Denmark Cracks Down on Mortgage Banks as New Bill Not Enough

Banks operating in the world’s biggest mortgage-bond market per capita will be required to cut sales of short-term bonds as Danish lawmakers say a proposal unveiled this month to curb risks doesn’t go far enough.

Denmark wants banks in the nation’s $530 billion mortgage bond market to cut issuance of short-term bonds even after legislation addressing refinancing risks is pushed through, according to Benny Engelbrecht, spokesman for the ruling Social Democrats on the parliamentary committee overseeing banks.

“The mortgage industry shouldn’t use the new draft legislation as an excuse to continue issuing as many one-year bonds as they want,” Engelbrecht said yesterday in an interview in Copenhagen. “The level must come down.”

Investors and issuers are still reeling after the government unveiled a proposal this month that the mortgage industry says is unprecedented in the market’s two-century history. One-year bonds, criticized by rating companies and the central bank for being too short to finance mortgages as long as 30 years, would be extended by 12 months at a time if an auction fails, or if interest rates rise by at least 5 percentage points. The notes finance about 40 percent of Danish home loans.

Investor Premium

Pension funds including PFA, which manages about $67 billion in assets, have warned they’ll demand a premium to hold the new bonds as compensation for the risk of not being repaid when the notes fall due. Alan Boyce, chief executive officer of a joint venture backed by billionaire investor George Soros, is urging the government to exercise caution in “messing with” a model he says has functioned well so far.

The industry has already taken steps to curb issuance of the short-term bonds, and says there are limits to how much it can do. One-year mortgage financing peaked in September 2012, when it reached 1.3 trillion kroner ($228 billion) and accounted for 52 percent of the total. Issuance dropped to 47 percent a year later.

“We’ve started different initiatives to switch borrowers into other loans,” Karsten Beltoft, director of the Danish Mortgage Bankers’ Federation, said by phone. “But we can’t take away mortgages from people who want them. We can’t force borrowers to tap into other loan types. They have to choose themselves.”

Yield Effect

Shrinking supply of short-term mortgage notes is also contributing to lower yields. The home-loan unit of Danske Bank A/S, Denmark’s biggest bank, yesterday sold one-year bonds at an effective yield of 0.14 percent, the lowest on record, according to spokeswoman Hella Gebhardt Roennebaek.

Borrowers have flocked to the bonds after benefiting from lower interest rates. Denmark, whose modest public debt load supports a stable AAA rating, has cut interest rates to record lows to defend the krone’s peg to the euro. The nation’s benchmark deposit rate has been below zero since July last year. That’s driven down mortgage rates as Danes every year refinance more than half the nation’s gross domestic product.

Lawmakers in the $340 billion economy argue Denmark needs to respond to criticism from rating companies and to new stable funding rules designed to ensure banks can withstand a 12-month funding freeze.

Acknowledging Risks

Even bankers groups acknowledge there are risks.

“The need to protect the system against refinancing risks warrants that issuance of bonds with short-term refinancing must come down,” Beltoft said.

Though Denmark’s mortgage-bond market weathered the worst of the global financial crisis, homeowners refinancing their mortgages suffered a sudden surge in borrowing costs in 2008 after the failure of Lehman Brothers Holdings Inc. triggered a liquidity squeeze and sent Danish rates to an eight-year high. Back then, the government adjusted pension laws to allow the nation’s biggest investors to continue to hold mortgage bonds, which suffered from a market-wide sell-off, propping up the industry through swift intervention.

Adjustable-rate mortgage bonds, which can have maturities of one, three or five years, were first introduced in 1996. That started a shift away from the traditional fixed-rate, 30-year bonds that have underpinned stability in the mortgage system since its creation in 1797. Risks born of new mortgage products now need to be stemmed, Engelbrecht said.

New Regulations

“New regulations will require banks to tailor mortgage financing more closely to individual borrower profiles,” he said. “That in itself should also contribute to cutting issuance of short-term bonds.”

Engelbrecht also warned mortgage banks against assuming that refinancing risks are the only area lawmakers are watching. Standard & Poor’s and the central bank have cautioned against an over-reliance on interest-only loans following their introduction a decade ago. Since then, Danes’ reluctance to amortize has bloated private debt levels and households in the Scandinavian nation now owe their creditors 321 percent of disposable incomes, according to the Organization for Economic Cooperation and Development. That’s a world record.

“Just because lawmakers are now addressing the refinancing doesn’t mean the industry can lean back and ignore other potential risks,” Engelbrecht said.

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