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The Impact of the Credit Crisis on Nordic Counterparties. Nordic Capital Markets Forum Peter B Nowell. 26 February 2008. Contents. Section 1 Distribution of US sub-prime RMBS 03 Risk retention in CDOs of ABS 04 Leveraged funds 05 Section 2 European Credit Spreads 06

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The Impact of the Credit Crisis on Nordic Counterparties

Nordic Capital Markets Forum

Peter B Nowell

26 February 2008


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Contents

Section 1

Distribution of US sub-prime RMBS 03

Risk retention in CDOs of ABS 04

Leveraged funds 05

Section 2

European Credit Spreads 06

UK Banks / Spanish banks 07

Norwegian municipalities 08

Liquidity portfolios 09 Nordic securitisation 10

Restructuring SIVs 11

Pricing credit, liquidity and volatility 12

. . .


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Distribution of US sub-prime RMBS

  • Bonds sold to

    • US Agencies

    • Money market funds

    • SIVs

    • CDOs of ABS

    • Hedge Funds

  • Minority sold to real money investors such as insurance companies, pension funds

Capital structure


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Risk retention in CDOs of ABS

  • Equity tranche sold to hedge funds

    • Funds use income to short ABS markets through CDS, ABX indices

  • Mezzanine tranches sold to investors or other CDOs of ABS

    • Risk layering

  • “Super-senior” tranche retained by originating bank

    • Well above rating agency AAA attachment point

    • “Risk remote”

Hybrid CDO of ABS


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Leveraged funds

  • Leveraged investors

    • Able to leverage up to 33 times on AAA assets, 10 times on BBB

    • Now reduced to 5 times on AAA, no leverage against BBB

  • Bear Stearns Funds

    • Invested in AAA CDOs of ABS and CLOs

    • Leveraged 10 times or more

    • Collateral seized during June 2007

    • Attempt to auction bonds failed, pushed all structured credit markets down

    • Funds went into liquidation in July 2007, no recovery for investors is expected.


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European Credit Spreads

  • Rising credit spreads for all

    • RMBS/CMBS spreads too wide for securitisation to provide cheap funding on its own

    • Bank cost of funds significantly higher, but not as wide as CDS spreads

    • Focus on covered bonds, repo with ECB for funding

    • Even sovereign spreads in CDS are wide – but government bonds still issued at low yields – positive basis


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UK Banks / Spanish banks

  • Bank of England

    • Restrictive use of collateral for repos

    • Stigma of using emergency funding from BoE – Northern Rock

    • Sale of assets or expensive interbank funding instead – Alliance & Leicester, Bradford & Bingley

  • Bank of Spain

    • Consistent with European Central Bank requirements for repo

    • Accept AAA EUR RMBS as collateral

    • Increase in repos from Spanish banks from EUR 18 bn in August 2007 to EUR 40 bn in January 2008

    • Mainly from new issue RMBS deals retained by originators for use as repo collateral

  • Comparisons with Nordic central banks

    • Sweden admits SEK or EUR assets including CLOs

    • Norway accepts corporate bonds with sufficient haircut

    • Denmark is very restrictive on collateral


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Norwegian municipalities

  • Borrowing to invest

    • Several Norwegian municipalities borrowed money secured on future revenues from levies on hydroelectric power product

    • Borrowings were invested in capital markets products that were themselves leveraged

    • Chain of participants – Citigroup -> SEB -> Terra Securities -> Municipalities

    • Legality of borrowing, capacity, misrepresentation, client understanding


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Liquidity portfolios

  • Eksportfinans 15/2/08

    “The turmoil in the international capital markets throughout the third and fourth quarter of 2007 has been challenging to Eksportfinans and led to unrealized losses in Eksportfinans’ liquidity portfolio. 

    The portfolio consists of highly rated bonds with strong creditworthiness. The losses in the liquidity portfolio are likely to be reversed gradually, based on the bonds’ maturity. However, the unrealized losses do affect Eksportfinans’ results for 2007. Eksportfinans is not exposed to mortgage loans or sub-prime loans in the United States . 

    Due to the situation in the international capital markets, the Group experienced a loss of NOK  149 million for the year 2007 compared to a profit of NOK 159 million in 2006. Profit excluding unrealized gains and losses on financial instruments amounted to NOK 294 million in 2007, compared to NOK 243 million in 2006.

    In December 2007, Eksportfinans announced an issuance of NOK 1.2 billion in new share capital from existing owners....”

  • SBAB 31/1/08

    “SBAB’s liquidity portfolio is a liquidity reserve intended to manage liquidity and refinancing risk. SBAB has liquidity reserves that correspond to liquidity requirements for 30 days or more. The liquidity portfolio has no exposure to the US residential mortgage market or to sub-prime loans in any other market. The portfolio amounted to SEK 31.0 billion as per 31 December 2007. The bonds in the portfolio can be pledged at the Riksbank or the European Central Bank. SBAB values each security individually at market value and reports the change in value in the income statement. Consequently, the unrealised change in market value affects the net operating income. The change in market value as per 31 December 2007 amounted to SEK -616 million and is a result of the financial turbulence that affected the credit market during the second half of 2007.”


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Nordic securitisation

  • Danske Bank’s synthetic securitisation

    • Spreads significantly wider since 2007

    • Cost of capital for a new deal significantly higher

    • Super-senior risk no longer taken by monoline insurers

    • Return to raising capital through equity or convertible debt?

  • Other issuers

    • No RMBS deals yet from Nordea, SEB, SHB

    • Under Basel 2 only mezzanine tranches are attractive to distribute – retain AAA and super-senior risk anyway


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Restructuring SIVs

  • Jyske Bank

    • Investments in capital notes of Structured Investment Vehicles (SIVs) – usually rated BBB and historically paying Libor+250-300 bps from a leveraged portfolio of AAA / AA rated ABS and bank subordinated debt

    • SIVs funded largely through ABCP and short dated MTNs

    • During 2007 cost of funding rose dramatically and returns to capital noteholders disappeared

    • Investors encouraged to do “vertical slice” transactions – sell back capital notes at a discount and buy the underlying ABS at a neutral mark to market effect

    • SIVs shrink and require less CP funding as a result

    • Jyske Bank exchanged DKK 150 mio for DKK 1.5 bn of underlying assets – mark to market hit as a result

    • Will benefit from “pull to par” as assets approach maturity – WAL of 3-4 years

    • Still invested in Gordian Knot and CDOs


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Pricing credit, liquidity and volatility

  • Importance of liquidity

    • Icelandic banks 365 days+ of liquidity now needed to tide them over

    • Countrywide drew down on its USD 10 bn of liquidity lines – Northern Rock had less than USD 2 bn of contingent liquidity

  • Impact of pricing

    • Banks returning to lend and hold as markets become more difficult

    • Securitisation will return but focus on covered bonds in the meantime

    • Opportunities for Nordic banks to expand as investment banks and others reduce balance sheet and lending in all regions

    • Difficulties for medium sized institutions in receiving credit lines as risk limits reduce in a cautious environment

  • Impact of volatility

    • Clients sitting on the sidelines in case bonds become cheaper tomorrow

    • Loans, guarantees and non-MTM products more attractive

    • Back to basics in risk management