Moody’s welcomes proposal to end one year ARMs bonds, but sees no Danish consensus
Monday, 9 January 2012
A phasing out of one year bullet bonds used to finance adjustable rate mortgage loans proposed by the Danish Mortgage Banks’ Federation (Realkreditforeningen) would be credit positive for Danish covered bonds and Danish issuers, according to Moody’s.
The Federation has called for such a move in response to regulatory pressure from domestic and international bodies – including the Danish central bank, European Commission and Moody’s – but the Association of Danish Mortgage Banks (Realkreditrådet) remains committed to the instrument. The Federation’s members are Danske Bank subsidiary Realkredit, Nordea Kredit and LR Realkredit, while the Association represents Nykredit, with its subsidiary Totalkredit, as well as DLR Kredit and BRFkredit.
Moody’s said in a comment in its Weekly Credit Outlook published today (Monday) that “in the end, the positive effect of these initiatives will depend on how market participants choose to implement them”. It noted that the Federation represents 43% of Danish mortgage lending and the Association 42%.
“So far,” it said, “there is no market-wide consensus on which suggestions to implement.”
(See article here for comments from the two associations on their positions.)
The rating agency said that the elimination of the one year covered bonds would be credit positive for the covered bonds because it would reduce their annual refinancing risk, and for Danish banks and mortgage credit institutions that widely use covered bonds for funding, investment and liquidity purposes.
Moody’s said that the refinancing risk of one year covered bonds is “significant” because issuers depend on regular market access to roll over one year bonds that finance 20-30 year mortgages. It noted that the volume of one year bonds has increased from less than Dkr100bn in 2000 to Dkr1.2tr (Eu162bn) as of the third quarter of 2011, which is half of outstanding mortgage debt and equivalent to almost 70% of Danish GDP.
The rating agency noted that mortgage credit institutions have worked on several strategies to mitigate the refinancing risk, but said that these were insufficient to change its opinion.
“These include spreading the covered bond auction dates over the year and restricting the leverage of loans backing the covered bonds, which reduces credit risk and thus mitigates refinancing risk,” said Alexander Zeilder, senior analyst on covered bonds at Moody’s. “Several suggestions publicized so far to address refinancing risk are credit positive but are not strong enough to change our key credit assumptions because on their own these changes do not fully remove the refinancing risk inherent in one year bonds.
“Removing refinancing risk would be achieved if one year bonds were replaced by a revival of traditional Danish bonds where loan and bond amortisation as well as maturity dates are matched.”
The Danish Mortgage Banks’ Federation has said that a move away from one year bullet bonds would also make sense because they are penalised under proposed net stable funding ratio (NSFR) requirements under Basel III, and Moody’s said that lengthening the maturity of issuance would ease Danish banks’ ability to comply with the new framework.