Fitch: Danish bill tackles consequences, but not causes

Mar 27th, 2014

A Danish bill on conditional mortgage bond maturity extensions will help reduce liquidity risk, but does not on its own reduce refinancing risk in the country’s mortgage system, said Fitch, urging the industry to continue its efforts to tackle this risk by other means.

Christiansborg Castle, seat of the Danish government

Christiansborg Castle, seat of the Danish parliament

The new law was passed in parliament on 11 March and provides for the mandatory maturity extension of Danish mortgage bonds in certain stressed situations. Fitch — which acquired some Danish mortgage bond rating mandates after some issuers dropped Moody’s due to a disagreement over the latter’s rating approach — said that the new bill will address “some of the consequences of the Danish funding structure”, but does not address the causes.

“The maturity extension will transfer the refinancing risk from the mortgage institutions and their borrowers to the investors,” said the rating agency. “It does not address the significant refinancing concentrations created by a large volume of mortgage bonds being refinanced during a short time, nor the material proportion of short term interest-reset products in the market.”

It noted that the potentially systemic liquidity risk of a failed auction is cut by the law’s provision for an extension of the bonds, and that there is also an interest rate trigger — an increase by more than five percentage points on certain bonds since the previous auction — for extension.

Fitch assumes that a complete failure of a refinancing auction is extremely unlikely, and that the interest rate trigger would be the most likely driver of maturity extensions. If an auction did fail, however, the new bill would remove the need for the central bank to immediately step in with liquidity provision.

Because the bill does not, however, address refinancing concentrations and highly leveraged households, the Danish mortgage industry needs to continue efforts to lengthen the maturity profile of mortgage bonds, according to Fitch.

This is important “in this wholesale-funded mortgage system with a large mortgage bond market equivalent to around 140% of GDP”, it said.

“The industry’s more detailed assessments of mortgage affordability, recent initiatives to reduce interest tax deductibility, and increased interest rates on short term loan products are soft measures by international standards, but demonstrate a willingness by the authorities to deal with the problems,” added Fitch.

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