Law and regulation in the Danish mortgage-credit system
The Balance Principle
The balance principle in the Danish Mortgage-credit Loans and Mortgage-credit Bonds Act regulates the financial risk of the mortgage credit institution resulting from differences in payments between loans and funding, fluctuations in interest rates and exchange rates and the use of financial instruments.
The principle states that the payments on the debtor side and the creditor side of a mortgage-credit institution must balance as a whole within certain limits. This is achieved by issuing a bond or a portfolio of bonds each time a loan is granted.
Simplistically, the risk of the mortgage credit institution is limited to credit risk, i.e. the risk on the borrower's ability to meet his obligations.
Danish mortgage-credit institutions are by law prevented from undertaking any substantial currency, liquidity or interest rate risk due to the "balance principle".
Limits on risk
The balance principle regulates the financial risks of the mortgage-credit institution resulting from differences in payment between loans and funding, fluctuations in interest rates and exchange rates and the use of financial instruments.
The principle states that the payments on the debtor side and the creditor side of a mortgage-credit institution must balance as a whole within certain limits. This is achieved by issuing a bond or a portfolio of bonds each time a loan is granted.
Simplistic: The risk of the mortgage-credit institution is limited to credit risk, i.e. the risk on the borrower's ability to meet his obligations.
Provisions
The balance principle is governed by a number of provisions in the Danish Mortgage-Credit Loans and Mortgage-Credit Bonds Act, and is regulated by detailed executive orders issued pursuant to the Act by Finanstilsynet (the Danish Financial Supervisory Authority).
The main provisions of the balance principle are as follows:
- Issued mortgage bonds must be secured on loans issued against mortgages on real property. However, up to 2% of the bonds may be issued against security in particularly secure substitute assets like for instance government bonds (i.e. substitute cover).
- Mortgage-credit institutions’ interest rate risk related to lending and funding may not exceed an amount equal to 1% of the capital base given a shift in the yield structure of +/- 1 percentage point (including twists of the yield curve).
- Liquidity deficits following different payment flows in relation to lending and funding are limited to a proportion of the capital base of a mortgage-credit institution. The size of such proportion varies depending on how long into the future liquidity deficits appear.
- The exchange-rate risk of mortgage credit institutions must not exceed an amount equal to 0.1% of the capital base.
- Mortgage-credit institutions must not incur prepayment or index-linked risks in connection with the lending and funding. Furthermore, it is prohibited to fund callable loans by way of a combination of non-callable bonds and options on repayment at par.
- Only options with a maturity of up to four years may be applied in relation to lending and funding.
- Mortgage-credit institutions’ interest-rate exposure related to the investment of the mortgage-credit institutions’ capital base may not exceed 8% of the mortgage credit institutions’ capital base.
Consequences
The balance principle has consequences for the way a Danish mortgage credit institution can operate.
First of all, the mortgage loans granted must be funded with mortgage bonds. Loans disbursed as bond loans must be funded with bonds of the exact same nominal value and interest rate as the loans. Loans can be disbursed as cash loans where the principal and the interest rate of the loans differ from the issued bonds, but where the cash flow of the loans must match the cash flow of the bonds issued.
Secondly, the borrowers pay for the services of the mortgage-credit institution on top of the loan, by fees (front-end-fees) and administrative margins (interest margins). Apart from covering the expenses of the mortgage-credit institution, the net profits contribute to the build-up of reserves required by law.
Thirdly, mortgage bonds are generally tap issued in the bond market, reflecting the ongoing lending and refinancing activity.
Fourthly, the bonds issued reflects the demand by the borrowers. When borrowers request 30 year fixed rate, annuity loans with a prepayment option, the mortgage-credit institution has to issue similar mortgage bonds, and likewise when borrowers request an ARM loan with annual refinancing, the mortgage institution have to issue bonds, resulting in an annual interest rate change (RTL-/RTL F-bonds).
Capital requirements
According to the Financial Services Act, the capital base of a mortgage.credit institution must at all times amount to at least 8% of the institute's risk-weighted assets and off-balance sheet items.
If a mortgage-credit institution fails to meet the requirement of capital base, the Danish Financial Supervisory Authority (DFSA) may set a time limit within which the requirements must be met. If the institution fails to meet the requirements within this period, the DFSA may suspend its license to undertake mortgage-financing activities. The mortgage-credit institution will, in such a situation, continue to receive instalments, coupons and fees on the existing mortgage loans and pay instalments and coupons on the relating mortgage bonds.
If a mortgage-credit institution should be declared bankrupt, bondholders will rank prior to all other creditors regarding the right to repayments on the mortgages and to the assets held in the reserve funds of the mortgage-credit institution. No claims of other creditors will be satisfied until the bondholders have received what is due to them.
Since the birth of the Danish mortgage-credit system in 1797, no institution has ever gone bankrupt. Only in a very few cases in the 200-year history have payments to investors been delayed. The last example dates back to the 1930s.
Lending Limits
The Mortgage-Credit Loans and Mortgage-Credit Bonds Act stipulates limits on loan-to-value (LTV), maturities and repayment profiles.
Mortgage-credit loans can be raised for various purposes: for new construction, for the purchase of an existing property, for remortgaging (refinancing) and for other purposes (top-up loans).
The mortgage credit institutions must value all properties individually and assess the creditworthiness of each prospective borrower. As a main principle, a mortgage credit institution may grant a loan up to the statutory limit. The lending limits vary between different categories of property. The limits are shown in the table below.
| Property type | Maximum LTV |
Maximum maturity |
| Per cent | Years | |
| Private residential property | 80 | 30 |
| Vacation homes | 75 | 30 |
| Residential rental property | 80 | 30 |
| Office and shop property | 60 | 30 |
| Industrial property | 60 | 30 |
| Agricultural property | 70 | 30 |
| Loans w/government guarantee | 80-100 | 30 |
Mortgage-credit institutions may not grant loans exceeding the limits, even if the borrower is extremely creditworthy. The basic idea is that it is easier to assess the long term value of a property than the long term creditworthiness of a prospective borrower.
Land registration and cadastre
A prerequisite for the effectiveness of the Danish mortgage-credit system is the protection of the mortgage-credit institutions' rights on the borrower's real property. To this end, rights and claims relating to a property in Denmark are registered with the Danish Land Registration System (in Danish: Tinglysningssystemet).
Any plot of land in Denmark is mapped in the Cadastral System (in Danish: Matrikelsystemet) designated with a title number. The title number is used in the Land Registration System, where the rights and claims on a title number are ordered by rank. The ranking is based on the principle of "first in, first right", and in the event of the property owners' default on a claim, the ranking directs the order of execution.
The ranking order of the mortgages on a given property must be set out in the Land Register in which registration is made subject to a judicial examination. Any person who suffers a loss as a consequence of errors committed within the Land Registration System may claim compensation from the Danish Treasury.
Compulsory sale
The Danish system of compulsory sale ensures that mortgage-credit institutions can enforce their rights if the borrowers cannot pay. The mortgage-credit institution may put the property up for forced sale in case the borrower fails to pay.
A forced sale (auction) will be carried through by the enforcement court which is part of the court system in Denmark. The mortgagees will be covered by the bid sum at the auction in the ranking order registered with the Land Registration System.
The forced sale system in Denmark is highly effective, and it typically takes no more than six months from the time when the borrower defaults on the loan until a forced sale can be carried through.
Mortgage legislation
Recent legislation
Overview of the new Danish covered bond legislation addressing refinancing risk
The scope of the new Act is to address refinancing risk when the underlying loan is longer dated than the bonds utilised to fund it.
The Act was implemented on 1 April 2014 for 1-year ARM loans and was fully phased in on1 January 2015 for up to and including two years of funding.
The Act introduces two types of triggers:
- Refinancing failure trigger (RF)
- Interest-Rate trigger (IT)
A presentation of the legislation addressing refinancing risk (including a FAQ) is available and has been prepared as a joint effort of the Danish mortgage banks. View the presentation
The first BRFkredit bonds with triggers were opened on 28 March 2014.
General mortgage legislation
The legal provisions particular to the Danish mortgage-credit system focus on several areas which aim at protecting mortgage-bond investors:
- Danish mortgage-credit institutions are by law prevented from undertaking any substantial currency, liquidity or interest-rate risk. This is called the balance principle
- Danish mortgage-credit institutions are required to maintain a capital adequacy ratio of at least 8% of risk-weighted assets
- Regulation on loan-to-value limits, maturities and repayment profiles
- Holders of Danish mortgage bonds hold a preferential claim should a mortgage-credit institution be wound up by the courts (although such compulsory winding-up has never occurred)
- The legal principles are supported by the Danish Land Registration and Cadastral System
Danish mortgage credit institutions are subject to the joint financial sector legislation as set out in the Danish Financial Business Act (in Danish: Lov om finansiel virksomhed), which contains provisions on ownership, management, best practices, client information, consolidation, financial reporting, capital requirements etc.
The granting of mortgage-credit loans in Denmark is regulated by the Danish Mortgage-Credit Loans and Mortgage-Credit Bonds Act and executive orders issued pursuant to the Act.
These Acts and consolidated Acts have been translated by the Danish Financial Supervisory Authority. In case some acts may have been updated since the translations, these are marked with "Excluding minor amendments". Please note that only the Danish versions have legal validity.
Translations are available on the website of Danish Financial Supervisory Authority translated Acts.
Financial supervision
All financial institutions operating in Denmark are supervised by the Danish FSA (Finanstilsynet).
The Danish FSA is part of the Ministry of Business and Growth .
The main task of the Danish FSA is to supervise compliance with financial legislation by financial institutions and issuers of securities as well as investors on the securities market.
Public risk information is to be given in situations in which the limit values of the Supervisory Diamond are exceeded (introduced in June 2010).
The Danish FSA translates parts of the legislation and regulations. Only the Danish version has legal validity.