Moody’s and Danske Bank Duel over Basel III

Bloomberg ran a story titled ‘Danske Bank’s Patience With Moody’s Evaporates’

We have been following the Danish Banking wreck for a while, so let’s start with comments on each bank. This is no small matter, Danske has approximately $600 billion in assets or 2x Denmark’s GDP. Morgan Stanley has about $750 billion in assets, to put it in another perspective.

Danske Bank:

It is very much a question of who have lost patience with whom! The mortgage bank Realkredit Danmark is owned by Danske Bank. As to faulty models: I recall from the news stories circulated in the Danish press at the time of the break-up between Moody’s Corporation (NYSE:MCO) and Realkredit Danmark that the chief spin doctor (Steen Bocian) of Danske Bank responded to the criticism from Moody’s Corporation (NYSE:MCO) concerning undercapitalization of Realkredit Danmark: “If need be Danske Bank will add more capital to Realkredit Danmark.” (Quoted from memory)

Now that is indeed a strange model: If Danske Bank transfers equity to Realkredit Danmark these shares will be eliminated when the books are consolidated on a concern level! Bocian and Danske Bank obviously found it very good accounting practice to count the same equity twice! I call that cooking the book and possibly not legal.

As to CEO Danske Bank Eivind Koldings contention of Moody’s not getting the “systemic support” in Denmark right, there is a twist to that story: A couple of months ago Danske Bank borrowed 41 bio. DKK from the ECB’s EFSF on a 3 year basis – what was not really in vogue at the time is that the Danish Central Bank almost simultaneously guaranteed the EFSF 40 bio. DKK, according to the Prime Minister, in a public report to a parliamentary committee. If that is a larger or smaller “systemic support” than in Sweden where the State is a major shareholder in Nordea – that could be construed as a matter of opinion.

Jyske Bank:

Jyske Banks inability to follow financial thinking is notorious. The only major bank in Denmark Jyske Bank had to take significant losses in the Greek debacle. At the same time Anders Dam (CEO of Jyske Bank) in a EU committee hearing was unable to get understanding from the committee members (except of course from the British) for his passionate resistance to the Tobin-tax proposal in EU.

Nykredit:

Moody’s Corporation (NYSE:MCO) has“…crossed the line for fairness,” adding the bank “simply cannot follow Moody’s arguments.” What a strange defence!

No the story is not so much about Danske Bank and Moody’s.

In the Danish Business newspaper Børsen there is a bit more on the actual topic:

Here there is a more troubling point than whether you like Moody’s or not.

We are talking the implementation of the Basel III requirements. There are two terms here:

Liquidity coverage ratio.

1. According to Børsen only 40% of the liquid assets can be bonds issued by the bank or the mortgage bank itself.
2. The mortgage bonds are not in the same class as sovereign bond which count 100%, whereas mortgage bonds weighs only 85%.

Net stable funding ratio (NSFR or NSF ratio).

It is the ratio of long term assets (loaned to customers) funded with long term stable funding (borrowed by the bank).

Flexible interest mortgage loan with 30 year maturity is financed by issuing/selling bonds of one year maturity – it must be said to be generous to allow the issued bonds to count with 2/3 value.

1. That is: A loan of 1 mio. flexible interest has to be covered with the sale of 1½ mio. in one year bonds.

Problems for the Danish mortgage banks

1. As the major buyer of the flexible interest bonds are the issuers or their concern banks – directly or indirectly we are talking about a real problem. Of the 200 bio. USD loans to homeowner 2/3 are flexible interest loans and 2/3 of these are without service on principal.
2. The salability on the market is dependent on how close to cash the bonds are – sovereign bonds are cash (even long maturity sovereign bonds can be sold off easily – possibly with a minor discount). If real estate mortgage bonds only count 85% of a sovereign bond you need to have 18% more real estate mortgage bonds to have the same liquidity as with sovereign bonds.
3. As there is severe problems in selling the flexible interest bonds as it is the issuance of a further 70 bio. DKK in one year bonds or other funding leads us right back to the liquidity coverage ratio.

Let’s face it: Enforcing this regulation will be the death of Danish mortgage banking – they are in trouble so many ways. The possibility of refinancing the home owner’s loans seems remote – again for several reasons.

It seems like the mortgage banks trust their political muscle to overturn the European Commission’s proposal. Furthermore the banks only claim to have some understanding in the European Parliament – whether this is desperation or wishful thinking and pathetic whining? Well, as I recall it CEO of the Danish Central Bank has publicly said: “ …. the probability is very little”.

Even if the Danish mortgage banks could get some exemptions and some adjustments to the percentages – it is doubtful that it will be enough – the problems are simply to great.

There could be an argument f.i. to count the fixed interest, convertible annuities (all conditions necessary) as sovereign bonds, as in case of a panic sell off there are 1 mio. greedy home owners ready to refinance to get a profit out of it. The problem is that these loans account for less than ¼ of the loans.

This leads us back to the divergence of opinion between the Danish banks and Moody’s where Eivind Kolding of Danske Bank – et alia – apparently considers it an absolute certainty that their arguments will carry the day .