Nykredit to cut auctions and ISINs in bid for LCR magic

May 27th, 2016

Nykredit is planning to cut ARMs auctions from four times to twice a year as part of an initiative aimed at offering fewer but larger lines of covered bonds to meet LCR Level 1B criteria that have affected pricing in the Danish market, where the latest auction season ended solidly.

Nykredit imageThe Danish mortgage industry and country’s authorities lobbied hard for covered bonds to be treated favourably in EU Liquidity Coverage Ratio criteria, but although they were successful implementation of the requirement has led to increasing divergence in the Danish market, with issues hitting a Eu500m or Dkr3.75bn threshold for Level 1 LCR treatment trading tighter than those that are only eligible as Level 2A assets.

A market participant said that the spread between Level 1B and 2A series is around 5bp for one to five year bonds refinancing ARMs, while some issuance that does not even meet 2A eligibility trades 10bp-15bp wider than 1B-eligible paper.

Meanwhile, an increase in the number of types of bonds being sold – in parallel with developments in mortgage products – and the spreading out of sales across the year has complicated auctions, with Realkredit Danmark, for example, taking the unprecedented step of cutting an individual auction in November after it was dissatisfied with the bids it received amid heavy supply.

Market participants said that action was necessary to address such issues, and Nykredit, Denmark’s biggest mortgage lender, has now announced plans to adjust its mortgage loan funding to simplify its bond offerings to produce fewer but larger bond series, with LCR considerations driving the initiative.

“It’s a reaction to the discussion of the LCR requirements, where you need to get above this magical Eu500m in order to get the Level 1 treatment,” Morten Bækmand Nielsen, head of investor relations at Nykredit Realkredit, told The CBR. “There was a lot of product development going on, especially in the early 2000s, and we had our two tier mortgaging system that also resulted in more ISIN codes coming out. Now we are kind of reversing that trend.

“We have a lot of big issues, but we also have a number of smaller ones, and we need to address that because there is such a big extra spread on bonds that will not reach this Eu500m level. It is simply bad for our customers to be funded in a bond below the Eu500m mark, and therefore we said, OK, let’s see what we can do in order to get rid of these smaller bond series and consolidate the issuance into bigger ones.”

After having led the move to hold quarterly rather than the historic annual auctions of bonds to refinance adjustable rate mortgages (ARMs), Nykredit will cut these back to twice a year, for 1 January and 1 July maturities. It will continue to hold sales of other products, such as floating rate notes, in the other two quarters.

The move to quarterly auctions had been driven by concerns from the Danish central bank and rating agencies about the previous concentration of funding, but according to Nielsen the benefits of the quarterly funding will not be lost, partly because it will still be holding four sets of sales and partly because the volume of short dated ARMs such as one and two years has fallen sharply – from some 26% of Nykredit’s loan portfolio at its peak to around 9%.

He said that the overall package will be implemented over the long term to ensure compliance with the Danish FSAs supervisory diamond for mortgage credit institutions.

One early move is to change the refinancing date for five year ARMs due for refinancing in October from 1 October 2021 to 1 July 2021, which Nykredit said will increase the size of the bond series maturing on the latter date. Other measure include a rejigging of business done out of different capital centres.

Other issuers are taking similar steps to Nykredit’s scheduling move. BRFkredit already offers most of its new ARMs with an April payment date and has said it is investigating the possibility of moving existing January and October loans to April to create bond series that fulfil Level 1B requirements.

Issuers are also continuing with initiatives designed to move borrowers away from shorter dated ARMs altogether, with Realkredit Danmark, for example, this week increasing fees on such products.

Analysts at Danske Bank expect the steps taken by Nykredit and the other institutions to have fewer ISIN codes to improve liquidity and to lead to a reduction in supply of Level 2B and non-LCR bonds.

“Given expectations regarding the forthcoming Net Stable Funding Ratio (2018), including the requirement for a certain share of long term funding for non-Level 1/1B asset purchases, we do not expect spreads between Level 1B and Level 2A/3 assets to narrow going forward,” they said.

However, another analyst said that moves towards addressing the issues were being taken only slowly and was sceptical about the extent to which a solution was being implemented.

“Nykredit has at least now acknowledged there is a problem,” he said. “But there is still a long way to go.”

Nykredit was the only Danish issuer to sell traditional ARMs bonds this week, issuing Dkr8bn of one years, Dkr2.1bn of three years and Dkr1.5bn of five years that are all Level 1B-eligible. The one and three year bonds were sold on Monday and Tuesday and achieved bid-to-covers ranging from 4.08 to 6.34 across the two days, while the five year was sold on Wednesday with a bid-to-cover of 2.77.

The majority of the week’s sales were of floating rate notes, from DLR Kredit, Nordea Kredit and Realkredit Danmark, selling Dkr5.85bn, Dkr28.6bn, Drk22.24bn, respectively.

Analysts said that spreads performed at the short end going into the week’s sales and that the FRNs were priced at a little tighter level than expected. Danske analysts said that the auctions had overall generated “solid” demand, with another analyst saying that demand was supported by high reinvestment needs.

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