Banks issuing bonds in Denmark’s $500 billion mortgage market face possible downgrades as refinancing remains concentrated in too few auctions, according to Standard & Poor’s.
Four years after agreeing to move away from annual December bond offerings, the quarterly auctions banks settled on haven’t spread out sales enough to reduce the risk that there might not be buyers for the short-term bonds refinancing mortgages as long as 30 years, said Per Tornqvist, a Stockholm-based analyst at S&P.
“Spreading out the auctions hasn’t to date sufficiently improved ratios that we measure, and still leaves us with Danish banks scoring comparatively poorly to their peer group of banks globally,” Tornqvist said in an interview.
Danish lenders, including Nykredit Realkredit A/S and Realkredit Danmark A/S, the mortgage arm of Danske Bank A/S, are struggling to figure out how they can keep offering their most popular product -- adjustable-rate loans -- without incurring downgrades from S&P. The funding mismatch inherent in their refinancing model presents a risk and lenders need to take steps over the next two years to reduce the funding or face downgrades, according to S&P.
Nykredit’s index of the most-traded Danish mortgage bonds was at 401 at the end of last week, compared with a high of 411 in May, according to data compiled by Bloomberg. Bonds in the index have returned 34 percent since the end of September 2008, when the collapse of Lehman Brothers Holdings Inc. sent global financial markets into a tailspin. U.S. Treasuries longer than one year have returned 20 percent over the same period. Since the crisis began more than five years ago, investor have remained loyal to Denmark’s mortgage-bond market, which hasn’t seen any defaults in its more than 200-year history.
Still, the biggest banks in AAA rated Scandinavia are more vulnerable to funding shocks than peers in the U.S., France and Italy, S&P said in July. The International Monetary Fund also warned Sept. 5 that the region as a whole must do more to fortify its banks. If global wholesale financing markets tightened sharply, the region’s banks would be hit “hard,” the Washington-based organization said.
About 50 percent of Danish borrowers refinance their mortgages each year to get new interest rates, resulting in bond sales as high as $228 billion annually, according to the Financial Supervisory Authority in Copenhagen. That’s an amount equal to about 66 percent of Denmark’s economy.
“It’s appropriate that banks can operate without access to the market for about one year,” Tornqvist said. “That can be achieved in different ways.”
Nordea Kredit, the mortgage arm of Nordea Bank AB, last week became the second lender in two months, after Realkredit Danmark, to offer loans that are financed by three-year bonds and carry a rate that adjusts every six months. The Stockholm-based bank also said Sept. 12 it will raise prices from Jan. 1 on adjustable-rate loans, better reflecting their risk while keeping margins on conventional, fixed-rate loans.
Supplementing loans financed by longer bonds with more auctions and even selling them through tap issuance, as Swedish banks do, would have a greater effect on reducing risks than just offering the new products alone, Tornqvist said.
“Longer maturities, in combination with an even spread of the debt to be rolled over, is the mechanics of managing refinancing risks,” Tornqvist said.
Denmark’s mortgage banks agreed to move to quarterly auctions of adjustable rate mortgages in 2009, a year after the collapse of Lehman Brothers froze short-term funding markets. They have since largely based new loans on bonds maturing in April, July and October, reducing the amount needed to be refinanced in December to about half.
The lenders have had limited success in switching borrowers to longer-maturity loans as benchmark rates in Europe remain at record lows as the region emerges from a recession.
The industry has said borrowers have benefited from the loans, which helped them tap into record-low rates after Denmark became a haven from Europe’s debt crisis. Denmark resorted to negative interest rates last year in response to a capital influx that had threatened the krone’s peg to the euro, pushing mortgage rates to record lows.
In August and September auctions, borrowers refinanced almost 90 percent of the bonds due Oct. 1 and that were used to fund adjustable-rate loans, Jan Oestergaard, a senior analyst at Danske, said last week. Of that, 86 six percent were one-year bonds.
“If you issue one-year debt only, you remain reliant on the market being open at all times,” Tornqvist said. “Spreading out auctions generally is something we have been watching, because it can have an impact on our assessment.”