Basel Seen Defying Logic in Denmark as Rule Hits Mortgages

Photographer: Freya Ingrid Morales/Bloomberg

Newly-constructed residential apartments stand in Orestad on the outskirts of Copenhagen. Close

Newly-constructed residential apartments stand in Orestad on the outskirts of Copenhagen.

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Photographer: Freya Ingrid Morales/Bloomberg

Newly-constructed residential apartments stand in Orestad on the outskirts of Copenhagen.

Denmark is warning that the world’s biggest mortgage market per capita is again under threat from a proposal by the Basel Committee on Banking Supervision.

A plan to limit single counterparty exposures to 25 percent of a lender’s tier 1 capital isn’t feasible in a market dominated by four mortgage banks, according to the Danish Financial Supervisory Authority and industry groups. Complying with the requirement would introduce currency risks and erode the very liquidity that Basel has told banks to build, they say.

“One reason we have a functioning market with good liquidity is because we have few issuers,” Karsten Beltoft, the head of the Danish Mortgage Bankers’ Federation, said in an interview. “They issue a huge amount of bonds. If there were 10 issuers, there would be fewer bonds from each.”

Denmark has been fighting the Basel committee since the group in 2010 unveiled liquidity rules that the government in Copenhagen says betrayed a misunderstanding of how covered bonds work. After persuading European regulators to adjust Basel’s requirements to boost the status of its mortgage-backed bonds, Denmark is now readying itself for the next round in its battle to defend its $480 billion home-loan market.

“Once again we can see that on the Basel Committee there is no real understanding of European covered bonds,” Peter Jayaswal, a deputy director at the Association of Danish Mortgage Banks, said in an interview. “We can see that every time they don’t really acknowledge that some covered bonds are very safe and very liquid instruments.”

Bank Failures

Basel is proposing tightening its large exposure rule to ensure banks aren’t put at risk if a single counterparty fails. The committee previously targeted a 25 percent limit of total capital, a guideline national regulators had some scope to sidestep.

In its March proposal, Basel warned that adding more capital won’t protect banks against the risk of large customers defaulting. Basel’s own recommendations for calculating minimum capital buffers don’t address concentration risk while local regulators’ efforts are inconsistent, Basel said in March.

Loan concentrations were in part to blame for more than a dozen bank failures in Denmark after the nation’s property bubble burst in 2008. The $320 billion economy contracted 0.6 percent in the final three months of 2012 and stalled in the first quarter as depressed house prices and record private debt loads sap demand.

Yet Denmark’s mortgage bond market has managed to withstand the nation’s housing slump and recession, thanks to rules limiting loan-to-value levels and requirements on lenders to provide extra collateral when loan sizes exceed legal thresholds.

Beating Treasuries

The industry has pledged 299 billion kroner ($52 billion) in additional collateral, or 145 billion kroner more than legally required, to maintain credit ratings, the central bank said last month. The buffers are enough for the industry to withstand a 13 percent drop in property prices, it said.

The most-traded Danish mortgage bonds in the Nykredit Realkredit A/S index have returned 35 percent since September 2008, the month Lehman Brothers Holdings Inc. failed. U.S. Treasuries with maturities longer than a year delivered investors 22 percent in the period. The figures include re-invested interest.

Basel’s single exposure rule “would have severe consequences for the liquidity and well-functioning of the Danish financial market,” the Mortgage Bankers’ Federation, the Association of Danish Mortgage Banks and the Danish Bankers Association said June 28 in a draft of a response to the Basel proposal. The concerns were echoed last week by the European Mortgage Federation and the European Covered Bond Council.

Pimco Purchases

Denmark’s mortgage bond market is four times the size of its outstanding government debt, and the country’s banks meet liquidity needs by holding about five times as much in mortgage securities as they do in government bonds.

The majority of Denmark’s mortgage bonds are sold by its four biggest lenders: Nykredit, Europe’s largest issuer of mortgage-backed covered bonds; Realkredit Danmark A/S, the mortgage unit of Danske Bank A/S (DANSKE); Nordea Kredit, the Danish mortgage arm of Nordea Bank AB (NDA); and BRFKredit A/S.

The depth and safety of Denmark’s AAA rated mortgage bond market has drawn investors including Pacific Investment Management Co., the world’s biggest bond fund. That’s held mortgage rates at record lows and eased the pain of the housing slump.

Currency Risks

A limit on single exposures would drive up interest rates and introduce currency risks as banks seek out other assets to meet their liquidity needs, the bankers groups said. They’re urging Basel to “consider the possibility for full or partial exemptions” in cases where there’s no history of default and “where the exposures in question play an essential role in the liquidity and well-functioning of the financial market,” according to the June 28 draft response.

Investor demand for the mostly AAA bonds has driven rates to record lows, easing the effect of a housing slump now in its fifth year. Interest payments fell 12 percent in May to 3.9 billion kroner, a record low, the Association of Danish Mortgage Banks said June 28.

The Danish mortgage bond market hasn’t suffered any defaults in its more than 200-year history. “That should be taken into account,” Jayaswal said. Basel should “allow for the possibility of full or partial exemptions,” he said.

To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at fschwartzko1@bloomberg.net

To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net Christian Wienberg at cwienberg@bloomberg.net

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