Denmark’s covered bonds retain their lure
Despite robust arguments with Moody’s last year and falling property values, Danish mortgage credit institutions see no reason why the long-standing covered bond market should weaken.
Denmark’s system of funding property purchases has managed to stay successful for two centuries. That may explain why two of the country’s largest mortgage credit institutions shrugged off the threat put forward by Moody’s last year about the viability of the firms and their products.
BRFkredit terminated its use of the agency’s ratings in October 2011 after disputing their methods. It turned, instead, to Standard & Poor’s. Earlier last June, Realkredit Danmark dropped Moody’s after the agency’s calculations demanded an additional DKK32.5bn (€4.3bn) in excess cover for the retention of an ‘AAA’ rating. It, too, turned to S&P.
Realkredit said at the time: “We have the highest solvency ratio of the Danish mortgage finance institutions (35.9%), and its low loss ratio did not exceed 0.2% at any time during the financial crisis. Consequently, it disagrees with Moody’s view of the Danish mortgage finance sector.”
But the challenge now instead may be Denmark’s continued property price deflation. On average, residential property prices are down more than 20% since they peaked before the credit crunch and subsequent financial crisis hit in 2007-08.
Danske Research noted recently that Q4 2011 data suggested property prices were at their lowest since Q3 2005.
For the Danish mortgage market, and the mortgage banks in particular, this asset price fall poses some particular challenges in light of the loan-to-value agreements that are part of the contracts underpinning the domestic market in asset-backed securities. For example, LTV ratios may vary between 40% for unbuilt land to 60% for vacation homes and to 80% for owner-occupied homes.
The decline in property prices has forced demand for more collateral, boosting the so-called cover pool for mortgage credit institutions, in order to stay within regulatory requirements and satisfy market demands. However, the idea that the entire market for this type of instrument is under threat is shrugged off by those active in the sector.
“You could say after the Lehman Brothers breakdown, the only assets investors could buy on the day and the following days were Danish covered bonds,” says Carsten Madsen (pictured), executive vice-president at BRFkredit.
“At the time, you had a big inflow of bonds and spreads going out. But it was the only stock they could sell, so when they [foreign institutions] needed liquidity, they could get it selling covered bonds. A lot of foreign banks were sellers, and Danish institutions were buyers in those days.”