Bloomberg News

Danish Risk Rekindled as Yield Hunt Stokes Mortgage Bonds

February 02, 2012

(Updates with bond spread in sixth paragraph.)

Feb. 1 (Bloomberg) -- Investors are rediscovering yield in Denmark as mortgage bond issuance crowds out the government’s plan for an early surge in debt sales.

Bond investors are searching for ways to boost returns after demand for the AAA nation’s bonds sent government debt yields to lowest in at least 20 years. At the same time, the trade that also drove Danish 10-year borrowing costs to below Germany’s is reversing as European leaders reached an agreement on a deficit pact and the European Central Bank in December stepped in with unlimited three-year loans.

“Government bonds are very, very expensive,” said Mikkel Hoegh, a senior economist at mortgage lender BRFKredit. “Denmark has been a safe haven, so many investors bought the bonds, but they’re more expensive now compared with mortgage bonds, so they’re making a switch.”

Nykredit Group and other Danish mortgage banks are finding ample demand as they step up supply and prepare for about a 170 billion-krone ($30 billion) debt auction in March. Lenders have been issuing a new 3.5 percent 30-year bond at the same time as the central bank is front-loading debt sales after borrowing costs plunged. The issuance has helped push yields on Danish 10-year bonds back to parity this week with German debt, after the spread went negative in November.

‘More Pressure’

The yield on the new 3.5 percent mortgage bond maturing in 2044 has increased four basis points to 3.82 percent since being issued on Jan. 13. Denmark’s 10-year government yield has jumped 11 basis points to 1.75 percent over the same time.

The Danish government pays five basis points less than Germany to borrow for 10 years, today’s prices show, compared with a discount of as much as 27 basis points on Dec. 1.

If mortgage bond sales “continues to be significant, we could see more pressure” on government bonds, said Jens Peter Soerensen, chief analyst at Danske Bank A/S.

Demand is holding up even as Denmark struggles with a property bubble that burst in 2007. House prices plunged an annual 8.5 percent in November as the gap between bid and ask prices widened, official data showed yesterday. Bad real estate loans led to three bank failures last year, two of which pushed losses on to senior creditors and exacerbated a funding squeeze.

U.S. Mortgages

Unlike the wave of losses in the U.S. mortgage market, no Danish mortgage bond has defaulted since the market was created in 1797, when debt was first sold to finance the rebuilding of Copenhagen after a fire in 1795 burned down 900 buildings. Most bonds are AAA rated and sold through lending facilities that are over-collateralized, giving them an extra buffer to withstand defaults.

The Nykredit Mortgage Bond Index, which includes the largest, most-traded of the securities, is trading about 0.2 percent below a Jan. 2 record high.

The 3.14 trillion-krone mortgage bond market, the third largest after the U.S. and Germany, also offers more liquidity than the government bond market. Some 22 billion kroner traded on average each day last year, compared with 3.57 billion kroner a day in the 670 billion-krone government bond market, according to data from the Nasdaq OMX Nordic exchange.

The Nordic country had seen an influx of capital as investors rewarded governments with low debt burdens and top ratings. Its public debt will reach 44.6 percent of the economy this year, compared with an average of 90.4 percent in the 17- member euro area, the European Commission estimated on Nov. 10.

Nordic Havens

Similar spread moves have also occurred in Norway and Sweden, which are also outside the euro. Norway’s 10-year note yields 56 basis points more than German debt, after that difference narrowed to as little as five basis points on Jan. 16. Sweden’s 10-year note yields eight basis points less than the German equivalent, down from an advantage of 64 basis points at the end of November.

By contrast, Italy’s and Spain’s 10-year yield spreads to Germany have this year narrowed 53 basis points to 417 basis points and 25 basis points to 319 basis points, respectively.

Bargaining with Greece over a debt writedown and its economic management is continuing as European Union leaders this week signed off on key planks to end the debt crisis. They agreed to accelerate the setup of a full-time 500 billion-euro ($659 billion) rescue fund and endorsed a deficit-control treaty. The ECB last month offered banks unlimited three-year loans, easing concern and sapping a capital flight to non-euro countries such as Denmark.

According to Rune Brinch Kristensen, chief analyst Nykredit Markets, a “higher-than-normal issuance” of three-year and five-year bonds from the mortgage lenders before a refinancing deadline has also weighed on the market.

“We recommend investors take advantage of the last days with higher issuance before the market is expected to come to a standstill until the auctions in March,” he said in an e-mailed reply to questions. “The lower issuance of medium-term Danish covered bonds might underpin the government bonds as well, but the relatively positive outcome from the EU summit is expected to be more positive for Germany than it is for Denmark.”

--Editors: Jonas Bergman, Tasneem Brogger.

To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at fschwartzko1@bloomberg.net

To contact the editor responsible for this story: Tasneem Brogger at tbrogger@bloomberg.net


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