Moody’s downgrades Iceland’s Housing Financing Fund

Global rating agency Moody’s today downgraded to Ba1 stable from Baa3 negative the senior unsecured debt and issuer ratings of Icelandbased Housing Financing Fund (HFF). Moody’s rating action was triggered by the lowering of HFF’s baseline credit assessment (BCA) to caa1 from b2, and follows the change in outlook for the government of Iceland (Baa3 senior) to stable from negative on 7 February.

The change in HFF’s BCA concludes Moody’s review that was initiated on 5 October 2012, reflecting (1) the weakening of HFF’s asset quality; (2) Moody’s expectation of continued weak profitability; and (3) HFF’s poor and further deteriorated capital ratio, which fell to 1.4% from 2.3% during H1 2012. The downgrade of HFF’s senior debt to Ba1, stable, from Baa3 negative reflects these stand-alone pressures offset by the continued high level of support from the Icelandic government.

The stable outlook on the senior unsecured debt and issuer ratings reflects the strength of and links to HFF’s owner, the Icelandic government, notably the guarantee following from the fund’s legal status, as well as the actions and intentions of the government. The lowering of HFF’s BCA reflects the strong likelihood of further systemic support being required to maintain HFF as a going concern given Moody’s expectation that (1) HFF’s deteriorated asset quality will continue to weigh on its credit strength; (2) both pre-provision and net profitability will remain weak; and (3) notwithstanding the ISK 13 billion government capital injection announced late 2012, HFF’s capitalisation remains low at approximately 3% at year-end 2012, and will likely deteriorate again in 2013, due to operating losses and additional need for write downs. HFF’s full reliance on market funding makes the fund sensitive to deterioration of investor confi- dence, which may be influenced by the fund’s low capitalisation or, over time, the removal of the governmentimplemented capital controls, which have been in place since December 2008.

HFF’s weakened asset quality is demonstrated by loans in payment suspension or in default increasing to 14.7% of gross loans at endDecember 2012, from 14.6% at yearend 2011, albeit that the rate of deterioration has slowed down. The stock of repossessed properties on HFF’s balance sheet increased by 46% at year-end 2012 relative to year-end 2011, and is expected to increase further in 2013. Of the entire stock of properties 41% were rented out at end-December 2012, and the remainder are at different stages of the sales process.

However, Moody’s believes there is a low probability that properties can be sold in the near future, especially outside the greater Reykjavik region in which commercial bank lending is concentrated. HFF’s establishment of a rental company in January 2013, which will specialise in renting out part of the repossessed properties, is only a minor mitigation to the risk that HFF is increasingly exposed to non-performing real estate on its balance sheet.