Act Addressing Refinancing Risk

In the aftermath of the financial crisis, a change was made to the Act regulating Danish mortgage bonds (ROs), covered mortgage bonds (SDROs) and covered bonds (SDOs). The change addresses issues of refinancing in cases where refinancing fails and stipulates the procedure of refinancing bonds issued by a mortgage bank under resolution.

Scope of the Act

The Act applies to underlying MBs, CMBs and CBs with a shorter maturity than the terms of the loan they fund. An example of such a loan is a 30-year mortgage loan with a 1-year interest rate reset period, i.e., the loan is funded by issuing bonds with 1 year’s maturity. These bonds are then replaced by issuing and selling new bonds with 1 year’s maturity.

The Act introduced contingent maturity extensions for bonds with a shorter maturity than the underlying loans. An extension takes effect if the interest rate on bonds with an original maturity of 2 years or less increases by more than 5 percentage points within 12 months (the interest rate trigger) or if refinancing fails (the refinancing failure trigger).

The purpose of the legislation is to clarify the position of borrowers, investors and mortgage banks during unusual economic circumstances, i.e., a failed refinancing or a sudden and sharp rise in the interest rate. A further purpose is to provide a clear procedure for refinancing loans, when the issuing mortgage bank is under resolution. The extension allows the bankruptcy trustee to liquidate the mortgage bank in accordance with loan agreements and bond terms until all mortgage loans granted by the bank have been redeemed.

The fixed-rate 30-year mortgage loan with the maturity of the underlying bonds corresponding to the loan term has traditionally been the favoured type of loan. However, the volume of non-pre-financed loans, like the example in the second paragraph, has increased since the mid-1990s. In 2014, these loans, financed by short maturity bonds, accounted for approx. 70 per cent of all mortgage loans according to Danmarks Nationalbank. While no refinancing auctions have failed to date, the chance of one, though slight, exists.

Download material on the new act - "Overview of the new Danish covered bond legislation addressing refinancing risk" (1.3 MB)