Danish IO refi plan credit negative, says Moody’s

A proposal by Denmark’s mortgage banks to relax amortisation requirements for borrowers on interest-only loans is credit negative for Danish banks, Moody’s said on Friday, because it highlights pressure on asset quality in the context of high levels of indebtedness and weak housing markets.

Denmark allowed mortgage lending on a maximum 10 year interest-only basis in October 2003, according to Moody’s, and the expiry of the first 10 year period in October 2013 has prompted concerns about borrowers’ repayment capacity.

In November the Association of Danish Mortgage Banks and the Danish Mortgage Bank Federation put forward a proposal that borrowers with expiring interest-only periods could renew their interest-only loans for up to 80% of the property prices and have to only amortise loan amounts in excess of that level.

Under current legislation borrowers with mortgages exceeding loan-to-value ratios (LTVs) of 80% cannot take out a new interest-only loan, meaning that the first tranche of borrowers on 10 year loans would have to amortise the full amount from October 2013, said Moody’s.

“The mortgage institutions’ proposal would only require such borrowers to amortise loan amounts in excess of 80% of the property value, compared with the significant rise in additional monthly installments that would otherwise be due if full loan amounts were amortised,” said the rating agency.

It said that the proposal is credit negative for Danish mortgage institutions and banks as it underlines the increased credit risk related to mortgages with an interest-only period, although it reduces the short term pressure on borrowers.

The rating agency said that since 2003 the amount of interest-only mortgages has increased significantly, and constituted 54% of total mortgage lending at the end of 2012. However, it also noted that according to the Danish Ministry of Business and Growth, as a result of positive house prices increases over the past 10 years most households will be able to renew interest-only mortgages within the allowed 80% LTV cap.

“The share of households that would still have an LTV exceeding 80% is unknown, but industry experts indicate it may be up to10% of the affected 36,000 households,” said Moody’s. “This compares to 4,700 households in arrears at end-October 2012, according to the Association of Danish Mortgage Banks.”