Risks in Danish Mortgage Market - RocSearch...140 160 0 20 40 60 80 100 120 140 160 DNK LD E S T R N NOR KOR E P A N C N A U L T R A T E L N N K X f GDP f GDP 2012 2000 Gross Household

Sample Deliverable

Risks in Danish Mortgage Market

Sample – Disguised and Abridged

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Danish Economy – Mixed Picture

“In the wake of the global economic crisis and of the burst of the housing market bubble, the Danish economy has grown hardly at all

since 2010 although weakness has been concentrated in a small number of sectors including the financial one. Over a longer

period, the country has lost ground in terms of GDP per capita compared to leading OECD economies, mainly due to lacklustre

productivity gains. The housing bubble contributed to the slowdown in productivity by causing a misallocation of resources and

the accompanying surge in household debt resulted in financial sector fragility. Reinvigorating productivity growth and enhancing

financial stability remain two key challenges for Denmark.” OECD (2014)

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Denmark Finland

Norway Sweden

Euro Area (17)

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Real GDP per capita (in constant 2005 PPPs)

Real GDP per hour worked (in current PPPs)

Chart A: Real GDP Growth Chart B: Gaps in GDP per capita and productivity to the

upper half of OECD countries



Danish Household Debt – Significance

• 5.6m (2014) people living in Denmark with approximately XX% debt-to-disposable income;

• Although Sovereign debt is low (XX% of GDP), household debt is the highest in OECD;

• Pension assets are high but are subject to high penalties for early withdrawal.

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SVK

MEX

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rce

nt

of

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P

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nt

of

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P

2012 2000

Gross Household debt is highest in OECD Household financial debt, 2011

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DNK NOR SWE FIN NLD GBR JPN USA FRA DEU

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Average excluding Nordic - 4



Danish Household Debt – Significance

0.0

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9.0

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Short euro rate Short rate Long rate

Total outstanding residential loans Total outstanding residential loans

Total outstanding residential loans Representative interest rate on new fixed residential

loans (%)

100,000

120,000

140,000

160,000

180,000

200,000

220,000

240,000

260,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

EURm

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

% GDP

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2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

% of disposable Income



Danish Banks – Not Without Risks

• The Danish banking system is almost 4x GDP;

• Danish banks’ Non-performing loans (NPL) are 3x the average of banks in Austria, Finland, France, Germany, the Netherlands,

Norway, Sweden, Switzerland, and United Kingdom (IMF, Xiao 2013);

• Profitability and asset quality is lower than in the other Nordic countries, reflecting the bursting of the housing bubble, lower

lending volumes and higher funding costs. (OECD 2014).

NPL Ratio of Danish banks v/s peers

Total assets/Total equity ratio

0

100

200

300

400

500

600

700

800

LUX

IRL3

GB

R

CH

E

NLD ES

P

SWE

DN

K

DEU FR

A

PR

T

BEL

AU

T

FIN

AU

S

CA

N

ITA

JPN

GR

C

KO

R

SVN

ISR

NO

R

CZE ES

T

HU

N

TUR

USA

SVK

PO

L

1621

0

2

4

6

8

10

12

2008 2009 2010 2011 Current

Pe

rce

nt

Danish Peers

0

40

80

120

160

200

240

Dan

ske

Ban

k

Han

de

ls…

Swed

ban

k

Dn

B

No

rde

a SEB

Euro

pe

ex. N

-4

Lati

nA

m.

USA

Asi

aex

. JP

N

JPN

Pe

rce

nt

Loan/Deposit ratios: Nordic-4 vs. RoW, 2011

(Sample contains 120 largest global banks)

The banking sector is relatively large

(Total assets as a percentage of GDP (2012)

0

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35B

anca

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Danish Banks – Not Without Risks

• “Deposits from credit institutions can be an unstable source of funding due in part to the credit institutions’ focus on counterparty

risks and that the deposits can be withdrawn at short notice.” Danmarks Nationalbank;

• Foreign borrowing increased during 2011-12, a period for stress for the Eurozone, and only subsided after Draghi’s “whatever it

takes” comments;

• Danske Bank has the 3rd highest loan/deposit ratio and the 3rd lowest deposits/total assets ratio compared to other EU banks.

Deposits/Total assets ratioLoan/Deposit ratio

0

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200

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700

800

Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12

Danish credit institutions and Danmarks Nationalbank Foreign credit institutions and central banks

Danish credit institutions Foreign credit institutions

DKK bn

0

10

20

30

40

50

60

70

80

90

100

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Danske

Nordea Denmark

Others

DKK bn

Banks’ rollover needsDanish banks: Deposits from credit institutions and central

-bank funding

0

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300

0

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Sven

ska…

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BES

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ING

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k

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ete

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eral

e

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isse

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ank

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Agr

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rce

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rce

nt

Average of 33 EU banks

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70

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Nat

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isse

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Gen

eral

e

Dan

ske

ban

k

Cre

dit

Agr

ico

le

Sven

ska…

Pe

rce

nt

Pe

rce

nt

Average of 33 EU banks



Danish Mortgage Market – Introduction

A significant contributor to the outsized financial services sector

Mortgage market is commonly characterised by the following:

• Danish mortgage bonds – a very safe investment (Source: The association of Danish mortgage banks);

• Danish mortgage bond market has 200 years of default-free history

• It is one of the largest in the world and the largest relative to the size of the economy

• In the traditional Danish mortgage system, loans are matched with bonds and borrowers can prepay their mortgages at anytime.

The Danish mortgage system

There is however a precedence of a Danish mortgage institution not being able to honour its obligations in full and on time. During the 1920s banking

crises, the bondholders of a second priority agricultural mortgage institution “had to agree to a prolongation of maturity by two years and a reduction of

the interest payments by half also for two years



Danish Mortgage Market – The Metamorphosis

However the market has changed dramatically over the past ten years:

• Mortgage loans used to be long term, fixed rate, and amortising, but today many are variable rate loans (adjustable rate

mortgages ARMs) and offer long interest only (IOs) payment periods (many up to 10 years);

• Loans represent a larger percentage of the collateral on the heels of easy credit from banks and lower home equity, with

Loan-to-Values (LTVs) ranging from XX% to XX% not being uncommon;

• What used to be a model market (e.g. loans given were perfectly matched with bonds issued) is now subject to significant

refinance risk, with requirements estimated to be circa EUR 158 bn per annum;

• Interest rate risk is impressive as borrowers do not understand the imbedded risks of their contingent liabilities (and have

been spoiled with lower rates);

• The operating environment for banks is getting hostile as their favoured covered bonds face a litmus test in the European

commission to avoid being considered as Level 2 assets;

• The Danish government might be required to step in to bailout, but the transfer of private liabilities into public liabilities is

impossible without triggering stress.



Mortgage Loans – Profile Evolution

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43

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47

0

200

400

600

800

1,000

1,200

1,400

Fixed Variable Fixed Variable Fixed Variable Fixed Variable

Q1 2004 Q1 2008 Q1 2011 Q4 2013

With amortisation Without amortisation

DKK bn

% of outstanding

Household mortgage - Credit breakdown by loan type

• Interest only (without amortisation) loans rose from XX% of the market in 2004 to XX% in 2013;

• Variable rate loans rose from XX% in 2004 to XX% of the market in 2013, with interest rates now at historical lows.



Amortisation Rate

• Only DKK XX bn (X%) of amortisation during 2013 against an outstanding mortgage loans of DKK XX bn;

• At that rate it would take 50 years to pay down (assuming rates stay low);

• Were amortisation to normalise we could witness a contraction in GDP as disposable income reduces.

0.0%

1.0%

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4.0%

5.0%

6.0%

0

500

1,000

1,500

2,000

2,500

3,000

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Mortgage credit institutions (MCI) Domestic lending

Amortisationof DKK mortgage loans (as % of MCI domestic lending), RHS

DKK bn



Mortgage Loans – Evolution of LTVs

• At least XX% of families with a mortgage loan have an IO loan that expires by 2021;

• Half of the IOs expiring until 2021 have LTV’s higher than XX% (IOs represent XX% of the market and they typically

have 10 years’ maturity);

• The break point for LTV for US in 2007 was XX%;

• EU transparency exercise 2013: LTV for Danske (XX%), Jyske (XX%), Sydbank (XX) and Nykredit (XX);

• The requirement to amortize is a new phenomenon;

• Defaults may lead to increase of houses on the market and put downward pressure on prices triggering a vicious cycle.

0

20

40

60

80

100

120

140

2013 2014 2015 2016 2017 2018 2019 2020 2021

LTV<60% 60%<LTV<80% 80%<LTV<100% LTV>100%

Number of families, in 1000s

Number of families with IO loans expiring in the relevant year



Mortgage Loans – Evolution of LTVs

• Many home owners are underwater and negative equity is notable;

• High LTVs equal banking stress – in the early 90’s two small banks collapsed, shaking the banking system and forcing

a curb on bank lending;

• The cumulative losses over 1990-1992 were X% of loans; forty of sixty problematic banks were merged

0

10

20

30

40

50

60

70

19

75

19

77

19

79

19

81

19

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19

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19

89

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91

19

93

19

95

19

97

19

99

20

01

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03

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05

20

07

20

09

20

11

20

13

Dwellings purchased at prices higher than today’s

prices

Borrowers can sit on negative equity for years until loans expire, amortisation or refinance is required. But who will realise those losses?Citizens, banks, the government or foreigners?

Loan-to-value ratio (as % of housing wealth)

0

50,000

100,000

150,000

200,000

250,000

20

04

Q2

20

04

Q4

20

05

Q2

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Q4

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06

Q2

20

06

Q4

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Q2

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Q4

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Q2

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Q4

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09

Q2

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Q2

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Q4

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Q2

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11

Q4

20

12

Q2

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12

Q4

20

13

Q2

20

13

Q4

One-family houses Owner-occupied flats



Mortgage Loans – The Unfortunate Reality

• Results of Arbuthnot’s Mortgage Affordability survey conducted by YouGov:

• XX% do not think that most people will be able to afford an increase in mortgage payments as IO period expires;

• XX% will find it difficult to repay if mortgage payments increase

Question 1: The 10 year interest only mortgage period for

many Danish mortgages will expire in the coming 36 months.

This would mean some borrowers would have to begin

paying down the principal (i.e. the mortgage along with the

interest). Do you personally think that most people will be

able to afford the increase in their monthly mortgage

payments?

Response of 557 Danish adult homeowners, XX% of which

own it through mortgage.

Question 2: If your mortgage payments were to increase,

approximately at what percentage level would you/your

household start to find it difficult to repay?

Response of 474 Danish adults who own their house

through a mortgage

36%

22% 5%

4%

11%

22%

0

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200

250

300

350

400

50% 100% 150% 200% > 200% Uncertain

Nu

mb

er

of

ho

me

ow

ne

rs

Mortgage payments increase assumption

18-34 yrs 35-54 yrs 55+ yrs62%

24%

14% No, I don’t think most people will be able to afford it

Yes, I do think mostpeople will be able toafford it

Did not know



Refinancing Risk – Maturity Mismatch

• In Denmark, Loans taken by the homeowners are funded by Danish Mortgage Bonds;

• Mortgage bonds used to be vanilla, matching perfectly the term and interest rate of the loan;

• Today many of these mortgage bonds are refinanced regularly and contain complex features as compared to the

German market which is fixed rate and fixed term and allows banks to issue mortgage loans;

• Rating agencies raised the flag that Danish mortgage banks face a maturity mismatch as per below:

• “Substantial market-funding reliance of most financial institutions increases vulnerability. Most market funds are in the

form of covered bonds which have historically been a stable funding source. But structural changes to that market have

increased refinancing risk, posing a particular concern for mortgage credit institutions whose access to alternative

funding is limited.” Moody’s Investors service (2012)

0

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

< 1 yr 1-5 yr 5-10 yr 10-20 yr 20-30 yr >30 yr

Bonds Loans

DKK bn

0

20

40

60

80

100

120

140

< 1 yr 1-5 yr 5-10 yr >10 yr

Bonds Loans

EUR bn

Danish covered bond mortgages (outstanding) German pfandbrief mortgages (outstanding)

Calculated by aggregating the issued covered bonds (by maturity) and outstanding lending (by

remaining maturity) of the following capital centres : Realkredit Denmark (S&T), Danske

(C,D&I), Nykredit Realkredit (H,E,G&I), Nordea Kredit (1&2), BRF Kredit (B&E), DLR Kredit

(B). These capital centres represent >90% of covered bond market

Maturity structure of outstanding Mortgage Pfandbriefe and their respective cover

pools, published in accordance to section 28 para. 1 no. 2 Pfandbrief Act



Refinancing Risk – Government Action

• To appease rating agencies and help avert a short term refinancing crisis, the government introduced an emergency

policy (w.e.f. April 2014) which forces maturing bonds to automatically rollover for 12 months were an auction to fail or

interest rates to increase disproportionately (+X%)

• Our analysis is that the forced extension of maturity effectively:

• removes the ‘default risk’ but does not eliminate the refinance risk;

• changes the profile of the bond from a floater to a capped-floater, which needs to be priced in;

• despite the interest rate cap, the borrower can face a significant increase in rates

The banks’ increased dependence on short-term market financing was challenged in autumn 2008, when foreign credit

institutions and the money market funds started to harbour doubts about the health of Danish financial institutions and

hence their creditworthiness. That uncertainty meant that part of the Danish banks’ obligations falling due in autumn 2008

were unable to be refinanced. This might be characterized as “a modern bank run”. Prof. Jasper Rangvid



Interest Rates Risk

• While the X% of ARMs in circulation are at historical highs, interest rates are at historical lows;

• Although it is expected that interest rates will remain low for years to come, homeowners appear complacent over the

degree and complexity of the interest rate risks being assumed;

• Danish monetary policy is only quasi independent from the ECB as the Danish currency (DKK) is pegged to the Euro. It

does not appear that the ECB will raise rates anytime soon but equally tying your monetary policy to a third party does

present risks, which should not be discounted;

• There is a history of interest rate volatility. In 2008 the Danish Central Bank was forced to raise rates to X% to protect

the DKK from a sell-off. Going forward, any forced selling or repatriation of funds by foreign investors could force rates

higher again. These rate increases would then be passed onto the borrowers, the same borrowers (many on variable-

rate mortgages) who have become accustomed to low monthly payments.

-0.1

0.0

0.1

0.2

0.3

0.4

0.5

0.6

-1

0

1

2

3

4

5

6

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Perc

ent

Perc

ent

Lending rate Certificate of deposit rate Arrears, RHS

Arrears respond to interest rate cycles (with a lag)



Credit Risk

Two occasions of senior credit default in recent memory

• Amagerbanken was taken over by the Danish Financial Stabilitet as part of the ‘Bank Package 3’ bail-in rules in

February 2011. Senior debtors faced a XX% haircut. It was the first instance of a haircut for senior creditors in Europe

after the global financial crisis.

• Fjordbank Mors in June 2011 was taken over by Finansiel Stabilitet, with a preliminary valuation of DKK 7.8bn (EUR

1bn) — which covered about XX% of senior liabilities. Investors in the bank’s senior debt and depositors with in excess

of EUR 100,000 limit were facing haircuts of circa XX%.

Very few defaults can raise a crisis

• During the Nordic crisis in the early 90’s, losses over debt outstanding were relatively insignificant. Today this number

stands at XX%, peaking at XX% for owner occupied properties and XX% for commercial properties, therefore we do

not need to see a significant uptick in defaults to experience a crisis.



Regulatory Pressures

• The financial services industry is undergoing significant changes, banks are required to hold increasingly liquid assets

(LCR) and more capital to buffer against losses (CRR/CRD IV;

• Why is this significant? Because the EBA has recommended to the EU commission that Danish Mortgage bonds be

deemed level 2 from a liquidity perspective as opposed to level 1;

• This translates into the possibility that Danish institutions may be forced into reducing their holdings in these bonds in

order to meet more stringent liquidity requirements. We also question whether those sellers will be able to continue

supporting forthcoming bond auctions;

• One of the main pension funds (PFT) announced they no longer intend on increasing certain Mortgage Bonds holdings

whilst Danske Markets (a division of Danske Bank) has recommended to long-only investors to reduce their overweight

to a certain class of mortgage bonds (short maturity, non-callable bullets).



Regulatory Changes

• The Danish government is lobbying aggressively for Danish mortgages to be classified level 1, continually pointing to a

Danish central banking study which attempted to demonstrate that their mortgage market was liquid during the credit

crisis;

• Southern European countries would welcome level 2 classification, as banks will be forced to buy sovereign bonds and

this would help reduce their funding costs;

• The central bank has made it clear that they want a reduction in refinancing-risk as they want to avoid becoming a

lender of last resort.

30%

70%

Danske Bank (30%)

Other Danish financial institutions (70%)

Financial institutions hold XX% of Danish mortgage market

of which:

Composition of liquid assets in the LCR for systemic credit

groups

13%

16%

12%

56%

1% 2%

Cash and central-bank reserves (13%) Certificates of deposit (16%)

Government bonds (12%) Mortgage bonds (56%)

Corporate bonds (1%) Other assets (2%)



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