By Sujata Rao and Carolyn Cohn
LONDON, Jan 10 (Reuters) - Investors who once flocked to Iceland’s booming economy now see the country’s banks as more exposed to the global credit crunch than many less developed markets, pushing the price of credit insurance to record levels.
Iceland’s banks have been on a borrowing spree in recent years to fund an expansion out of their tiny home economy and have invested in overseas assets from the Netherlands to Hong Kong.
Their assets now are seven times the gross domestic product of Iceland, a thinly populated country of 300,000 people but with one of the world’s highest per capita incomes.
The problem is that the banks’ expansion has been financed mostly via wholesale funding, a strategy that involves raising cash through money, loan and bond markets rather than deposits.
That all worked well in the cheap-money environment of recent years. Now with credit costs having soared and global financing channels shuttered, investors fear these banks — like highly leveraged institutions anywhere in the world — may find it hard to refinance debts rolling due in the near future.
That has prompted investors to take out insurance protection via credit default swaps — derivatives to hedge against default or restructuring — and premia on the A-rated banks have raced to record levels which in some cases outstrip sub-investment grade emerging markets like Ukraine or Turkey.
Kaupthing KAUP.IC is estimated to have some 300 billion Icelandic crowns ($5 billion) of debt maturing in 2008. Glitnir GLB.IC has a similar amount but Landsbanki LAIS.IC has a manageable 76 billion.
Kaupthing’s five-year CDS have blown out to 380 basis points, a more than 10-fold rise from 26 bps in the middle of 2007.
CDS for Landsbanki at 220 bps and Glitnir at 285 bps have also widened more than 200 bps in this period. This compares with the 260 bps and 190 bps cost of taking out five-year protection on Ukraine and Turkey, which are rated a lowly BB-.
“(Icelandic banks) are among the most leveraged financial institutions in the world, and in the current environment, banks and countries that are most leveraged are getting beaten up the most,” said Danske Bank economist Lars Christensen.
“Not only are they highly leveraged but their assets are primarily in Scandinavian and UK retail and property, which is not the best combination these days.”
The other issue is the intricate structure of cross-holdings. Speculation this week of troubles at investment firms Gnupur and Exista EXISTA.IC hit the share market, which mostly consists of financials, many of which own stakes in each other.
But many say the outlook is not as dire as it looks because some trades in these CDS may be plays on swings in global risk appetite rather than specifically on Icelandic bank risk.
“These are high-beta banks and the market is heavy and to express a short this way is a fairly common trade. That dynamic has been in place a long time,” said Tom Jenkins, financials analyst at RBS Global Banking and Markets in London.
Iceland already underwent a stress-test last spring when rating agencies highlighted the economy’s macro-imbalances and the banks’ reliance on wholesale funding. Since then, the banks have tried to diversify investor bases and increase deposits.
While their loan-deposit ratios still compare unfavourably to most European peers, analysts point out that banks’ different strategies and profiles mean such comparisons can be misleading.
Fitch Ratings estimates customer deposits fund 42 percent of Kaupthing’s lending, versus less than 30 percent in 2004, while Glitnir’s deposit-lending ratio has risen to 37 percent.
The ratio for Landsbanki is a very respectable 75.5 percent, mainly due to its high-interest UK savings account Icesave.
All this should help banks weather the current liquidity squeeze, says Alexandre Birry, a banking analyst at Fitch.
“All banks are leveraged institutions but the nature of funding sources varies between banks. In the past few years, Icelandic banks have used wholesale funding sources to a great extent to fund asset growth,” Birry said.
“But the situation is evolving, they have recently been sourcing a larger proportion of funding in the form of deposits,” he said.
Tight markets are making the banks innovative. Kaupthing sold a debut Mexican peso bond in 2007 and acquired the offshore deposit business of Britain’s Derbyshire Building Society.
“They should be able to manage it (refinancing). Kaupthing’s Mexican deal was well-bought for example, there is still a deep dollar market and they can do private placements and syndicated loans,” Jenkins said. “However these are high-beta credits and they will struggle to outperform in the next few months.”
(Editing by Ruth Pitchford)
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