Fitch: Iceland Debt Relief Programme Appears Fiscally Neutral

Reuters

LONDON, December 06 (Fitch) Iceland's proposals to relievehousehold debt via mortgage write-offs and tax-exempt private pension schemesavings appear consistent with the authorities' stated commitment to fiscalconsolidation, Fitch Ratings says. However, another round of write-downs maydent investor perceptions of Iceland's business environment, and the prospectof foreign bank creditors in the failed banks bearing most of the cost may makeit more difficult to remove capital controls.The government aims to fully finance the plan, viaas-yet-unspecified budget adjustments, and tax increases - primarily an increase in thelevy on Icelandic banks' balance sheets from 0.145% of total outstanding debt to0.366%. This bank tax is levied on Iceland's new banks as well as on its failedbanks, Kaupthing Bank, Glitnir Bank, and Landsbanki Islands, through theirwinding up committees. Announcing a fully financed programme that is not expected toinvolve additional borrowing suggests the authorities have avoided a weakening oftheir commitment to fiscal consolidation. When we affirmed Iceland's 'BBB'Foreign Currency IDR in October, we identified as a rating sensitivity any weakeningof this commitment that caused the pace of the government debt ratioreduction to slow.By reducing household debt, the programme may have a positiveimpact on the Icelandic economy, where the private sector debt overhang hasweighed on consumption.However, by increasing the financial institution tax (includingon Iceland's failed banks, which remain disproportionally large) it reducesthe amount of money that the failed banks' foreign creditors can ultimatelycollect and may further dent international investor sentiment towards Iceland.This could have a negative impact on investment, growth, and external finances,and may make it even more challenging to unwind capital controls in an orderlyfashion.Another risk is that customers of Iceland's Housing FinancingFund (HFF) may attempt to take advantage of the debt relief by refinancingtheir HFF mortgages and moving to other lenders. The HFF is already subject tosubstantial refinancing risk, as borrowers can prepay HFF loans, while HFFbonds are not callable. An increase in mortgage repayments would increase thisrisk, meaning recapitalisation needs could exceed the relatively modest levelin our current assumptions. These assumptions see HFF recapitalisation addingaround 0.2pp to the public debt to GDP ratio per year. Safeguards restrictingrefinancing are under discussion, and the Icelandic authorities are currentlyassuming that ISK5-10bn will have to be put aside as a cushion for thepotential effects of higher prepayments.Iceland's coalition government said over the weekend thatinflation-linked mortgages would be written down, or borrowers incentivised torepay them, in a programme worth about ISK150bn (around 8.5% of GDP).The scheme has two components. A direct write-down ofinflation-linked mortgage principal is achieved by splitting loans into a primary loan,and a relief loan equivalent to up to 13% of the original loan. The maximumwrite-down per household will be ISK4m (around USD33,500). The Treasury willpay off the relief loans in four annual instalments of ISK20bn. The secondcomponent is the introduction of a three-year tax exemption on third pillarprivate pension savings used to repay mortgage debt.The proposal still has to be approved by the Icelandicparliament, and so is subject to amendments. It also remains to be seen if Iceland'snew banks or its legacy bank resolution committees may challenge the increase inthe bank levy.If approved, the first write-downs under the new programme couldbe seen in mid-2014, the government estimates that borrowers who benefitfrom both principal reduction and tax exemptions could reduce theirmortgage principal by up to 20% by end-2017.Contact: Alex MuscatelliDirectorSovereigns+44 20 3530 1695Fitch Ratings Ltd30 North ColonnadeLondon E14 5GNMark BrownSenior DirectorFitch Wire+44 20 3530 1588Media Relations: Peter Fitzpatrick, London, Tel: +44 20 35301103, Email: peter.fitzpatrick@fitchratings.com.The above article originally appeared as a post on the FitchWire credit market commentary page. The original article can be accessed atwww.fitchratings.com. All opinions expressed are those of Fitch Ratings.Applicable Criteria andALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS ANDDISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THISLINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION,RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLEON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS,CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'SCODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATEFIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLEFROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHERPERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES.DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN ANEU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUERON THE FITCH WEBSITE.

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