Nordic agencies have long stood among the top tier of debt market borrowers. They are renowned for their top notch ratings and safe credit risk.
These issuers also form a prominent part of the public sector debt capital markets, receiving strong investor demand, allowing them to comfortably raise over €40bn combined annually for their funding programmes.
But that could all change.
Standard & Poor’s published its first ever tailored methodology for non-US public sector funding agencies in May, having previously rated these agencies — including the Nordic ones — using its criteria for banks, multilateral lending institutions and other financial institutions. It acknowledged that public sector agencies differ vastly from other institutions and therefore required their own criteria.
Following the publication of the new criteria, S&P placed all 10 of the affected agencies under review, of which four were from the Nordic region — Kommunalbanken, KommuneKredit, Kommuninvest and Municipality Finance.
The new methodology differs from the previous criteria by focusing on factors such as an issuer’s funding and liquidity profile, which was the main cause for the downgrade of Denmark’s KommuneKredit in July.
“KommuneKredit has one of the strongest enterprise risk profiles out of the 10 agencies, but its financial risk profile, such as the assessment of its liquidity position, is not as strong as the others,” says Carl Nyrerod, director in the international public finance practice at Standard & Poor’s in Stockholm.
S&P downgraded KommuneKredit by a notch from AAA to AA+, removing the triple-A rating it had held for 18 years.
While the ratings for the other three Nordic agencies are unchanged, they could also be in line for downgrades.
“In general, Nordic agencies have robust enterprise risk profiles but somewhat weaker assessments of funding and liquidity in relation to the funding gap analysis as prescribed by the criteria,” says Nyrerod.
A lower credit rating could mean wider spreads and lower deal sizes as a result of reduced investor demand.
Shortly after its downgrade, KommuneKredit was in the market with a benchmark issue, selling a five year in August with a spread of 12bp through mid-swaps.
The deal attracted a final book of over €900m, compared to the book of more than €2.4bn that it achieved for its previous five year benchmark in May. The Danish agency had to settle for issuing a size of €500m, a far cry from the €1bn it typically prints for a five year euro benchmark.
The spread was less of a concern, pricing just 1bp wider than the minus 13bp for its five year in May. However, the leads — BNP Paribas, LBBW and Sociéte Génerale — said they took a “cautious approach” in the pricing of the bond.
“We thought about [the impact of the downgrade] over and over again and it was the reason why we started at minus 10bp area,” said one SSA banker at one of the leads. “We originally planned to come in tighter. A more cautious approach was desired.”
Making adjustments
In response to the looming threat of a downgrade, some Nordic agencies are making adjustments to strengthen their funding and liquidity profiles.
“We have increased the duration of our funding throughout the year to match the duration of our lending portfolio,” says a funding official at one of the affected Nordic agencies.
However, KommuneKredit is not in any rush to make any adaptations to its funding profile, despite the downgrade.
“A lot of investors are curious as to what we are doing in response to the downgrade,” says Lasse Vest, vice president in KommuneKredit’s funding team in Copenhagen. “What we are working on right now is analysing our options. The goal is to come back to triple-A with S&P if there is no high cost involved.”
One option for the Danish agency would be to change its maturity profile to more evenly match its liabilities with its assets. KommuneKredit’s average maturity of funding is over five years, which is shorter than its 7.7 years for lending.
“While amending the maturity profile of our funding will help us in having our triple-A rating from S&P restored, it is not necessarily something that we will do,” says Vest. “If you add duration to your funding profile, it comes with a cost. Our mission is to provide low cost funding to our members and clients. It’s hard to do something radical that is not cost-effective.”
