The one-year mortgage bonds that helped homeowners keep up debt payments during the toughest months of Denmark’s recession now pose a threat to economic stability, according to the head of a government commission investigating the causes of the financial crisis.
“There is a risk, and the risk is relatively large,” Jesper Rangvid, a professor of finance at the Copenhagen Business School who’s overseeing an 11-person commission due to release its findings next month, said in an Aug. 5 interview.
Denmark stands out as the Scandinavian nation to have suffered most during Europe’s debt woes. Its debate on how to wean households off cheap, yet potentially volatile, debt echoes a dilemma facing policy makers across much of the globe, where the response to over-indebtedness has been to feed demand for borrowing.
Refinancing their mortgages annually saved borrowers as much as 50 billion kroner ($8.9 billion) since Denmark’s housing market collapsed five years ago, the Association of Danish Mortgage Banks estimates. Still, Danes relying on adjustable-rate mortgages took a hit in 2008, when the central bank sent rates to an eight-year high to stop krone assets being dumped.
The one-year bonds have been singled out by the central bank, Moody’s Investors Service, Standard & Poor’s and Fitch Ratings as being risky because they finance mortgages as long as 30 years. Rangvid’s committee will publish its recommendations in September.
Denmark’s $500 billion mortgage bond market is the world’s largest per capita. Since their introduction in 1996, adjustable-rate mortgage bonds have displaced traditional 30-year, fixed-rate loans to account for more than two-thirds of lending to owner-occupied properties. Loans that refinanced annually peaked last year at almost one-third of the $256 billion outstanding in residential mortgages.
“The amounts outstanding are so large, and the amounts that have to be refinanced yearly are so large,” Rangvid said. Though the fallout of Denmark’s housing bubble “would have been worse” if borrowers hadn’t been able to refinance and benefit from record-low interest rates, now is the right time to scale back issuance of the notes, he said.
Doing so would “make the system safer” albeit at the cost of a “small” decline in house prices, Rangvid said.
Though Denmark’s public debt load is half the euro-zone average, helping transform its bond and currency markets into havens from the turmoil in southern Europe, the nation’s housing collapse has undermined consumer confidence and stunted economic growth.
The $355 billion economy stalled in the first quarter after contracting 0.5 percent last year. Denmark was also in a recession in the final quarters of 2011, according to the statistics office.
Danes bear the world’s highest private debt burden, at 310 percent of disposable incomes, according to the Organization for Economic Cooperation and Development. Though households also boast some of the world’s biggest savings in the form of pensions and home equity, a more-than 20 percent slump in property prices since 2007 has eroded the value of those assets.
Against that backdrop, the option of annual refinancing helped households reduce their interest costs. Rates on the one-year bonds sank as low as 0.35 percent at auctions last year, compared with 3.5 percent on 30-year fixed-rate mortgages.
The price of Nykredit’s bond maturing April 2014 fell to a 19-month low today in Copenhagen trading. The bond declined to about 101.10 as of 12:10 p.m. local time, according to Nykredit prices available on Bloomberg. The yield was at 0.26 percent.
Yet Moody’s and S&P argue the “substantial mismatch” between funding and lending maturities needs to be addressed.
S&P last month cut its outlook on the ratings of Denmark’s biggest issuers, including Danske Bank A/S and Nykredit Realkredit A/S. Industry efforts to wean borrowers off the bonds may not be enough and regulatory intervention could be needed, according to S&P.
A committee appointed by the government to identify Denmark’s too-big-to-fail banks said in March systemically important lenders should aim to comply with a basic stable funding level from 2014, a step that could exclude one-year financing. That’s four years earlier than a net stable funding ratio to be set by the Basel Committee on Banking Supervision, which Denmark says it will incorporate into its final rules.
That’s not enough to bring about the necessary shift, according to S&P. The rating company criticized Denmark’s committee on systemically important banks for offering “very limited” guidance to the mortgage industry on how to meet stable funding requirements.
Some banks have indicated they’d welcome regulatory intervention rather than risk being the first to self-impose stricter funding rules. Mortgage lenders have already started scaling back issuance.
“The problem is that we cannot sit with all the main players around the table and agree, because this of course would be in violation of competition rules,” Eivind Kolding, chief executive officer of Danske Bank, said last week in an interview. That may ultimately necessitate a ban, he said.
“We don’t think there is a need for regulation,” said Peter Jayaswal, deputy director at the mortgage association. “The banks are taking different actions to ensure they’ve got the right risk profile. It’s better that way than to have some kind of regulation that would not be that flexible.”
The government and Financial Supervisory Authority argue that a ban on one-year bonds risks undermining a nascent recovery in Denmark’s housing market. House prices rose 0.5 percent in May from April, and 3.9 percent from a year earlier, Statistics Denmark said July 31.
“The position of the housing market is a strong argument for taking a quite gradual approach,” Ulrik Noedgaard, director general of the FSA, said in an June interview.
Rangvid argues higher mortgage rates are an acceptable price to pay to rid the economy of the risk annual refinancings pose.
“There are some good things about interest-only loans and variable-rate loans, and there are some risks,” he said “Probably right now, the risks are quite big, so we have to find some kind of balance.”