Oct. 31 (Bloomberg) -- Denmark proposed a plan to protect its $360 billion mortgage-bond market from a sell-off by pension funds, the second rescue package this month.

The government, the Financial Supervisory Authority and the Danish Insurance Association agreed to let pension funds, which hold 25 percent of outstanding mortgage debt, change the way they calculate future obligations, reducing pressure on portfolios and preventing a ``systematic divestment'' of mortgage bonds, the Copenhagen-based Economy Ministry said in a statement today.

Denmark's mortgage bond market, the world's third largest after the U.S. and Germany, has suffered declines as some investors shunned property-related assets. The bonds faced a sell- off as pension funds sought to avoid dropping a notch in regulatory rankings after price declines threatened to reduce their portfolios.

``This has led to a total shift of mood'' in the market, said Jens Peter Soerensen, chief analyst at Danske Bank in Copenhagen. ``And the gains haven't fed through yet, yields can still come down a lot from where they are now.''

The news sent yields on mortgage bonds lower, with the yield on the 4 percent note due 2038 dropping 0.11 of a percentage point to 5.86 percent as of 11:32 a.m. in Copenhagen, according to prices provided by Danske Bank A/S.

`Serious' Impact

``A major sell-off of mortgage bonds would have serious consequences for those saving up for their pension, as well as home owners, as prices would fall and interest rates would rise,'' the Economy Ministry said in a statement on its web site today.

Pension funds will temporarily be allowed to use their mortgage bond holdings to calculate obligations, allowing them to set aside fewer provisions, the ministry said. They will also be allowed to take into account improved profits assumed under ``a normalization'' of markets when calculating solvency ratios.

The funds will also no longer risk triggering an ``orange light'' in the so-called traffic light system, corresponding to falling down a notch in the FSA's rankings if their portfolios don't fulfil certain criteria. Instead, funds will report on a quarterly basis to the FSA how they're allocating their reserves.

The changes will allow pension funds to avoid booking losses of as much as 60 billion kroner, Peter Skjoedt, deputy director at the Danish Insurance Association, said in a telephone interview.

Household Threat

The yield on the 4 percent mortgage-backed paper due 2038 has risen more than 0.3 of a percentage point this month, before today's announcement. That compares with a 0.04 percentage point rise in Denmark's 4 percent government note due 2017.

Higher mortgage yields are also threatening households, with flexible-rate mortgage holders facing jumps in debt payments when they refinance in December.

The central bank has raised the benchmark interest rate twice this month, bringing it to an eight-year high of 5.5 percent, as policy makers try to keep the krone fixed to a target rate against the euro. The bank's sole mandate is to defend the currency peg.

Under a bank agreement struck on Oct. 10, Denmark will guarantee all banks deposits, including inter-bank loans, in a 35 billion kroner ($6.39 billion) arrangement that will be funded by the country's commercial lenders.

Today's rescue package announcement doesn't require passage through parliament, the ministry said. The agreement runs until the end of 2009.

Danish mortgage bonds haven't defaulted in their more than 200-year history.

To contact the reporters on this story: Tasneem Brogger in Copenhagen at tbrogger@bloomberg.net;

Last Updated: October 31, 2008 07:24 EDT