// THEMA FIXED INCOME
DANISH MORTGAGE BONDS By Michael Denbaek and Peter Thiberg in cooperation with Astrid Gehoel-Ceelen
In the current low yield environment, Danish mortgage bonds are a very attractive alternative for EUR, USD and JPY fixed income investors, given that Danish mortgage bonds offer a relatively high expected return and a very low credit risk. DENMARK Denmark is a AAA-rated small open economy. Since 1982 the currency has been pegged to first the Deutsche Mark and since 1999 the Euro. The Danish central bank has a substantial currency reserve in order to support the DKK if ever needed. (The current size of the reserve is approximately 60.6 bn. Euros.) This ensures that the currency rate between Danish kroner and Euro is kept in a narrow range. Furthermore, the official Danish deposit rate is lower than the ECB’s, which provide a gain for those wishing to hedge the DKK into EUR. In addition, the Danish economy is faring better than many eurozone countries. The fiscal balance is sound and Denmark has a high trade balance surplus.
BORROWERS The Danish mortgage bond market has existed since 1797 and is the largest
covered bond market in Europe (393 bn. Euro). Almost all real estate is financed through issuance of mortgage bonds rather than bank loans. Most Danes own their own houses and apartments and consequently have high levels of gross debt. However, looking at net debt (including pension savings), Danish households are among the wealthiest in Europe.
INVESTORS The primary investor base are the Danish pension and financial sectors. They allocate large amounts to Danish mortgage bonds as the base part of their portfolios. The share of foreign investors has been rising for the past years and is currently 21.3% and in the segment of callable bonds it’s as high as 34.1%. The explanation for the recent rise is the attractiveness of the expected return as well as the extremely low yield on
Figure 1: Volume in European covered bond markets by country (EUR bn.)
Source: European Covered Bond Council Fact Book 2018
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NUMMER 5 / 2019
alternative AAA-rated fixed income investments.
CALLABLE MORTGAGE BONDS The Danish mortgage bond market consists of non-callable bonds, floating rate notes, and callable bonds. All are issued under the Covered Bond label, ensuring enhanced credit quality compared to ‘standard’ mortgage credit bonds. They are AAA-rated and highly liquid, with daily issuance and a very active secondary market. Callable mortgage bonds are the most interesting part of the market (and form approximately 33% of the outstanding bonds) since they offer a substantially higher expected return than comparable AAA-rated fixed income investments worldwide (hedged to the same currency). The callable bonds are callable by individual borrowers at par effectively 4 times per year. Every mortgage loan is financed by issuance in a particular bond. If a borrower has a loan and he wants to refinance into a different loan with more favorable terms, he can chose to call/ redeem his current loan and take a new loan. If the price of the bond of his current loan is above par, the borrower will exercise his option to prepay and he will inform his mortgage bank. The mortgage bank publishes prepayment information every week and each quarter the collected prepayment amount is paid out pro rata to each bond holder. The investor will experience a cash inflow and a reduction in nominal for each callable bond, depending on the specific prepayment ratio. Since bonds only prepay when market prices are above par,
