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Short-term Danish mortgage bonds, singled out by the central bank and rating companies as a threat to the $500 billion industry, are the best debt investment in Denmark, according to the head of Pacific Investment Management Co. (ALG5JAE)’s covered bond operations in Europe.
“There’s not a lot of incentive for us to go out on the curve,” Kristion Mierau, Munich-based senior vice president at Pimco, which manages the world’s biggest bond fund, said in an interview. One-year notes, used to finance 20- and 30-year mortgages, provide the highest return given their risk, when purchased together with a currency hedge, he said.
The bonds identified by Pimco as Denmark’s best-returning debt class are injecting refinancing risks into Denmark’s home- loan market, according to the central bank, Moody’s Investors Service and Fitch Ratings. The Basel Committee on Banking Supervision’s stable funding requirement is also making the one- year bonds less appealing to issuers.
Some Danish lenders have responded by trying to wean borrowers off the adjustable-rate mortgages that the short-term bonds finance. Realkredit Danmark A/S, the mortgage arm of Denmark’s biggest lender Danske Bank A/S, has run ads to persuade borrowers to switch to loans backed by longer bonds and has even charged higher fees for the one-year notes.
The Danish Housing Ministry said it will shift to fixed- rate mortgages with longer maturities, to finance new public housing projects.
About 80 percent of the 475 billion kroner ($83 billion) headed for refinancing auctions starting this month will be one- year bonds, Realkredit Denmark estimates. The deadline for borrowers to switch mortgages was Oct. 31.
Lenders have encouraged borrowers to shift to mortgages backed by bonds with maturities of at least three to five years, to lock in record-low rates. The Mortgage Bankers’ Federation has also urged issuers to make customers less reliant on annual refinancing.
“What we hear from the mortgage banks is that it will have an effect, but we will have to see how big that effect will be,” Karsten Beltoft, director of the Mortgage Bankers’ Federation in Copenhagen, said in an interview. “The signals we have gotten until now indicate the effect may be between 5 and 10 percent changing from one-years to longer-dated adjustable- rate mortgages.”
As long as it remains unclear how much will be issued in three- and five-year notes, Pimco sees limited appeal in the securities, Mierau said.
“The way it looks now, I don’t see compensation being so extraordinary, especially considering the uncertainty in supply and demand, which has implications for valuations and liquidity,” he said. “Lending institutions have made efforts to incentivize homeowners to rotate into three- or five-year loans and reduce the growing refinancing risk in the system.”
Denmark’s mortgage-bond market has moved away from traditional fixed-rate, callable-at-par securities into more varied debt instruments. Some 55 percent of outstanding loans are in adjustable-rate bonds, the central bank estimates, after the products were introduced in 1996. Interest-only loans, which the central bank has criticized for exacerbating volatility in the country’s property market, were sold starting in 2003.
Nykredit’s bond maturing Jan. 1, 2014, had a bid-to- maturity yield of 0.52 percent at 10:20 a.m. in Copenhagen trading, after peaking at 1.1 percent in April. That compares with a yield of 1.44 percent for Nykredit’s note maturing Jan. 1, 2018.
Low rates on longer-term bonds may turn investors away while appealing to borrowers, Martin Lundholm, chief analyst for Spar Nord Bank A/S’s capital management division.
“Before we were reluctant to give advice on loans other than one-year bonds,” Lundholm said. “If the rates fell and they had to sell their homes, they would have had to buy back their loans at over 100 and that was problematic. Now the rates have been so low so long, they can’t really fall anymore.”
Though mortgage yields have sunk to record lows, the notes still offer better returns than government debt. The yield on Denmark’s 2 percent note due November 2014 was minus 0.036 percent yesterday. The central bank has left its deposit rate at minus 0.2 percent since July to counter a capital influx that threatened the krone’s peg to the euro.
“If you can get a one-year bond and hedge it and come back with a 0.5 percent yield, that is a compelling alternative to government bonds,” Mierau said. “We’re picking up roughly 40 basis points on the hedge. That’s a nice sweetener on the trade.”
Fitch Ratings this week cited refinancing risks when it lowered ratings on short-term bonds issued by Realkredit Danmark. Notes sold out of the lender’s capital center T, which has 285 billion kroner in covered bonds, were cut to AA+ from AAA, following changes to Fitch’s ratings criteria.
Non-Danish investors’ holdings of one-year mortgage notes rose to 410 billion kroner in September, or 54 percent of the total held offshore, the Association of Danish Mortgage Banks estimates. For Danish investors, one-year bonds made up 26 percent of the total.
“It’s a market that’s held up well during the crisis,” Mierau said. The Danish mortgage market is among the few with “opportunities” in the short end, he said.
While Denmark’s government debt is less than half the euro- zone average, allowing the country to be treated as a haven from Europe’s debt crisis, private indebtedness is the highest in the world, at 322 percent of disposable incomes in 2010, Standard & Poor’s estimates. The country’s housing market will continue to decline until 2014 after prices sank 25 percent since a 2007 peak, the government-backed Economic Council said yesterday.
“It’s not that Denmark is a shining star-- it has its own problems, including the housing market,” Mierau said. “But if you compare it with Spain, Portugal or Italy, they have a more complex situation. Net-net, Denmark is a less dirty shirt.”
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