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Investment Research
29 July 2011
Flash Comment
Moodys take action on Danish covered bonds
Moody’s announced yesterday a series of rating actions on Danish covered bonds. In this
Todays key points
document we briefly describe the action taken by Moody’s and attempt to assess the
market impact focusing on the downgrade of Nykredit Capital Centre D. Moodys has downgraded
Nykredit Capital Centre D from
The major headlines are as follows.
Aaa to Aa1 but confirmed all
Moody’s has downgraded Nykredit Capital Centre D from Aaa to Aa1 but confirmed other Nykredit Capital Centre
all other Nykredit Capital Centre including Totalkredit Capital Centre C. including Totalkredit Captal
Moody’s has placed all BRFkredit covered bonds on review for downgrade. Centre C.
Moody’s has confirmed DLRkredit at Aa1 (both General Capital Centre and Capital Moodys has placed all BRFkredit
Centre B) but lowered the TPI (Timely Payment Indicator) from ‘High’ to ‘Probable- covered bonds on review for
High’. downgrade.
Moody’s has withdrawn the ratings of Realkredit Danmark’s covered bonds at the Moodys has confirmed DLRkredit
request of the issuer (although Moody’s claim to have withdrawn the ratings “for its at Aa1 but lowered the TPI
own business reasons”). (Timely Payment Indicator) from
High to Probable-High.
The announcement did not contain any information regarding Nordea Kredit. The rating
actions follow Moody’s previous downgrades of the respective issuer ratings and Moodys has withdrawn the
Moody’s assessment of the issuer’s response to Moody’s request for further credit ratings of RDs covered bonds.
enhancements. The downgrade of Nykredits
Below we provide a table with covered bond ratings and overcollateralisation (OC) Capital Centre D from Aaa to Aa1
requirement for all capital centre rated by Moody’s. will have a negative market
impact on bonds issued out of
Table 1. Covered bond ratings and OC requirement Capital Centre D.
Capital centre Covered bond rating Minimum OC requirement In particular, bonds with a high
Nykredit CC D Aa1 2.5% spread risk and bonds with a high
Nykredit CC E Aaa 11.5% share of pension funds investors
Nykredit CC G Aa1 14.0%
and/or foreign investors will be
Nykredit General CC Aa1 0.5%
affected.
Totalkredit CC C Aaa 3.0%
DLR CC B Aa1 15.0%
DLR General CC Aa1 8.0%
BRF CC B Aa3 8.5%
BRF CC E Aa2 14.5%
BRF General CC Aa3 5.0%
RD CC S Withdrawn 18.0%
RD General CC Withdrawn 5.5% Senior Analyst
Christian Riemann-Andersen
Source: Moody's +45 4512 8565
chande@danskebank.dk
Senior Analyst
Christina Emilia Falch
+45 4512 7152
chfa@danskebank.dk
Important disclosures and certifications are contained from page 6 of this report.
www.danskeresearch.com
Flash Comment
Actions regarding Nykredit
The biggest surprise in yesterday’s announcement was probably the downgrade of
Nykredit’s Capital Centre D. Nykredit stated that the cost of defending the Aaa rating (i.e.
providing OC) was simply too high and would pose a potential financial risk in the future
for Nykredit. The surprise is anchored in the fact that prior to yesterday’s announcement
Nykredit provided an OC of 5.7%, which was close to the 7.0% requirement Moody’s
sent out 1 July. However, we have been informed by Nykredit that the actual requirement
was substantial higher than 7%. The significant increase in OC requirement is not related
to any worsening of credit quality (actually the collateral score has been unchanged over
the recent quarters) but attributable alone to Moody’s tougher stance on mortgage loans
with refinancing (both interest reset loans funded by non-call bonds and xIBOR-related
products that are refinanced). These loans currently constitute roughly 38% of the total
capital centre.
Following the downgrade to Aa1 Nykredit has to provide an OC of only 2.5%. However,
the level currently provided (5.7% as of 31 March 2011) is close to the 5.3% required to
maintain the AAA at S&P (data of December 2010) so investors should not expect a large
fall in the provided OC and there will be no significant transfer of OC from Capital
Centre D to, for example, Capital Centre E.
Regarding Capital Centre E, Nykredit yesterday announced how it will gradually phase in
Moody’s OC requirement of 11.5%. Nykredit currently provides OC (as of 31 March
2011) of 7.1% and intends to increase this to 8% in October 2011, to 10% in January
2011 and expects to reach the 11.5% target in April 2012. In absolute numbers, Nykredit
will have to add OC of DKK8bn. Hereafter, Nykredit expects the OC requirement to
decline gradually again towards 6% as interest-reset loans are refinanced into a new
capital centre.
Concerning the new capital centre, Nykredit could not provide any details on the expected
ratings but clearly did not rule out that the new centre could receive a spilt rating, i.e.
AAA from S&P and only Aa1 from Moody’s, given their tough stance on interest reset
loans. Moody’s requires three times as much OC for loans with an embedded refinancing
than for loans without refinancing. Hence, a capital centre for refinancing loans only
would probably face an OC requirement in the region of 15-18%.
Actions regarding BRFkredit
Moody’s has placed BRFkredit’s covered bonds from Capital Centre B and E as well as
the General Capital Centre on review for downgrade “to reflect ongoing discussions with
BRF on their plans for the programmes”. Moody's says it will consider BRF's proposal to
restructure the programmes “and these proposals may include a transfer of ARM loans
into a new Capital Centre H, as well as the addition of further collateral to existing
programmes”. In the case of the General Capital Centre, “BRF is also exploring with the
Danish FSA whether it is possible to add collateral in a form Moody's considers
‘committed’”.
Actions regarding DLRkredit
For DLRkredit Moody’s affirmed the Aa1 rating of both Capital Centre B and the
General Capital Centre. However, Moody’s notes that the committed OC (i.e. OC for
which the issuer is restricted in moving at its own discretion) provided by DLRkredit in
both capital centres translates into ratings of only Aa2. However, given the level of the
total OC provided (i.e. both committed and voluntary) and that reliance on voluntary OC
is limited to one notch, Moody’s has decided to stick with the Aa1 rating.
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Flash Comment
However, Moody’s has decided to lower the TPI from ‘High’ to ‘Probable-High’. This
stems from the fact that for issuers rated below single A, Moody's considers the level of
OC in committed form relative to the level of expected cover pool losses. Given the
current ratio for both capital centres, Moody's has lowered the TPI. As a consequence,
given the issuer rating of Baa1, there is no TPI-leeway for either capital centre. Hence, a
one-notch downgrade of the issuer rating would feed directly through to a one-notch
downgrade of the covered bonds to Aa2. DLRkredit’s issuer rating is currently on
negative outlook (this also goes for Nykredit and BRFkredit).
Actions regarding Realkredit Danmark
Moody’s has withdrawn the Aaa ratings for both Capital Centre S and the General Capital
Centre. Moody’s notes that while RD has announced that it could honour the 18% OC
requirement in Capital Centre S this was not done and that the level provided prior to the
withdrawal of 10.1% was consistent only with a Aa2 rating.
Expected markets impact on Nykredits Capital Centre D
We expect the downgrade of Nykredit’s Capital Centre D from Aaa to Aa1 to have a
negative market impact on the bonds issued out of Capital Centre D and , in particular, to
affect bonds with a high spread risk and bonds with a high share of pension fund investors
and/or foreign investors.
We expect to see a negative price effect on RO bonds as a result of the impact from
Solvency II when the RO bonds in capital centre are downgraded from Aaa to Aa1 as the
capital charge for pension funds will double. In the final technical specifications for
Solvency II the capital charge due to the spread risk will thus be calculated according to
the formula below.
MV duration
i i i F up (rating i )
Fup(rating) is set according to rating and duration (see table below).
Table 2. The new spread risk weights
New F(rating) up Duration floor Duration cap
AAA (UCITS) 0.6% 1 53
AAA 0.9% 1 36
AA 1.1% 1 29
A 1.4% 1 23
BBB 2.5% 1 13
BB 4.5% 1 10
B or lower 7.5% 1 8
Unrated 3.0% 1 12
Source: CEIPOS
The downgrade by Moody’s of Nykredit’s Capital Centre D will result in an increase of
the F(rating) factor from 0.6% to 1.1%, which means the capital charge under Solvency
II will almost double. Nykredit’s Capital Centre D also has an AAA rating from S&P but
according to Solvency II the second highest rating must be used in the calculation of the
capital charge. However, there is a possibility that Nykredit could get an AAA rating
from Fitch before the implementation of Solvency II. In this case, the lower rating from
Moody’s would not have an effect on the capital charge for pension funds.
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Flash Comment
The increase in capital charge will, in particular, have an effect on bonds with a high
spread risk such as long-dated floaters and capped floaters and callable low-coupon
mortgage bonds. In the enclosed Appendix we calculate the difference in the return
requirement under Solvency II for a selection of Danish covered bonds under the
assumption that the bonds are downgraded from Aaa to Aa1. As shown in the table the
return requirement would increase by 20-40bp for the long-dated floaters and capped
floaters and callable low-coupon mortgage bonds. If we look at the bond types and the
maturity profile of the bonds in Capital Centre D, there is a relatively large amount of
long-dated floaters, capped floaters with maturity 2018 and 2038 in Capital Centre D (see
the chart below).
Chart 1. Maturity profile of the bonds in Capital Centre D
Capped floaters Floaters Callables Non-callables
100
80
60
40
20
0
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2025
2026
2028
2031
2033
2034
2035
2036
2038
2041
Source: Danske Markets
The implications of a lower rating in Solvency II is also crucial for new RO bonds issued
after 1 January 2008. Until now the pension fund sector has bought the new RO bonds,
which are cheaper than the corresponding SDO bonds, because they are not CRD
compliant and there is a higher risk weight for banks. If we take a closer look at the bond
type composition in Capital Centre D, the new RO bonds amount to around 15% of the
total outstanding amount of mortgage bonds (see the table below).
Table 3. Bond type composition in capital centre D
Volume (DKKbn) DKK EUR Total
Grandfathered RO 233.5 31.4 264.9
- Callables 107.0 1.1 108.1
- Capped floaters 84.8 0.4 85.2
- Floaters 25.8 29.2 55.0
- Non-callables 15.9 0.7 16.5
New RO (20% risk weight) 36.9 9.4 46.3
- Floaters 27.6 0.3 27.9
- Non-callables 9.1 9.1 18.2
- Callables 0.2 0.0 0.2
Total 270.4 40.7 311.1
Source: Danske Markets
Some foreign investors in Danish covered bonds could also be affected by the downgrade
of Nykredit’s Capital Centre D due to investment regulations that allow investments only
in Aaa rated bonds. In this case, some foreign investors could be forced to sell their
holdings of Danish covered bonds.
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Flash Comment
Looking at the investor distribution of the 10 biggest bond series in Capital Centre D,
there is a high investor share of life insurance and pension funds investors and/or foreign
investors in the 4’35, 5’38, 5’38io, CF 5’38, FRN Jan-13, FRN Jan-18 and FRN Jan-38
(see the table below). As mentioned earlier, these investor segments will be affected by a
lower rating for Capital Centre D and hence there is a risk that we could see some selling
of these bonds.
Table 4. Investor distribution on a selection of bonds in Capital Centre D as of June 2011
975729 976016 976148 976326 976466 976563 976571 976601 976644 978027
4'35 5'38io CF 5'38 5'38 CF 5'17io FRN 2018 FRN 2018 CF 5'18io FRN 2038 FRN 2013
Grand New RO Grand Grand Grand Grand Grand Grand Grand Grand
Non-financial 0.0%
institutions 26.9% 14.0% 2.3% 12.4% 14.5% 12.5% 7.5% 12.6% 1.5%
Financial
institutions 17.6% 35.3% 59.7% 36.8% 57.7% 24.2% 86.2% 75.7% 25.8% 37.0%
Life insurance
Pension funds 12.8% 19.3% 29.3% 18.5% 6.3% 57.7% 4.0% 3.4% 26.4% 25.0%
DsP and SP 0.9% 3.5% 1.2% 2.2% 9.6% 3.8% 0.0% 4.3% 0.5% 0.1%
Households 15.2% 10.5% 1.3% 7.9% 6.9% 1.7% 0.1% 2.8% 2.6% 0.1%
Other
domestic 1.2% 1.9% 0.9% 1.5% 0.7% 0.3% 0.1% 0.8% 1.1% 0.5%
Foreigners 25.4% 15.5% 5.4% 20.7% 4.3% 0.0% 9.7% 5.4% 31.0% 35.8%
Source: Danske Markets
Appendix
Table 5. Capital charge and return requirement for Aaa and Aa1 rated bonds under Solvency II
Bond Bond Price Spread Capital charge Return requirement
Type risk Aaa Aa1 Difference Aaa Aa1 Difference
Callable 438 96.20 6.8 4.1% 7.5% 3.4% 28.5 52.2 23.7
Callable 438io 95.75 7.3 4.4% 8.1% 3.7% 30.8 56.4 25.6
Callable 441 94.55 7.3 4.4% 8.0% 3.6% 30.6 56.1 25.5
Callable 441io 93.55 8.3 5.0% 9.1% 4.1% 34.8 63.7 29.0
Callable 541 100.60 5.6 3.4% 6.2% 2.8% 23.6 43.2 19.6
Callable 541io 99.80 6.0 3.6% 6.6% 3.0% 25.3 46.4 21.1
Callable 641 105.20 4.1 2.4% 4.5% 2.0% 17.1 31.3 14.2
Callable 641io 104.75 4.3 2.6% 4.8% 2.2% 18.2 33.3 15.1
Callable 741 108.45 3.7 2.2% 4.1% 1.9% 15.7 28.8 13.1
Callable 531 102.80 4.7 2.8% 5.2% 2.3% 19.7 36.1 16.4
Callable 431 97.80 5.8 3.5% 6.3% 2.9% 24.2 44.4 20.2
Non-call. RD 212 (Jan) 100.23 0.4 0.3% 0.5% 0.2% 1.8 3.3 1.5
Non-call. RD 214 (Jan) 99.74 2.4 1.4% 2.6% 1.2% 10.0 18.3 8.3
Non-call. RD 216 (Jan) 96.99 4.4 2.6% 4.8% 2.2% 18.3 33.6 15.3
Capped floater CF 518io 98.10 5.7 3.4% 6.3% 2.9% 24.0 44.0 20.0
Capped floater CF 638 96.68 10.9 6.5% 11.9% 5.4% 45.6 83.6 38.0
Capped floaters CF 538 95.64 10.8 6.5% 11.9% 5.4% 45.3 83.1 37.8
Floater FRN Jan-12 100.45 0.4 0.3% 0.5% 0.2% 1.8 3.2 1.5
Floater FRN Jul-18 99.00 6.3 3.8% 6.9% 3.1% 26.4 48.5 22.0
Floater FRN Oct-38 93.25 17.2 10.3% 18.9% 8.6% 72.1 132.2 60.1
Source: Danske Markets
5| 29 July 2011
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Flash Comment
Disclosure
This research report has been prepared by Danske Research, a division of Danske Bank
A/S ("Danske Bank"). The authors of the research report are Christian Riemann-
Andersen, Senior Analyst, and Christina Emilia Falch, Senior Analyst.
Analyst certification
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views expressed in the research report accurately reflect the research analyst’s personal
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research analyst was, is or will be, directly or indirectly, related to the specific
recommendations expressed in the research report.
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Flash Comment
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