation could lead to lower financing costs and thus offset any decreased profitability linked to the higher capital requirements on mortgages.

Only one day after the announcement on new risk weights in Sweden, a spokesman for the Norwegian central bank supported the policy by stating that “risk weights on mortgages of 35% to 40% are closer to our thinking than the 15% that was proposed by Sweden” (Bloomberg, 27 November 2012). A reciprocity relationship between the Nordic countries could also become reality in the future, meaning that, for example, foreign banks’ subsidiaries in Sweden would also be required to adhere to the newly implemented 15% risk weight floor.

The ongoing debate about risk weights did not hold back Norwegian borrowers, as the net supply of covered bonds rose from Eu6bn in 2011 to Eu8.6bn this year. Therefore, 2013 is likely to be a year with increased focus on senior unsecured funding. Asset encumbrance levels and regulators aside, the cost advantage of utilising secured versus unsecured funding has narrowed by almost one percentage point over the last year, which should give Norwegian issuers further incentive to relieve encumbrance levels going forward. Moreover, covered bond redemptions in 2013 and 2014 are very limited, totalling only Eu3bn.

As touched upon above, Swedish banks have offered investors the contrary in terms of bond supply this year, the main reasons being an expensive cross-currency basis swap and a well functioning domestic covered bond market. Eu15.1bn of euro denominated senior bonds have been issued for diversification purposes and to sustain market presence, all while taking advantage of low euro senior-covered spreads.

From a redemption perspective, over Eu11bn of covered bonds will mature in the coming two years, which further supports our expectations of increased supply in secured format from Sweden in Euroland. The majority of the Eu8bn of senior redemptions in 2013 have already been prefunded.

In late November, Sweden’s Finance Minister Anders Borg warned banks in the country that the government may limit banks’ foreign borrowings in order to protect taxpayers from potential future losses. The statement originated from the Swedish FSA, who earlier warned that banks under its supervision are overly dependent on short term funding in overseas currencies. The Riksbank, with the chairman of the Basel Committee on Banking Supervision, Stefan Ingves, responded that a limit on banks’ foreign borrowing will not be supported by the central bank, as exchange rate shocks to the banking system will fade as the new Basel III accord is implemented. As such, there are no indications Swedish banks will dramatically alter their funding or currency mix in the near future, while in addition all larger banks are fully LCR compliant already.

From Finnish borrowers, there were no real surprises during 2012 in terms of new issue supply dynamics. With the largest Nordic bank utilising its Finnish platform for secured funding, issuance this year has been skewed towards bonds backed by residential mortgages. This will most likely be the case in 2013 as well.

On the regulatory front, however, the Finnish government proposed in late November a new bank levy of 0.125% of RWA, intended to raise Eu500m over three years for a new bank rescue fund. Next, the proposal faces a parliamentary debate, but it could come into effect as early as January 2013. If so, the bank tax would be credit negative as profitability is reduced and attempts to shore up capital ratios through retained earnings are therefore weakened for Finnish financial institutions.

With stabilisation on the horizon for Denmark’s housing market, one could see the country resurfacing in the euro covered bond market in the coming year. The country’s largest lender faces to some extent the same regulatory uncertainty regarding the proposed bank tax in Finland, as the last three covered bond issues have originated from its Finnish subsidiary.

The majority of the smaller and less frequent Danish issuers have visited the market this year and are therefore not expected to return, except for opportunistic trades later in the year.

Positive news is scarce these days, although one item surfaced from the Danish regulator last week, as it is considering extending a deadline for banks that fail regulatory solvency tests from 48 hours up to three months. The grace period of up to three months will only be given to banks who commit to sell off assets, raise capital, change management or restructure the business in order to avoid insolvency. A modification like this could aid in reducing the number of bankruptcies, which the country been struggling with since the start of the crisis, or at least allow troubled entities to unwind their business in a more orderly fashion.

To summarise, Norwegian and to some extent Finnish issuers will most probably switch towards more senior transactions in 2013, while Swedish and Danish banks will utilize overcollateralised cover pools to back new secured bonds over the coming year. According to Crédit Agricole CIB senior covered bond analyst Florian Eichert, the 2013 euro benchmark covered bond supply forecast for the Nordics totals Eu18bn. That being said, no one knows what central banks have in the bag for 2013.