Rescue Plan for Danish Mortgage Market Puts Ratings in Doubt

Credit assessments for all short-term Danish mortgage bonds will probably need to be reviewed after lawmakers unveiled a plan to extend their maturities, according to Fitch Ratings.

“The base case scenario will now be completely different,” Cosme de Montpellier, a London-based senior director for covered bonds at Fitch, said yesterday in a phone interview.

Denmark’s government presented its latest draft proposal today that, if approved, will extend maturities on one-year bonds by 12 months at a time if refinancing auctions fail or if rates rise more than 5 percentage points between auctions. The government plans to extend the feature to other short-term covered bonds to protect an economy that’s dwarfed by the nation’s $530 billion mortgage market.

Business Minister Henrik Sass Larsen presented a first draft of the plan on Nov. 6, four months after Standard & Poor’s said existing legislation and industry measures were failing to resolve refinancing risks. The government proposal also follows central bank criticism of the mortgage system’s over-reliance on one-year bonds to finance home loans as long as 30 years.

Industry Ignored

Today’s proposal rejects an industry plea to drop the 5 percentage point trigger for all short-term bonds, a measure mortgage banks argue will give borrowers a false sense of security and add an unnecessary layer of complexity to the market. In a compromise, the government limited the 5 percent trigger to notes shorter than three years.

“The interest-rate trigger had been particularly harshly criticized by both the mortgage industry and some investors,” Jan Weber Oestergaard, senior analyst at Danske Bank A/S, said in a note. “The latest draft eases application of the interest-rate trigger.”

The Business Ministry wants to make its proposal binding for one-year notes from April, and for other short-term bonds from 2015.

Denmark hasn’t yet provided enough information to show how its proposal would work for Fitch to decide how ratings will be affected, de Montpellier said yesterday. Raters and investors still don’t know what constitutes an auction failure or what the legal maturity date is for bonds affected by the proposed legislation, he said.

The government said today bonds whose maturity is extended if rates rise more than 5 percentage points will carry the rate from the previous year’s auction plus 500 basis points. If the note is extended again, rates won’t be reset, according to the proposal. Issuers in resolution will have their short-term notes converted into longer-term bonds that take the maturity of the home loan they back, at a fixed rate.

Issuer Ratings

Though the proposal calls into questions bond ratings, it probably won’t affect issuer ratings, Jens Hallen, a director at Fitch, said yesterday in a phone interview.

The plan “provides clarity on what will happen and that is positive,” Hallen said. “But in terms of what goes into our rating, for the auctions to fail has already effectively been taken into consideration.”

The government has already amended its proposal once, after banks and investors balked at the initial Nov. 6 plan to extend maturities by as much as 30 years.

Though a subsequent decision to limit the extension to 12 months at a time met with industry favor, the proposal still has critics.

Adding a mechanism that changes maturities on existing bonds builds a layer of complexity into a model that has so far performed well because of its simplicity, according to Jesper Rangvid, a finance professor at Copenhagen Business School and head of a government-appointed committee that investigated the causes of Denmark’s housing and banking crises.

Market Complications

“This structure complicates the covered bond product,” Carsten Madsen, an executive vice president at mortgage lender BRFkredit A/S and incoming chairman of the European Covered Bond Council, said in an interview. “It’s not very usual that legislation is put on the table like this one was.”

Madsen questions the government’s decision to make changes to a two-century-old market without properly consulting with the industry first.

“It could have been worked out more thoroughly,” Madsen said. “It is sort of complicated stuff, and it’s not something that you just change or do in a couple of days. The devil is in the details and you should respect that.”

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