Factors in Jyske Bank’s and Sydbank’s decisions to pool home loans (prioritetslån) in a BRFkredit capital centre for financing through SDOs include savings that will be made against senior unsecured issuance and achieving a critical mass for issuance, officials at the banks told The Covered Bond Report.

The two banks will refinance the lending via covered bonds (SDOs) issued by BRFkredit’s capital centre E. Arbejdernes Landsbank has initiated plans to do likewise and is seeking approval from the Danish FSA.

Sydbank and Jyske Bank had previously financed home loans through senior unsecured loans, but costing as much as 200bp more than covered bonds, this has become very costly. For example, 2.5 year senior unsecured debt from Jyske Bank would have to pay about 125bp-150bp more than a covered bond, with senior spreads at 175bp-200bp, according to Steen Nygaard, head of treasury at Jyske Bank.

“We would like to have term funding, and we needed a new source of funding because senior unsecured is very expensive,” he told The Covered Bond Report.

Jacob Skinhøj, chief analyst at Nordea Markets also said that funding home loans through senior unsecured issuance had become very difficult for banks. He also suggested that Basel III may have played a role in the move.

“All banks in Europe are trying to reduce their balance sheet,” added Skinhøj, “so I think this is in part due to Basel III.”

Another analyst suggested that although Basel III was a possible factor for the move, it would only minor.

“It’s not Basel III that is the main reason, but that spread between senior and covereds” he said.

Nygaard confirmed Basel III had also played a small role in the decision as one of the reasons for adding another source of term funding.

Whatever the reason, Michael Pedersen, portfolio manager at BRFkredit, said the agreement means the banks will have access to very cheap funding.

“Jyske Bank has said it will be able to compete on pricing now with Danske Bank and Nordea,” he said.

The typical loan to value (LTV) ratio is expected to be about 60%, according to Mogens Kristensen, general manager at Sydbank. Home loans with an LTV exceeding 80% at the time of transfer will be not be permitted into BRFkredit’s capital centre E.

According to one market participant, the process will involve Sydbank and Jyske Bank transferring their home loans to BRFkredit’s capital centre because of strict Danish covered bond legislation. After a transfer, individual checks will then be performed on all the loans.

Another said that Jyske Bank and Sydbank will also guarantee losses above an LTV level of 50%.

Skinhøj at Nordea said BRFkredit is gaining from the situation in that its liquidity in covered bonds will improve. He expected issuance of SDOs to grow by about 10% of BRFkredit’s total covered bond book within a couple of years. Another analyst put that number at about 5%-10%.

Together, Sydbank and Jyske Bank expect to contribute Dkr20bn (Eu2.69bn) in home loans for capital centre E. Sydbank has Dkr6bn in home loans on its books and Jyske Bank around Dkr14bn, but only loans originated since the FSA gave its approval are allowed to be transferred to BRFkredit under the terms of the agreement.

Nygaard at Jyske Bank said the bank is planning to ask the FSA for approval of its pre-existing loans. Loans that are less than six months old are expected to be the easiest to get approved, while older loans might be a bigger obstacle, he said.

Kristensen said Sydbank will not transfer a large amount of home loans.

“The FSA wanted to be sure that we followed the strict rules of the legislation, which is why we are starting with the loans originated from the day this was approved,” he said.

Part of the reason for working with BRFkredit is that neither bank had enough loans to issue its own covered bonds.

“Issuing covered bonds out of your own institution requires a large critical mass,” said Nygaard at Jyske Bank. “We wanted to find a partner to work with us; we never had an ambition to go to the market alone.”

Kristensen said Sydbank had considering issuing covered bonds itself but it also did not have a large enough volume of loans, whereas the arrangement with BRFkredit was more advantageous.

“BRFkredit already has about Dkr100bn in its capital centre E,” he said, “so with Jyske Bank, we will start with liquidity from day one.”

Sydbank and Jyske Bank have promised the new development will not affect their pre-existing respective relationships with Nykredit/Totalkredit and DLR Kredit whereby they refinance traditional mortgage loans (realkreditlån) for those banks. Traditional mortgage loans are offered at a much lower interest rate than home loans.

“This relationship will be just the same,” said Nygaard at Jyske.

Morten Baekmand, head of investor relations at Nykredit, said the two banks account for about a quarter of Totalkredit’s Eu63bn in traditional mortgage loans, as two of more than 90 participating banks.

Baekmand said the agreement between BRFkredit and Sydbank and Jyske Bank was “positive for the banks’ funding situation”.

He added that the market would be very small for this programme compared with the traditional Danish mortgage market.

“The banks have said the loans will end up being about Eu2.5bn, compared to Eu340bn in the Danish market overall,” said Baekmand.

Market participants expected other issuers to approach BRFkredit in the future.

“I think you will see interest in this because it’s a very good model,” said Kristensen.

Skinhøj at Nordea said he expects other small banks to join with BRFkredit, too. He noted that BRFkredit was the only independent mortgage bank, with the remaining five all being owned by banks, rendering BRFkredit the only mortgage bank likely to enter into such an agreement.

Nygaard at Jyske said he knew BRFkredit was open to other banks approaching it.

“How the BRFkredit and banking sector relationship develops from here is an open question,” he said.