IMF Says Iceland’s Debt Relief Risks Housing Fund: Nordic Credit

Iceland’s plan to help households buckling under inflation-linked mortgages is bad news for the state’s Housing Financing Fund, according to the International Monetary Fund.

The government unveiled plans last month to reduce household debt by 150 billion kronur ($1.28 billion), in part by raising taxes on banks and offering tax breaks for homeowners. The move, which was a pre-election promise, risks backfiring because of the burden it will place on HFF’s balance sheet, according to the IMF.

“The household debt relief program will increase risks related to the HFF, because it will increase prepayments of mortgages held with the HFF,” Daria Zakharova, IMF mission chief to Iceland, said in an interview. “This will further aggravate its negative carry and it will require increased capital injections from the budget.”

HFF, which has 490 billion kronur in outstanding bonds that are guaranteed by Iceland’s Treasury, has been on the brink of insolvency as it loses market share and as households weakened by the nation’s 2008 collapse struggle to repay loans. The lender can only offer inflation-linked loans, which are losing out to regular mortgages from commercial banks.

Sigurdur Erlingsson, HFF’s chief executive officer, declined to comment in an e-mail from a company spokesman.

Capital Adequacy

The IMF, which is conducting stress tests, says it has seen estimates that Iceland may have to provide “about 10 billion kronur over the next four years” to the HFF to keep its capital adequacy ratio at the current 2.5 percent, half of the 5 percent regulatory minimum. The government has estimated it would inject 9 billion kronur through 2015, after already backstopping the fund with 46 billion kronur since 2009.

Iceland announced last month that it plans to provide homeowners with inflation-linked loans with as much as 80 billion kronur in direct debt writedowns and provide 70 billion kronur of tax exemptions over three years. More than half that relief will go to borrowers with loans from the HFF. The measure will partly be financed by a tax on banks.

Of HFF’s household loans, 11.8 percent are in default, with an underlying value of 77.1 billion kronur, according to an October report. Landsbankinn hf, Iceland’s largest lender, estimated in June it may cost the Treasury 100 billion kronur to save HFF from bankruptcy.


The government’s proposal, which is equivalent to 9 percent of Iceland’s $14 billion economy, also adds risks to the economy as a whole, according to the IMF.

“We have argued during our last mission to Iceland that across the board debt relief for households is ill-advised and that a better use of any new revenue, including in this case from the new bank levy, would be to lower the still-high public debt,” said Zakharova. Also, the chance that the measures put pressure on consumer prices and that the banks will resist the taxation through litigation are “serious risks,” she said.

“If the levy on the banks proves unworkable, the government may find it difficult to unwind the debt writedowns,” said Zakharova. “And this could eventually increase public debt.”

Higher Rates

The country’s central bank has strained to contain inflation, which soared as high as 6.5 percent last year. Inflation has since eased to below 4 percent after the central bank intervened in the currency market to boost the krona.

The central bank yesterday kept rates unchanged for a ninth meeting even as it warned that the government’s debt plans could spur faster tightening.

The government’s debt proposals “will stimulate domestic demand,” the bank said. “Given the scope of the debt relief measures and their distribution over time, a tighter monetary stance should suffice to bring inflation back to target in coming quarters.”

The island’s economic expansion is outpacing growth in the euro area and in the member countries of the Organization of Economic Cooperation and Development, according to the Paris-based group. The economy will grow 2.7 percent next year, compared with 2.3 percent of the whole OECD, the group forecast on Nov. 19.

While Iceland has made “impressive progress” there are still many “challenges,” according to Zakharova who also recommended that the country set up a committee to review the “institutional set up of the HFF from the ground up.”

“If the government thinks it should continue its commercial activities, there should be a viable solution found to the fact that they are facing a huge repayment risk and at the same time they have non-callable liabilities,” she said.

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