Friday, June 21, 2013

Reuters: Bankruptcy News: Danish risk weighting row touches bank capital nerves

Reuters: Bankruptcy News
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Danish risk weighting row touches bank capital nerves
Jun 21st 2013, 10:31

Fri Jun 21, 2013 6:31am EDT

* Bankers fear Danske treatment could set precedent

* Risk weighting increases create capital shortfalls

* Asset quality review prompts regulatory action

By Aimee Donnellan

LONDON, June 21 (IFR) - Denmark's shock decision to reprimand Danske Bank for the way it calculates risk-weighted assets has not only left the bank with a potential capital hole of DKK8bn (EUR1.07bn), but has also raised fears that other banks may be similarly exposed.

Under the new orders announced by the Danish FSA on Monday, Danske Bank's risk-weighted assets would rise, leading to an increase in capital requirements and meaning the bank would have to set aside more cash to cover its corporate exposures.

Bankers are now expecting Swedish and Norwegian regulators to take similar action, which could leave the region's banks with insufficient capital that would need to be replenished either through new equity or subordinated bond issuance.

Nordic regulators are among the toughest in Europe, but they also allow for some of the lowest risk weightings in the region.

"Investors and regulators have been concerned about the level of risk weighting of assets across Europe for some time," said Daniel Bell, head of EMEA DCM capital products at Bank of America Merrill Lynch.

"A floor on residential mortgage risk weights has already been imposed in Sweden and Norway, so it's not surprising to see another regulator querying internal models."

A broader regional crackdown to help remedy that has already begun. Last month, Sweden's regulator introduced a 15% risk weighting floor for mortgages, while Norway is considering imposing a 35% floor.

BAD TIMING

Danske's total capital ratio was 21.6% at the end of the first quarter, but that would fall to around 19.1% under the new requirements. Its Core Tier 1 ratio, meanwhile, was 15.1% at the end of the first quarter, compared to the minimum 9% that is required by the European Banking Authority.

Although its capital levels are still among the highest in Europe, its shares tumbled nearly 6% as the bank warned it may not be able to pay its 2013 dividend in full.

Other issuers - including UniCredit, BBVA and UBS - have easily raised similar amounts to Danske's EUR1bn capital needs in recent weeks via subordinated bond issues, but the timing for Danske is far from ideal.

It follows a 75bp widening in the iTraxx Subordinated index to more than 250bp in the past six weeks and a sell-off in cash bonds that has made investors more nervous about the product.

"Politicians don't seem to realise that they are asking banks to raise capital across the board at a time when investors are wary of buying the product," said a London-based DCM banker.

BBVA's USD1.5bn Additional Tier 1 bond, for example, fell to 94.50 from a high of 104.50, although Danske's last capital deal - a USD1bn 25NC5 Tier 2 bond issued last September - has been fairly resilient and is still bid above par.

LACK OF COHESION

The implications for European banks could be even more far-reaching, bankers warn, and a lack of cohesion in risk weighting across the region is now being addressed by regulators.

An asset review is expected ahead of the EBA stress tests scheduled for 2014, and is aimed at creating a level playing field for banks in Europe and to boost the credibility of the tests.

"Risk weights in the stronger EU countries tend to be lower than in the weaker ones, and with the announced asset quality review we could see some further regulatory action in other jurisdictions, possibly starting in the north and spreading south," said Bell.

In the UK, in-depth asset quality reviews have already taken place, and so some banks may be spared further regulatory reviews.

In Germany, however, banks have particularly low risk weightings, with Deutsche Bank thought to have some of the lowest.

GOOD NEWS FOR INVESTORS

It is not all bad news though, especially for investors in banks' old-style Tier 1 instruments.

In many cases, the coupons on these bonds effectively step down at their call dates because interest rates have fallen so sharply since the bonds were sold. For issuers, this means the instruments have provided a cheap form of debt that they have been reluctant to call.

Now that regulators deem those instruments to be inefficient capital, issuers will be less concerned about cost and more focused on how to remedy the unexpected shortfall.

"We hope other regulators follow a similar line, but for the moment the process of creating a level playing field for European banks is painfully slow," said a London-based portfolio manager. (Reporting by Aimee Donnellan; Editing by Natalie Harrison, Julian Baker and Philip Wright)

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