No change to bank solvency as Swedish regulator reacts to Nordea HQ switch

Nordea’s decision to move its headquarters to Finland, and Sweden’s loss of direct oversight over its largest bank has led to regulatory changes that will cut Swedish banks’ capital-to-RWA ratios. However, this does not imply weaker solvency, says Scope.

Once its switch to Helsinki is completed, supervisory arrangements for Nordea (rated AA- with Stable Outlook) will change. Scope Ratings notes in a new report that the European Central Bank, in conjunction with Finnish supervisors, will be primarily responsible for setting the group’s capital requirements under Banking Union rules. Sweden’s regulator, the FSA, is concerned that this could lead to competitive distortion in Sweden where players in the domestic mortgage market face different capital requirements for their exposures.

So, as of 31 December 2018, the FSA is proposing to apply a hard Pillar 1 requirement for Swedish residential mortgages under the provisions of Article 458 of the Capital Requirements Regulation (CRR). This allows a competent home supervisory authority to apply risk-weighting measures relating to systemic or macro-prudential risks. The changes will affect banks exposed to Swedish mortgages that have permission to use the IRB approach – and potentially includes branches of foreign banks subject to reciprocal agreements between Nordic regulators.

As a result, Swedish banks’ total capital requirements – a metric that investors watch closely – will decrease as a percentage of risk-weighted assets (RWAs). That’s because the denominator in the capital ratio – the risk exposure amount (REA) – will rise owing to the increase in risk weights on Swedish residential mortgages. The headline impact (with 4Q17 as the baseline) will be between 1.7% for Nordea and 9.1% for Swedbank.

Reported total capital ratios will also decline owing to higher REAs: the estimated reduction is 1.9% for Nordea and 10.1% for Swedbank.

“Investors should be clear that the anticipated fall in reported total capital ratios is a technical effect and doesn’t imply an overall weakening of Swedish banks’ solvency positions, although it may affect market perceptions of the banks’ AT1 securities,” said Jennifer Ray, a bank analyst at Scope, and author of the report.

“The issue is not just that Swedish banks’ reported capital ratios may no longer exceed most European peers by such a noticeable margin; reported CET1 ratios are also expected to fall, thereby cutting the ample headroom to the Maximum Distributable Amount (MDA) threshold the banks have,” Ray said. The MDA defines the point at which automatic dividend restrictions apply, potentially affecting banks’ AT1 securities.

The existing 25% risk-weight floor for mortgages via the Pillar 2 add-on arrangement is not a hard requirement so does not factor in Swedish banks’ MDA calculations. Even though that is being replaced, Scope already discounts the relatively high headline CET1 ratios of Swedish banks in its methodology, and thus does not foresee any AT1 rating implications.

Nordea expects its future capital requirements to be addressed as part of the formal Supervisory Review and Evaluation Process (SREP) for 2018. If the Swedish proposal is passed and Finland reciprocally adopts it, depending on the timing, it could apply to Nordea at any time after the beginning of 2019.

Some analysts anticipate a release of equity by Nordea after its re-domiciling. Scope does not consider this as the most likely scenario, as Nordea has said that maintaining a capital position consistent with issuer ratings in the AA category is strategically important. Implementation of the FSA’s proposal to cover Nordea’s future Swedish branches of the Finnish bank would make such an equity release less likely, in Scope’s view.

In addition to Nordea, Scope has assigned issuer and debt ratings to Svenska Handelsbanken and to Swedbank. The ratings of both banks, A+ and A, respectively, are currently on review for possible upgrade and the agency expects the review to be concluded soon.

To see the full report, click here.

Nordea’s decision to move its headquarters to Finland, and Sweden’s loss of direct oversight over its largest bank has led to regulatory changes that will cut Swedish banks’ capital-to-RWA ratios. However, this does not imply weaker solvency, says Scope.

Once its switch to Helsinki is completed, supervisory arrangements for Nordea (rated AA- with Stable Outlook) will change. Scope Ratings notes in a new report that the European Central Bank, in conjunction with Finnish supervisors, will be primarily responsible for setting the group’s capital requirements under Banking Union rules. Sweden’s regulator, the FSA, is concerned that this could lead to competitive distortion in Sweden where players in the domestic mortgage market face different capital requirements for their exposures.

So, as of 31 December 2018, the FSA is proposing to apply a hard Pillar 1 requirement for Swedish residential mortgages under the provisions of Article 458 of the Capital Requirements Regulation (CRR). This allows a competent home supervisory authority to apply risk-weighting measures relating to systemic or macro-prudential risks. The changes will affect banks exposed to Swedish mortgages that have permission to use the IRB approach – and potentially includes branches of foreign banks subject to reciprocal agreements between Nordic regulators.

As a result, Swedish banks’ total capital requirements – a metric that investors watch closely – will decrease as a percentage of risk-weighted assets (RWAs). That’s because the denominator in the capital ratio – the risk exposure amount (REA) – will rise owing to the increase in risk weights on Swedish residential mortgages. The headline impact (with 4Q17 as the baseline) will be between 1.7% for Nordea and 9.1% for Swedbank.

Reported total capital ratios will also decline owing to higher REAs: the estimated reduction is 1.9% for Nordea and 10.1% for Swedbank.

“Investors should be clear that the anticipated fall in reported total capital ratios is a technical effect and doesn’t imply an overall weakening of Swedish banks’ solvency positions, although it may affect market perceptions of the banks’ AT1 securities,” said Jennifer Ray, a bank analyst at Scope, and author of the report.

“The issue is not just that Swedish banks’ reported capital ratios may no longer exceed most European peers by such a noticeable margin; reported CET1 ratios are also expected to fall, thereby cutting the ample headroom to the Maximum Distributable Amount (MDA) threshold the banks have,” Ray said. The MDA defines the point at which automatic dividend restrictions apply, potentially affecting banks’ AT1 securities.

The existing 25% risk-weight floor for mortgages via the Pillar 2 add-on arrangement is not a hard requirement so does not factor in Swedish banks’ MDA calculations. Even though that is being replaced, Scope already discounts the relatively high headline CET1 ratios of Swedish banks in its methodology, and thus does not foresee any AT1 rating implications.

Nordea expects its future capital requirements to be addressed as part of the formal Supervisory Review and Evaluation Process (SREP) for 2018. If the Swedish proposal is passed and Finland reciprocally adopts it, depending on the timing, it could apply to Nordea at any time after the beginning of 2019.

Some analysts anticipate a release of equity by Nordea after its re-domiciling. Scope does not consider this as the most likely scenario, as Nordea has said that maintaining a capital position consistent with issuer ratings in the AA category is strategically important. Implementation of the FSA’s proposal to cover Nordea’s future Swedish branches of the Finnish bank would make such an equity release less likely, in Scope’s view.

In addition to Nordea, Scope has assigned issuer and debt ratings to Svenska Handelsbanken and to Swedbank. The ratings of both banks, A+ and A, respectively, are currently on review for possible upgrade and the agency expects the review to be concluded soon.

To see the full report, click here.