Arbuthnot Latham research throws doubt on status quo of Danish bond market
Arbuthnot Latham & Co, Limited, the private banking arm of the Arbuthnot Banking Group, has highlighted concerns about the Danish mortgage bond market.
While some argue that the Danish mortgage bond market is safe, robust and benefits from a ‘200 year default-free history, Arbuthnot Latham disagrees and points to the fact that the mortgage market has changed materially over the past 10 years.
Principal author of Arbuthnot Latham’s research, Co-Chief Investment Officer, Gregory Perdon, says: “The Danish household is the most levered in the developed markets (According to the OECD with 309% debt to disposable income ratio). Economic growth is lacklustre; the property market is still well beneath the highs (meaning a considerable amount of negative equity in the system); with borrowers over reliant on Interest Only loans and Adjustable Rate Mortgages (57% and 71% of the market respectively). From a liquidity perspective, the bond market is mismatched exposing participants to significant refinancing risk, as much of the market is re-financed annually. As borrowers’ amortisation begins to kick in, we believe that the households may struggle to adjust to a new reality and the market may turn to the government for ‘significant assistance’.
“We are not alone in our conclusions. Danske Markets has cautioned long only investors over certain mortgage bonds, whilst Spar Nord Bank recently highlighted the degree of increases in monthly instalments borrowers may face. Similarly, the International Monetary Fund (IMF) has gone on record arguing that the re-financing risk is significant and even the Danish Central Bank has warned over the over-abundance of risky mortgage borrowing.
“Several years on from the global financial crisis we ask the question, ‘Have we not learned from our mistakes?’ Our suggestions about steps that could be taken now to mitigate the risks that we have identified include:
• Force a reduction and subsequently ban the issuance of new Interest Only(IO) loans as there is already enough leverage in the system;
• cap the future interest rates of newly issued Adjustable Rate Mortgages (ARMs), helping to mitigate interest rate risk;
• encourage borrowers to begin amortising their debts;
• as opposed to allowing banks to generate revenue in the form of ‘Admin Fees’ the regulator should force banks to reflect their ‘admin fees’ in the interest rate paid by the borrower ensuring the market is more transparent;
• widen the currency peg to signal confidence in the Danish free market; and
• gradually adjust rates upward to fend off speculators whilst signalling borrowers to limit their leverage. “
Gregory Perdon says: “As we looked deeper into this subject, we became more and more convinced that the market is underestimating the risks. In order to avert a potential crisis, the government, banks and stakeholders should come out and admit that the system is unsustainable - no longer the same it has been for the past 200 years and take decisive action to address the issues at hand. This process would send a strong message to investors, domestically and internationally, that a proactive approach is being taken which will enhance credibility and potentially help avert contagion with other markets in the future.”
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