‘Be more conservative,’ Nationalbank’s Rohde tells Danish lenders

Denmark’s mortgage banks should take a more conservative approach to lending in a bid to reduce risks that the granting of overly accommodative types of loans and covered bond issuance have introduced, the country’s central bank governor said in a speech on Tuesday.

Lars Rohde, Danmarks Nationalbank

Addressing members of the Danish Mortgage Banks’ Federation, Lars Rohde, governor of Danmarks Nationalbank (DN), said that mortgage banks have granted customer-friendly loans that have increased risks in the Danish mortgage system, and that it was up to the industry to take steps within the existing legislative framework to reduce these.

He identified three main risks or challenges and their sources: refinancing risk and credit risk stemming from widespread use of adjustable rate loans; a continuous 80% LTV compliance requirement linked to covered and covered mortgage bond issuance; and the upcoming expiry of interest-only periods on deferred amortisation loans.

Extensive use of adjustable-rate loans has introduced a refinancing risk that did not exist previously, said Rohde, adding that the industry has helped reduce “the immediate risk of a doomsday scenario” by taking measures such as spreading refinancing auctions across a year.

However, credit risk in adjustable rate loans is another potentially destabilising mechanism, he said, and overall the popularity of such loans “has made it necessary to structure the mortgage credit business with a view to retaining investor confidence”. The best solution in his opinion is to reduce the loan-to-value ratio, for example to 60%, for adjustable rate loans.

Issuance of covered bonds and covered mortgage bonds has introduced a new type of risk, according to Rohde, because of a requirement to keep LTVs at 80% or pledge top-up collateral, which has to be financed and can be expensive.

“The solution is not to introduce the possibility of opting in or out of the obligations relating to covered bonds or to be more complacent about meeting the top-up requirements when housing prices fall,” he said. “That could dent the credibility of the system.”

Mortgage banks that issue covered bonds must take on the responsibility linked to ensuring the robustness of their business even if house prices fall, said Rohde, and this can be achieved within the existing legislative framework, for example by lowering LTVs.

The pending expiry of interest-only loan periods on the first deferred-amortisation loans is another source of risk in the context of lower house prices, according to Rohde, but the existing framework for prolonging interest-only loans should not be expanded.

“I cannot recommend that,” he said. “It would not support the robustness of the Danish mortgage credit system if homeowners do not reduce at least the peak of the loan that exceeds 80 per cent, especially since the rate of interest is currently close to zero — much lower than it was when these loans were raised.”

Plus, according to the central bank’s calculations, most homeowners will be able to meet the extra costs of financing the remainder via a more expensive bank loan with amortisation.

The Danish mortgage industry had proposed that borrowers with expiring interest-only loans be allowed to renew deferred amortisation loans for up to 80% of the value of their property and only have to amortise loan amounts in excess of that level, but this was rejected by the government recently.

Overall, the mortgage bank sector is in a position to address the challenges it faces by taking voluntary action, said Rohde, namely by taking “a slightly more conservative approach to lending”.

“Avoid going right to the limits — that will increase robustness,” he said.