Analysts at BRFkredit have put forward a proposal that Denmark’s mortgage banks limit the LTVs of mortgage loans in cover pools when property price rises exceed those explainable by fundamental economic factors, in an attempt to come to a compromise position for the industry.

If the LTVs of mortgage loans in SDO cover pools increase above those required by the Capital Requirements Directive, mortgage institutions have to add capital to the cover pools. However, observers have pointed out that in an extreme scenario this could prove very difficult or expensive.

As part of a five point plan to address pressures facing the Danish mortgage model, Nykredit last June said that it will introduce a two tier mortgage funding system, whereby mortgage loans with an LTV of up to 60% will be funded with SDOs and those with LTVs of 60%-80% will be funded through traditional ROs. The requirement to add capital does not apply to ROs, as they are not designed to meet CRD requirements.

However, other Danish institutions, such as Realkredit Danmark, have not followed Nykredit’s example, but are understood to be looking at basing initial LTVs on a longer term valuation of properties that would guard against so much capital being required should LTVs as currently calculated fall.

The proposal is aimed at being a contribution to the debate and not because BRFkredit is in favour of two tier mortgages, with BRFkredit preferring to avoid two tier mortgages by addressing the underlying causes in the legislation.

BRFkredit’s analysts have proposed that mortgage banks should work together and lower initial LTV limits for new loans funded in SDOs when property prices increase more than can be explained by fundamental economic factors. Funding in excess of the adjusted LTV limit will be obtained from a mix of ROs and traditional bank funding under their proposal.

“This reduces the extreme scenario risk of not being able to fulfill the requirement to stay within LTV limits for SDOs at all times without adding unnecessary costs in times of declining or steady property prices and thus reduces the procyclical nature inherent in the current mortgage model,” said Thomas Kilde Krath, financial analyst at BRFkredit.

According to Lenn Mikkelsen, financial analyst at BRFkredit, they are seeking a common solution for the Danish mortgage system as having standardised features would make it easier for borrowers and investors. He said that their proposal draws on the two methods of dealing with the issue that have so far emerged.

“Our contribution is that it is actually possible to combine the two, a long term value with the two tier model of Nykredit,” he told The Covered Bond Report.