The Danish Mortgage System

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					The Danish Mortgage System

    Presentation for Icelandic Confederation of Labour (ASÍ)
                  Reykjavik, 24 January 2012

               Peter Jayaswal, Deputy Director
            Association of Danish Mortgage Banks
    The Danish mortgage system in a nutshell

•    Low, competitive prices on real
     estate loans

•    Transparency in prices and early
     redemption conditions

•    Available to all with real estate

•    Investors get safe and liquid

•    Supports financial stability

     Important political objectives
                          Mortgage bank lending plays
                          a significant role in Denmark

         Banks and Mortgage banks                                                      Market value of government debt and
               total lending                                                            mortgage backed covered bonds

Source: Danmarks Nationalbank, November 2011
Note: Values are based on outstanding amount excl. lending to Monetary Financial Institutions, MFI
                              20-01-2012 16:16

Covered bonds share of GDP

Source: ECBC Factbook, 2010
Security of supply                                  √
Current and attractive market prices of bonds       √
Transparency                                        √
Prepayment at market prices and without "penalty"   √
Investor security                                   √
   a. Low loss risk                                 √
   b. Stable funding/liquidity                      √
Self-supporting                                     √
Diversified loan opportunities and responsible      √
Three fundamental conditions


                            system             Well-
              Well-                         developed
           developed                          market
        ”infrastructure”                    conditions
                                           and ”practise”
Tight legislation


                              system             Well-
                Well-                         developed
             developed                          market
          ”infrastructure”                    conditions
                                             and ”practise”
Statutory framework in Denmark

 The mortgage banks only grant loans against a mortgage on real property within
  a fixed lending limit , 60-80 pct. (loan-to-value/LTV)

 The valuation of the real property and the calculation of the loan amount take
  place in compliance with a set of rules laid down by the Danish FSA

 The loan may solely be funded through the issuance of bonds. No access to
  raise finance in the money market

 The issuance of bonds by the mortgage banks is subjected to a balance

 The bond holders have a preferential status in the event of the bankruptcy of a
  mortgage bank

 The legislation also covers the practice on responsible lending
The Danish balance principle is extreme as
loans and bonds match perfectly
        Borrower                                                   Investor
              Disbursement of loan    sheet                  Bonds at market price

Interest & repayment on capital                 Interest & repayment on capital

Administration margin                           Wages and costs

Fees                                            Losses and provisions

                                     Mortgage   Taxes

Earnings on securities                bank


             The mortgage bank does not determine the interest rate!
Preferential status

                                                                        Senior debt   Creditors
                                                 Covered Bond            holders

               First priority claim
                                                 First priority claim

    Issuance       Issuance           Issuance
    of bonds       of bonds           of bonds

    Capital        Capital            Capital

    centre          centre            centre

      A               B                  C
                                                             Mortgage bank
High safety and liquidity for bond owner

•    The payments on the covered bond is secured by:
        –    The mortgage
        –    Guarantees                                                                                    Capital
        –    The credit institution's equity                                                               centre
        –    Supplementary security (funded by junior covered bonds)
•    No one has ever lost money on Danish covered bonds

•    Danish covered bonds are among the highest rated covered bonds with
     international credit-rating agencies

•    The bonds are listed at the stock exchange:
        –    Transparent price formation
        –    Market for trading the bonds

•    Transferability causes better prices

•    Danish covered bonds are as liquid as Danish Government bonds1
1)   Danish covered bonds and the Liquidity Coverage Ratio (Danish Central Bank and the Danish FSA, 23 August 2010)
                                                     20-01-2012 16:16

 Ownership of Danish covered bonds - November 2011

Source: Danmarks Nationalbank
Healthy principles secure responsible
lending and borrowing
Statutory LTVs are absolute – irrespective of insurance schemes and
other creditworthiness of the borrower

Two other, healthy principles apply:

    1. Credit risk remains on the balance sheet of the mortgage
        •   Responsible credit assessment and lending

    2. Borrower is personally liable for the loan
        •   Responsible borrowing
Danish mortgage institutions retain loans
on the balance sheet
The issuance of ”covered bonds" dominates mortgage funding in Denmark
Funding as percent of total mortgage lending
   90                                                                                       87

   70                       66                                                  65
   40                                   34
   20                                                    15                                                         13
                0                                                                                        0
                      United States                                Euro area                        Denmark

            CB backed by mortgage(on balance sheet)            MBS (off balance sheet)   Other sources, deposits, etc.

Note: US MBS include Agency MBS & CMO and Non-Agency MBRS & CMBS
      Euro area MBS include MBRS, CMBS & CDO
Effective foreclosure system

•   ”Flexicurity” of the Danish mortgage market – only possible due
    to the Danish security model (public safety net)

•   Regulated and swift foreclosure procedures guarantee access to

•   Average time from first arrear to finalised foreclosure is 6 months

      1. notice of missed   2. notice and debt   Creditor initiates   Foreclosure
      payment               collection           foreclosure          procedure finalised

      ½ - 1 month           1½ - 2 months        3 months             6 months              Source:
Market conditions and practise


                             system             Well-
               Well-                         developed
            developed                          market
         ”infrastructure”                    conditions
                                            and ”practise”
Practises by the mortgage banks

•     Loan origination only by a satisfactory documentation of income
      and wealth by debtor

•     Loans and hence credit risk remains on the balance sheet of the
      mortgage bank – healthy incentive structure not to originate loans
      to people who are not expected to pay back the loan

•     Loans are financed on a daily basis by tap-issues

•     Match-funding, which means that the loan book is mirrored by the
      funding side of the balance sheet

    Match-funding minimises market risk with the mortgage bank, while
    on-balance sheet loans ensure a prudent credit policy
Due to match-funding, the mortgage banks
tap issue bonds
•   The bond series are identical to the ”product side”

•   The bond series are open for issuance for typically 3 years
     •   Bullet bonds are open until maturity

•   The size of a bond series is not known a priori
     •   The success of a loan product determines ”issue size”

•   Liquidity is generated over time as bond series are traded every
    day through their life time in the secondary market
     •   New loans are issued and old loans are redeemed



                             system             Well-
               Well-                         developed
            developed                          market
         ”infrastructure”                    conditions
                                            and ”practise”
The Danish market infrastructure is optimal in terms
of transparency for the debtors and investors
Cash and bond settlement/trading                 The electronic title
                                                 registration system

         Danish Securities Centre
            (Regulated CSD)                                  Mortgage deeds
               ”VP Securities”

             The Exchange
           (Regulated market)                          MCI 1
              ”Nasdaq, OMX”

           Danish Central Bank
              ”Nationalbanken”                               Controlled by

                                    ”E-nettet”    The Danish FSA
    MCIMCI 2                                      ”Finanstilsynet”            20
Turning to the borrowers

Same conditions for all

After judgement of the credit rating, the borrower decides the loan with access
to the same range of loan types:
• Interest rate
• Amortisation
• Early redemption conditions
Same conditions for all

Households and companies          Mortgage bond                      Investors

               4% interest,
               amortisation and
               early redemption

               4% interest,
               amortisation and   4% 2044         4% interest,
                                                  amortisation and
               early redemption                   early redemption

               4% interest,
               amortisation and
               early redemption
    Match between bonds and loans
     Callable bonds        Bullet bonds           Capped floaters        Floating-rate
     • Fixed-rate                                                        notes
                           • Fixed-rate           • Floating-rate
     • 10Y, 15Y, 20Y and                                                 • 3M or 6M
B                          • 1–10Y maturities     • 6M Cibor + 0–
       30Y                                                                 Cibor/Euribor
o                                                  85bp
                           • DKK/EUR
     • Callable at par                                                   • 5Y, 10Y, 30Y
n                                                 • 5–30Y maturities
                           •Refinancing in                                 maturities
d    • Annuity              Dec, Mar and Sep      • 4-6% caps            • Callable at par
s    • 10Y interest-only                          • Callable at 102 or
       (IO) option                                105

     Fixed-rate annuity    Adjustable-rate        Capped floating-       Floating-rate
     mortgage loans        annuity mortgage       rate annuity           annuity loans
                           loans                  mortgage loans
L                          Interest reset 1-10Y
o                          Options:
a    Options:                                                            Options:
                           10Y IO option          Options:
n    10Y IO option                                                       10Y IO option
                           Amortise as if fixed   10Y IO option
s    Early redemption at
                           rate (maybe 5%
     par or market value
                           coupon) with varying
                                                   20/01/2012 16:16

Outstanding loans (stock) by loan type – Q3 2011

  Source: Association of Danish Mortgage Banks
Market-based prepayment system
 The balance principle creates the foundation
  for a unique, market-based prepayment

 Mortgage loans may be prepaid at market
  price and/or at par

 Benefits of a market-based prepayment
     Transparency
     Consumer protection
     Competition and customer mobility
     Financial security and stability

 Recognised by the EU Commission1 and The
  European Consumer’s Organisation (BEUC)2
1) White Paper on the Integration of EU Mortgage Credit Markets (Annex III, SEC(2007) 1634/4)
2) Mortgage Credit – Report of the Mortgage Funding Expert Group – BEUC Comments (2007)
The Danish mortgage system has been tested for more than 200
years – without losses to bondholders

                                                   Debt crisis
                                                   in Europe
    Financial systems were rocked by the crisis

•    The world has experienced a severe financial crisis, which has
     developed into an economic crisis that is still unfolding

•    The crisis has rocked financial systems across the globe

•    Danish economy was also hit profoundly:
     - GDP declined at 4,7% in 2008 and 3,0% in 2009
     - Unemployment rose from 1,7% to 4,4% in only two years
     - House prices declined by an average of 13% between 2007 and
     - 11 banks have ended up in Finansiel Stabilitet (public funded
     rescue mechanism for insolvent banks)

     This is the stage at which we must evaluate the Danish mortgage
                                     20-01-2012 16:16

Strong demand for Danish covered bonds

Source: iBoxx and Nykredit Markets
    Investors have confidence in Danish
    mortgage bonds
 Prices on jumbo CB, spread on european benchmark swap-contracts (3-years)

Source: Nykredit.
   Lending activity

                                                      Lending to Households

                                                From September 2008 to November 2011 lending
                                                from mortgage banks increased DKK 151 billion
                                                and from banks decreased DKK 35 billion.

                    Lending to Businesses

From September 2008 to November 2011 lending
from mortgage banks increased DKK 102 billion
and from banks decreased DKK 133 billion.

Source: Danmark Nationalbank
    Challenges to the Danish mortgage system

•    Continuously compliance with LTV and demand for supplemental collateral
     one-by-one. Even though the risk of loss is not one-by-one.

•    Refinancing risk due to mismatch between maturity on Adjustable-rate
     mortgages and the bonds funding the loans.

•    International regulation aimed at global banking systems that do not fit the
     Danish special mortgage bank system

•    Household’s debt due to increasing use of interest-only mortgage loans.
                             Assets and liabilities of Danish households, ultimo 2. Quarter 2011

           Source: Association of Danish Mortgage Banks based on numbers from Danmarks Nationalbank.
Prerequisites and challenges for building an
effective mortgage system

                                   Transparent fees and low profits

                                   Incentive for credit institutions to

                                        International regulation


                   confidence        Liquid covered bond market

                  Critical mass


                 Legal framework
More on the Danish mortgage model

              Website: