Next CB to Provide 3-Year Loans? Denmark

The Danish central bank will borrow a page from the ECB's playbook and provide 3-year loans to local banks next week (March 30). Denmark's banks (~120) have been largely locked out of the funding markets since senior creditors lost money when Amagerbanken failed a year ago.

Danish banks have to repay about DKK150 bln of state-backed debt next year. The take down of the three-year loans next week are likely cover around 2/3 of this. Some large Danish banks are reluctant to participate in next week's offering as it subordinates other senior creditors.

The three-year loans will carry an interest rate initially of the benchmark rate of 70 bp. The central bank uses interest rates to defend the DKK which trades in exceptionally narrow range against the euro. If it were to hike rates to defend the band the interest rate on the 3-year would rise as well. Recall the ECB's 3-year loans (LTRO) had an interest rate of 1%.

Like the ECB, Denmark's central bank has also liberalized collateral rules, which officials estimates frees up another DKK400 bln of collateral, allowing the top 2 of five tiers of assets to be used.

Denmark's housing market bubble ended in 2007. From then until the end of next year property prices are expected to decline by a quarter. Danish housing prices fell 8% at an annualized pace in Q4 11. Since 2008, a dozen banks have failed and the government has offered 4-5 different supportive packages, including state subsidies to merge. The government also provided loans directly to businesses as the bank lending dried up.

Perhaps most striking is that the Danish 10-year benchmark yield is essentially the same as the German yield (currently 1.85%). Yet in the CDS market, the cost of insuring Danish sovereign debt for five years is about 116 bp compared with 75 bp for Germany.

Where as the key repo rate in Denmark is lower than in the euro zone (70 bp vs 100 bp), the benchmark 3-month interbank rate is higher (Copenhagen interbank offered rate fixed at 98 bp today, while 3-month euribor is almost 81 bp.

The important take aways from this thumbnail sketch are 1) that unlike the major central banks who seem to have taken a wait and see attitude, the Danish central bank will be expanding its balance sheet; 2) that Danish sovereign bonds appear to be trading rich to Germany; 3) the fallout from the property bubble continues to be felt not only in the US, but Spain, Ireland, and Denmark; 4) given the tightly managed currency vs the euro, the DKK is unlikely to weaken despite the expansion of the central bank's balance sheet.