Standard & Poor’s sees longer term, CITA shift in Danish mortgage lending

Standard & Poor’s expects a shift in the Danish mortgage market towards longer term and CITA-linked loans, despite questions about their popularity in light of the costs associated with such mortgage products.

The rating agency noted in a release on Tuesday that under CRD IV banks are required by 2018 to maintain stable funding sources for their assets over a one year horizon, and that Danish one year adjustable rate mortgage (ARM) bonds may not count as stable funding under the rules’ current formulation. It said this could potentially drive lenders to move towards longer dated bonds and loans over time.

“This could represent a considerable shift in the Danish mortgage market, where one year ARM loans currently account for about 50% of new mortgage lending,” it said. “Some Eu110bn of one year ARM loans mature in the next 12 months, according to Danish central bank figures.”

S&P said lenders could start to replace one year ARM mortgage products with ARMs that have longer reset periods, likely three years. It also noted that the Danish government will require from January 2014 lenders to offer floating rate mortgage products linked to the Copenhagen Interest Tomorrow/Next Average (CITA) reference index.

“Such products would provide mortgage borrowers with alternatives to floating rate loans linked to the Copenhagen Interbank Offered Rate (CIBOR) — a product offered mainly to commercial borrowers,” it said. “For example, in the second half of 2013, Realkredit Danmark will reportedly offer a new CITA-linked mortgage product, which it will finance with a three year bond referencing the six month CITA rate.

“The bank said it hoped that the new product would offer borrowers some of the advantages of the one year ARM loan, while increasing the maturity of its outstanding bonds.”

The rating agency said it would apply the same default probability adjustment to CITA loans as it does to ARM and CIBOR linked loans, meaning that asset default risk in Danish covered bonds is not expected to rise if such loans become more prevalent.

S&P said it sees the potential shift towards CITA mortgage loans as credit neutral for covered bonds.

“However, we note that longer dated Danish covered bond issuance could be less liquid than one year bonds in the short term, potentially pushing up interest rates on the associated mortgage products,” it said. “Questions also remain about the premium that banks will charge borrowers for prepaying such loans, which could limit their popularity.

“Nonetheless, longer dated bonds could begin to replace one year bonds over time, in our view.”