(August 12, 2013) — The Icelandic government has called on its pension funds to be “flexible” on the terms of bonds issued by its Housing Finance Fund, but it appears the appeal has fallen on deaf ears.
The Icelandic Pension Fund Association has come out and strongly refuted the government’s plea, saying the pension funds–which own around 64% of Housing Finance Fund bonds according to Icelandic economist Olafur Margeirsso –won’t discuss changes to the terms unless they are “fully compensated”.
The Housing Finance Fund was set up by government in 1999 to provide house purchase and home improvement loans to individual borrowers. It was severely hit by the financial crisis as people defaulted on their loans, forcing the Icelandic government to inject ISK33 billion in 2010.
Speaking to Bloomberg, Thorey S. Thordardottir explained: “Legally, the pension funds aren’t allowed to negotiate differently.” In fact, agreeing to change the terms without compensation “could make the board members of Iceland’s 31 pension funds liable for any damages to their members”.
For many Icelandic pension funds, these bonds represent the biggest asset on their portfolio. Speaking to aiCIO, Hlynur Þór Björnsson, head of risk management at the Gildi pension fund, explained that the terms the government wants to change would affect the nature of the bonds.
Currently, the bonds are non-callable, but the Housing Finance Fund has found itself up against a duration gap in their lending portfolio versus their issued bond portfolio, caused by members of the public paying up their Housing Finance Fund loans by refinancing them through commercial banks.
“For the pension funds this is a problem because if the bonds become callable, the Housing Finance Fund will probably have to call in 20% to 30% of the issued bonds. In a land of capital controls where investment options are limited to only domestic securities this is a large problem,” Björnsson continued.
“When it comes to the issue of compensation, pension funds in Iceland mostly bought the bonds at a yield of higher than 4.2%. Now they yield at around 2.7% and the government wants to call in the bonds not buy them at current yields.”
The issue has come to a head as the national government continues to struggle to find a way for the Housing Finance Fund to avoid falling into insolvency.
Iceland’s Treasury could be forced to take on more than ISK100 billion ($830 million) in liabilities, according to a report from bank Landsbankinn in June.
In the Housing Finance Fund’s last report in March, it revealed it had a capital adequacy ratio of 3.2%, well below the 5% minimum requirement set by the regulator.
Defaults on home loans increased by 0.17% to 12.92% of the Housing Finance Fund portfolio in June, and to make matters worse, the fund is coming under pressure from the more attractive investment option of normal mortgages from commercial banks.
Pension funds were encouraged to buy the Housing Finance Fund bonds in 2010, in an attempt by the Treasury to increase liquidity in the economy.
The bonds have duration of around 10 to 13 years, are consumer price inflation indexed and have a government guarantee, making them one of the best long term asset for the Icelandic pension funds.
Initially, 26 pension funds agreed to buy the bonds from the Central Bank for a collective price of ISK88 billion.
The Icelandic Pension Funds Association said at the time that the deal was a good one, although it acknowledged the move would increase the pension funds’ risks.
Related Content: Iceland’s Success Story and Danish Pension Snaps Up Banking Crisis Casualty