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Would you buy Nordic capital?

09 February 2018
Richard Kemmish

For someone who enjoys the Nordic region so much, and who just loves covered bonds what I’m about to say might sound a little odd: I would never buy a Nordic covered bond.

My reasons are defensible. Covered bonds exchange a lower yield for better protection from credit events which are, lets face it, more remote in the Nordic region than any other. My thinking is presumably shared by investors who buy premium issuer AT1 bonds with a coupon of just 3.5% - that is roughly 3.5% more than the yield on the same issuer’s covered bonds. Assume a five-year time horizon, is the probability of a credit event for a premium Nordic region issuer more or less than the pv of the coupon difference over five years: roughly 17%? I think we all know the answer to that.
Of course there are technical factors, risk weights..liquidity..blah di blah… But the fundamental credit equation is clear: the further down the capital stack, the better your value for money.
Now the Nordic Bank Capital and Funding Forum in Stockholm next month would be pretty dull if we all sat around agreeing with that fundamental premise. So how can I play Devil’s advocate?
Rampant house prince inflation and the implications of Basle’s risk weight floor on the world’s lowest risk weighted balance sheets are hopelessly over-fished topics. So let me revert to my favourite bugbear: liquidity. 
Nordic banks are not as heavily deposit funded as most which, with the technical savvy of Nordic region investors is probably a good thing (they can remove deposits from a bank as fast as they can remember which folder the banking app is in). These investors are not just technically savvy, they are also price sensitive and motivated by things other than credit and price. Will we one day see a run on a bank’s deposits caused by a social media campaign? Or a cyber security breach? 
Or a higher yielding krone (/krona) deposit account offered by a Greek bank enjoying the European bank deposit guarantee?  
The flipside of (relatively) low deposit funding is a relatively high reliance on the covered bond market for liquidity. Is that a good thing? I would argue yes, whoever designed the net stable funding ratio would argue no (both the ‘required stable funding’ for encumbered mortgages and the ‘available stable funding’ from shorter dated covered bonds are downright unfriendly, particularly when compared to the treatment of deposits. Don’t get me started).
If liquidity is more of a risk than credit (as I always say, particularly in the Nordic region) then one factor is overlooked – some Nordic region covered bonds can provide (to borrow capital terminology) ‘going concern’ liquidity – via soft bullets that extend their maturity in an extreme stress scenario (but which, crucially unlike other soft bullets don’t require an issuer default. Gone concern liquidity – no use to anyone).
I might not want to buy Nordic covered bonds, but I’d like banks to issue more to protect their capital investors.


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