Danes face up to IO loan threat amid destabilisation warnings

Denmark’s mortgage banks are persevering with efforts to find a way of easing the impact on borrowers of the upcoming expiry of interest-only loan periods after recently having had a proposal rejected by the government, as rating agencies and the IMF warn about the risks posed by such loans.

Denmark allowed mortgage lending on a maximum 10 year interest-only basis in October 2003, and such loans have been very popular since then, accounting for 54% of total mortgage lending at the end of 2012. The original 10 year interest-only period expires in October this year, with the majority of such loans due to expire between 2017 and 2020, according to Standard & Poor’s.

The prevalence of interest-only loans and the approach of amortisation requirements have prompted concerns about borrowers’ repayment capacity in the context of high levels of household indebtedness and lower house prices and the impact this could have on the Danish mortgage system.

In a report published in January the International Monetary Fund, for example, called for “deferred amortization” mortgage loans to be limited for macro-prudential reasons and said that such loans contribute to a threat of higher delinquencies given high debt levels of Danish households.

Standard & Poor’s last Monday (25 March) said that the requirement for borrowers on interest-only loans to start amortising their debt could threaten the Danish mortgage market.

“As increasing numbers of interest-only loan periods will expire, this challenge could destabilise the Danish mortgage market as borrowers face potential dramatic increases in their instalments,” said S&P credit analyst Casper Andersen. “This could in turn lead to a sharp increase in arrears and potential foreclosures.”

Denmark’s mortgage banks have been busy anticipating the onset of repayment obligations by exploring possible solutions for those borrowers that may have difficulty amortising their loans, with uncertainty over whether or not they will be able to take out a new interest-only loan at the heart of the issue.

Under Danish legislation borrowers on a loan with an interest only period cannot be granted a new such loan if LTVs are over 80%, although Danske Bank senior analyst Jan Weber Østergaard noted that this is possible on condition that “security is not hereby substantially reduced”.

According to Karsten Beltoft, director at the Danish Mortgage Banks’ Federation, the federation and the Association of Danish Mortgage Banks felt that they had come up with a proposal that addressed the challenge of rising mortgage payments and was in line with the legislation. This foresaw borrowers with expiring interest-only periods being allowed to renew interest-only loans for up to 80% of the property prices and only have to amortise loan amounts in excess of that level.

“The vast majority of borrowers will be able to pay instalments,” he said, “but for those customers who will struggle to do so and if they have LTVs above 80% we came up with a pragmatic solution that we felt was a move in the right direction and permissible under current legislation.”

However, in a meeting on 19 March the Danish ministry of business and growth rejected this plan, according to Beltoft.

“The FSA does not agree that our proposal is in line with current legislation, and we have to accept that,” he told Nordic FIs & Covered. “We are discussing other possibilities that we will discuss with civil servants in the next month or so.”

The governor of the Danish central bank, Lars Rohde, spoke out against the renewal of interest-only loan periods on occasion of the release of Danmarks Nationalbank’s Q1 2013 monetary review on 20 March.

“The security of mortgage bonds must not be open to question,” he said. “If you grant the option of rolling the interest-only term, even when the property is mortgaged almost up to the roof, I believe we would be contradicting ourselves when we at the same time argue that Danish mortgage bonds should be considered as secure as government bonds.

“It is our recommendation that no changes be made to the legislation on this area.”

Ane Arnth Jensen, managing director of the Association of Danish Mortgage Banks, would not be drawn on the efforts to find alternative solutions.

“We want to keep an open position,” she told Nordic FIs & Covered. “We want to be able to give borrowers proper advice and are in regular dialogue with the ministry to try to find a solution.”

Danske’s Østergaard said that the prevailing “intense” focus on interest-only loans is due more to due diligence than anything else given that the number of borrowers who might be face difficulties repaying loan principal will initially be relatively limited.

He noted that, according to Danmarks Nationalbank estimates, 5,000 families have loans with interest-only periods expiring in 2013 and that 1,000-1,500 of these have an LTV in excess of 80%.

“Calculations indicate that currently around 10% of borrowers with IO periods expiring over the coming 9-10 years may face difficulties with repayments —these estimates are based on 2010 interest rate levels, which are higher than at present,” he said. “All else being equal, this adds up to just a modest number of families with an LTV >80% plus limited financial capacity to begin making repayments.”

S&P’s Andersen said that overall mortgage market stability could be threatened by an increase in the percentage of borrowers with LTVs higher than 80%, although the magnitude of LTV breaches remains manageable.

“However, politicians as well as mortgage lenders should be aware that given current low interest rates, tax incentives, and Denmark’s weak economy, the solution to the high LTV ratios observed isn’t likely to come from borrowers as incentives to amortise remain limited,” he said.