Danish Regulator Cracks Down on Mortgage Banks as Risks Grow

Denmark’s financial regulator is preparing a set of guidelines due to be unveiled next year to stop mortgage banks falling deeper into a funding mismatch spawned by reliance on short-term borrowing.

The Financial Supervisory Authority, criticized in a government-commissioned report last week for failing to curb risk-taking in the years leading into the financial crisis, plans to set limits on issuance of bonds backing interest-only and adjustable-rate mortgages in the $500 billion market, Director General Ulrik Noedgaard said.

“This is an issue that we have been looking at for some time,” Noedgaard said in a phone interview from Copenhagen. “We are gradually shifting the mortgage system toward a less risky profile, and the institutions themselves have been working on that.”

A government-appointed committee investigating the causes behind Denmark’s housing and banking crises said last week regulators should have done more to prevent an explosion in lending. More than one-third of the country’s commercial banks have closed since a property bubble burst in 2008 and Denmark is now home to the world’s most indebted households, according to the Organization for Economic Cooperation and Development.

“What we will do during 2014 is to come forward with a model” to curb reliance on interest-only and short-term funding and then “issue which targets there should be and at what point they should be met,” Noedgaard said.

Impairment Ratios

Impairment ratios at Nykredit A/S, Denmark’s largest mortgage lender, and BRFkredit A/S hit five-year peaks in 2009 of 0.74 percent and 0.9 percent, respectively, according to FSA data. At Realkredit Danmark A/S, the mortgage arm of Denmark’s biggest bank Danske Bank A/S, the ratio that year was 0.2 percent.

“While mortgage banks have had quite low losses, there are some variations,” Noedgaard said. “One of the things we hope to accomplish is to look at what explains those divergences and to bring that into” the guidelines, he said.

The FSA’s standards will be based on recommendations from the crisis committee, Noedgaard said. The clampdown on lending follows warnings from Moody’s Investors Service, Standard & Poor’s and the central bank that a shift away from 30-year, fixed-rate mortgages over the past decade is threatening Denmark’s financial stability as funding maturities no longer match loans and as borrowers stop amortizing.

First Step

Though average interest-rate costs slipped “marginally” to 2.794 percent in August, the declines are about to come to an end, the Danish Mortgage Bankers’ Federation said today.

“Higher rates are a first step toward a normalization,” said Karsten Beltoft, the association’s director, in an e-mailed note.

Danish Business Minister Henrik Sass Larsen also urged Danes to prepare for higher interest rates, in a speech today. He criticized the mortgage industry for issuing too many interest-only and adjustable-rate bonds in the years before Denmark’s crisis.

Mortgage banks refinance close to $230 billion every year, equivalent to about two-thirds of Denmark’s gross domestic product. The industry has defended adjustable-rate and interest-only mortgages, arguing they helped prevent foreclosures during the crisis by reducing borrowers’ mortgage payments.

Still, banks have already taken some steps to wean investors and borrowers off the loans by raising fees. The industry, which before 2009 only held annual refinancings of adjustable-rate mortgages, is also trying to mitigate refinancing risks by spreading sales over quarterly auctions. The Association of Danish Mortgage Banks said this week it’s even exploring the option of tap issuance.

Comply or Explain

Mortgage banks will be expected to comply with the new FSA guidelines or explain, Noedgaard said. The standards will probably go beyond limits on mortgage lending to include other thresholds such as lending growth in certain industries, he said.

Lenders also will be given time to meet the levels to avoid hurting a fragile recovery in the housing market, and the agency will consider property price developments as it sets the levels.

“That will be an important part of the calibration,” Noedgaard said. In the past, “we stayed away from making tough regulatory proposals because we thought that, taking into account the state of the Danish housing market, the gradual approach would be the right way to go about this, and we still think that is the case.”

Property prices slumped about 20 percent from their peak in 2007, a year before Denmark’s housing bubble burst. Single-family house prices are now at 88 percent of their 2006 values after rising an annual 3.2 percent in the second quarter, the statistics agency estimates.

“We can’t change or shift some of the proportions very much in a short time span and we wouldn’t want to do that,” he said. “The important part is to have the right reaction and to have the right speed.”

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