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March 21 (The following statement was released by the rating agency)
Denmark's new bill on mortgage bond maturity extensions will help reduce liquidity risk, Fitch Ratings says. But significant refinancing concentrations and highly leveraged households still require attention to further reduce systemic risk.
The bill passed parliament on 11 March and introduces mandatory extensions for Danish mortgage bonds funding longer-term mortgages. The potentially systemic liquidity risk of a failed refinancing auction is cut by extending the bonds, initially for 12 months with a 5pp interest rate increase. For short-term and variable-rate bonds without interest rate cap it also includes an interest-rate trigger for a maturity extension at this 5pp level. We expect this to be the most likely driver of extensions, rather than a complete inability to place the bonds. Borrowers on short-term reset periods would by implication benefit from a one-year interest-rate cap.
The maturity extension will transfer the refinancing risk from the mortgage institutions and their borrowers to the investors. It does not address the significant refinancing concentrations created by a large volume of mortgage bonds being refinanced during a short time, nor the material proportion of short-term interest-reset products in the market. We expect the industry to continue its efforts to lengthen the maturity profile of its funding, which is important in this wholesale-funded mortgage system with a large mortgage bond market equivalent to around 140% of GDP.
Some of the consequences of the Danish funding structure are addressed in the bill, but the causes are not. Danish households are the most indebted in Europe on a gross basis, although there is a large net financial assets position. As the savings market in Denmark is focused on pensions and life insurance products, the liquidity of these assets may be low in times of stress, exacerbating negative consumption effects in times of slow growth, rising interest rates, or higher unemployment. The industry's more detailed assessments of mortgage affordability, recent initiatives to reduce interest tax deductibility, and increased interest rates on short-term loan products are soft measures by international standards, but demonstrate a willingness by the authorities to deal with the problems.
We consider these issues in detail in our Special Report published today, "Denmark: Refinancing Risk and Financial Regulation," available at www.fitchratings.com. This report expands on our previous comment on the draft bill in November last year (see "Danish Mortgage Bond Extension Would Cut Refinancing Risk") and provides broader context around the Danish mortgage market.