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Biggest Iceland Mortgage Bank Sees Bailout Averting Default

FEB 21, 2013 12:32pm ET

Iceland’s biggest mortgage bank said the government would bail out the lender before it’s unable to honor its debts.

“There’s no risk of a default,” Sigurdur Jon Bjornsson, chief financial officer of the Reykjavik-based Housing Financing Fund, said in an interview late yesterday. “The Treasury, if it needed to, would bail out the fund.”

His comments were echoed by finance minister Katrin Juliusdottir today, who said the government is prepared to cover the struggling fund, which yesterday was downgraded by Moody’s Investors Service to junk. Moody’s cited a capital shortfall and growing loan losses. The cut to Ba1 from Baa3 was also based on HFF’s “full reliance on market funding,” Moody’s said.

“We were fully aware during the budget discussion last fall that the Housing Finance Fund was in trouble, but we also stated that the Treasury would back the fund,” Juliusdottir said at the Reykjavik-based parliament today. “Authorization has been granted to inject new equity into” the lender. “So we’re on the right path with the Housing Finance Fund.”

Iceland, which let its biggest banks default on $85 billion in 2008, said in November it’s ready to inject 13 billion kronur ($100 million) into state-backed HFF to keep the lender afloat. Yet even taking that support into account, the bank’s capital ratio was about 3% of its risk-weighted assets at the end of last year, compared with a 5% regulatory minimum, Moody’s said. HFF had $4 billion outstanding in bonds at the end of January.

The lender, which provides mortgages that are linked to the inflation rate, is losing business to commercial rivals such as Arion Bank hf and Islandsbanki hf, which are unfettered by such indexation. As inflation hovers above 4%, borrowers have turned away from HFF and sought alternative home loans to prevent their debt burdens growing with consumer prices.

The mortgage lender’s fate is being watched by offshore investors trapped by Iceland’s capital controls. Since the nation imposed currency restrictions at the end of 2008, investors have had few places to put their funds. HFF has provided a liquid market for some of the $8 billion in offshore kronur fenced in by the controls.

HFF’s assets are likely to continue to deteriorate, Moody’s said yesterday. Though the fund enjoys a “high level of support” from the government, its capital ratio sank to 1.4% from 2.3% in the first half of last year, Moody’s said. According to Sigurdur Jon Bjornsson, HFF’s chief financial officer, HFF’s small capital buffer doesn’t pose a threat to its survival.

 “We’re discussing a very large fund,” he said in a telephone interview late yesterday. “In comparison with other financial institutions it has lost about 5% of its assets, while other asset portfolios were written down by between 45% and 65%. These 5% aren’t enough to bring down the fund.”

Bjornsson said HFF executives will meet today to discuss “the downgrade and decide what we want to say about it.”

Moody’s earlier this month raised the government of Iceland’s Baa3 rating to stable from negative as the island emerges from its 2008 economic collapse. Iceland, which completed a 33-month International Monetary Fund program in August 2011, is now outgrowing much of Europe as it rebounds from its deepest recession in six decades.

Five-year credit default swaps on debt issued by the government in Reykjavik dropped to a low of 150 basis points this week, compared with 237 basis points on Italian debt and 252 basis points on Spanish debt. At the height of its financial crisis in 2008, default swaps on Iceland’s debt traded at 1,473 basis points. Moody’s rated Iceland Aaa until May 2008, five months before its financial system collapsed.