Icelandic Mortgage Bank HFF Needs Government Bailout

Four years after letting its commercial banks default on $85 billion, Iceland is preparing to bail out the nation’s biggest mortgage lender and dodge a junk rating from Moody’s Investors Service.

The bill for the capital injection is unlikely to exceed 13 billion kronur ($103 million), the government said in a statement to the stock exchange yesterday, confirming comments by Sigridur Ingibjorg Ingadottir, who heads the parliament’s welfare committee. Iceland’s Housing Finance Fund also “needs to renegotiate the terms of its debt,” Ingadottir said in an interview yesterday.

The lender, which had 516 billion kronur outstanding in bonds at the end of October, is the biggest issuer of debt in Iceland after the government. Foreign investors locked into kronur positions by capital controls in place since 2008 have bought HFF bonds for lack of alternatives. That’s driven asset prices higher and fueled inflation, spurring a vicious circle for the lender, which only issues mortgage debt linked to the consumer price index.

“There shouldn’t be any doubt about the government’s intentions to back the fund and I expect Moody’s will see it in the same way,” Styrmir Gudmundsson, a fund manager at Reykjavik-based Jupiter Capital Management hf, said in a telephone interview yesterday. “The proposed steps are positive and are likely to reduce the uncertainty clouding HFF’s operations.”

Under Review

While Moody’s on Oct. 5 affirmed HFF at Baa3, the rating carries a negative outlook and the lender’s standalone credit strength is under review for a downgrade. The affirmation of the rating, which is one step above junk, is based on an assumption that the government will refinance the fund by the end of the year, Moody’s credit analyst Oscar Heemskerk said in October.

The “risk is that there may potentially be a default at the HFF level, which is not paid for in time by the government,” Heemskerk said last month. “The government has strong reasons to fulfill their implicit guarantee. So we expect that investors get their money back,” he said.

The lender, which has fallen short of a 5 percent minimum capital requirement set by its regulator, is struggling to make debt payments as it loses market share to Iceland’s commercial banks. HFF, unlike the banks it’s competing with, can only issue mortgages indexed to inflation. Price growth exceeding 4 percent has put the fund at a disadvantage to rivals such as Islandsbanki hf and Arion Bank hf, which both provide standard mortgages. Consumer prices, which include changes in property values, rose an annual 4.5 percent this month after growing 4.2 percent in October, Statistics Iceland said today.

Callable Debt

Aside from changing the terms of its debt, HFF also needs to “get the owners of its bonds to agree to the debt being callable,” Ingadottir said. “That way the fund can pay up some of its outstanding debt using the available funds it has.” The fund subsequently said in a statement to the stock exchange that any change in repayment terms will be “in full cooperation with HFF’s bond owners.”

HFF securities were placed on a trading halt yesterday following Ingadottir’s comments. Market making in the lender’s bonds was subsequently suspended for the day. The fund then said that trade in HFF bonds would be adjusted “to temporarily increase the maximum market making bid-ask spread,” according to a statement to the stock exchange after markets closed yesterday.

‘Main Problems’

Ingadottir’s comments reveal “one of the HFF’s main problems in a nutshell: That the fund’s debts are not callable, whereas a substantial part of its lending, on the other hand, is callable,” Ingolfur Bender, an economist at Islandsbanki hf, said in a note. “The changed interest rate environment has brought this problem to light and it is unlikely to disappear any time soon, regardless of the capital contribution to the fund.”

Iceland’s central bank has responded to accelerating inflation by raising rates. Policy makers increased the benchmark lending rate a quarter of a percentage point to 6 percent on Nov. 14, as price growth remains well above the bank’s 2.5 percent target.

The government will now seek lawmaker backing to help HFF raise its capital to reach a minimum ratio of 3 percent, with as much as 13 billion kronur needed to reach that goal, according to a statement sent to the stock exchange following Ingadottir’s comments. The proposal will be put to parliament for inclusion in the 2013 budget.

Open Wound

If Ingadottir’s “remarks are correct, about the need for renegotiations with the creditors of HFF, it’s clear that HFF is facing a serious problem,” Bjarni Benediktsson, the leader of the opposition Independence Party, said in comments published on his Facebook page yesterday. “It’s obvious that the measures the government is introducing now are like a plaster on an open wound.”

HFF received 33 billion kronur in new funds from the government in 2010, after its capital adequacy ratio fell as low as 2.3 percent following the island’s 2008 economic collapse. The lender’s capital ratio was 1.4 percent last quarter.

Iceland has spent the last four years resurrecting itself after its biggest banks failed, an event that plunged the nation into its worst recession in six decades. The island emerged from a 33-month International Monetary Fund-led bailout in August last year.

The plan to save HFF is “just a first step toward placing the management of the Housing Finance Fund on a firmer footing in the long term,” Bender at Islandsbanki said.

To contact the reporter on this story: Omar R. Valdimarsson in Reykjavik valdimarsson@bloomberg.net.

To contact the editor responsible for this story: Jonas Bergman at jbergman@bloomberg.net.

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