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Pimco Looking at Longer Danish Mortgage Debt as Volume Grows

Pimco Looking at Longer Danish Mortgage Debt as Volume Grows
Denmark’s low rates have helped cushion the impact of a burst property bubble that’s triggered more than a dozen bank failures and sent the economy into a recession. Photographer: Linus Hook/Bloomberg

Pacific Investment Management Co. is ready to invest in adjustable-rate Danish mortgage bonds with maturities longer than one year as issuers in the $500 billion industry try to build up liquidity in the notes.

Volumes in three- and five-year bonds sold in auctions in November and December to refinance home loans rose by more than half even as the amount issued across all maturities fell, data compiled by Danske Bank A/S show. The extra liquidity in longer-dated notes is making them more attractive, said Kristion Mierau, senior vice president for covered bonds at the world’s biggest bond fund.

“The auctions in fact confirmed mortgage banks are getting traction in their efforts to incentivize borrowers to switch to three-year or five-year loans,” Mierau said in a telephone interview. The increase could make the bonds “a more compelling trade,” he said.

Issuers including the mortgage arm of Danske Bank, Denmark’s biggest lender, have urged customers to move away from mortgages that require annual refinancing as the central bank and rating companies warn of risks associated with short-term funding backing long-term loans. At the same time, borrowers have been drawn to record-low rates on the notes, which have dropped below 1 percent as investors seek out assets denominated in AAA rated Denmark’s krone.

‘Excess Cash’

“There is a lot of excess cash in the system which is very supportive for short-term instruments like Flex loans,” as the adjustable-rate mortgages are called, Mierau said.

The Nykredit index of Denmark’s most traded mortgage bonds hit a record high on Dec. 10 of 404.72, and closed yesterday at 403.67. Nykredit’s 2 percent mortgage note maturing Jan. 1, 2014, yielded 0.34 percent at 12:03 a.m. in Copenhagen after falling to a low of 0.26 percent on Dec. 7.

Rates on one-year Danish mortgage bonds fell in the latest set of refinancing auctions to an average of 0.42 percent, compared with 1.2 percent a year ago, according to the Copenhagen-based Association of Danish Mortgage Banks. Rates on three- and five-year bonds sold were at least 50 percent higher.

“Over the years, it has proven hard to lure the debtors away from” one-year bonds, Sune Mortensen, corporate head of advisory services at Nykredit A/S, Europe’s biggest issuer of covered bonds backed by home loans, said in an e-mailed response to questions.

Low Rates

Denmark’s low rates have helped cushion the impact of a burst property bubble that’s triggered more than a dozen bank failures and sent the economy into a recession. The yield on the country’s 3 percent government note due November 2021 eased two basis points to 1.14 percent in Copenhagen. That’s about 25 basis points less than yields on similar-maturity German bunds. The yield on Denmark’s two-year note eased two basis points to minus 0.11 percent. Gross domestic product will shrink 0.4 percent this year, the government estimates. Though home prices have dropped more than 20 percent since their 2007 peak, the foreclosure rate is only about a quarter the level it reached during the 1990s crisis.

The Danish central bank and Moody’s Investors Service have warned that one-year bonds, which make up about half the nation’s mortgage market, threaten to destabilize the industry because of a maturity mismatch to the 20- and 30-year home loans they fund. Issuers have responded by spreading refinancing auctions over the year and by encouraging borrowers to switch.

Investor Demand

Yet getting customers to switch to more expensive, longer-dated loans is proving hard. Success depends partly on attracting more investors, said Karsten Beltoft, director of the Mortgage Bankers’ Federation in Copenhagen.

“Demand from investors is important,” Beltoft said in an e-mailed response to questions. In that respect, the auctions have been a success, he said. “It has been possible to sell more bonds with three- and five-year maturities without widening the spread notably,” he said.

The average rate on three-year bonds in the auctions was about 0.75 percent, while the average rate for five-year bonds was about 1.25 percent, he said.

Pimco has favored one-year bonds because they offer better returns and deeper liquidity, Mierau said in an interview last month.

As of Sept. 30, 64 percent, or 635 billion kroner, of outstanding adjustable-rate home loans were financed with bonds with maturities of one year or less, according to the Copenhagen-based mortgage association.

Borrower Shift

Denmark’s five largest mortgage lenders in November and December auctioned 312 billion kroner in covered bonds that comply with European definitions, according to Danske Bank data. That represents a 13 percent drop from 2011. Combined with other products, the lenders sold about 450 billion kroner in bonds.

The share of covered bonds with maturities of two to five years climbed to 27 percent from 17 percent, according to calculations based on Danske Bank data. The amount of three-year bonds sold almost doubled to 45 billion kroner while five-year bonds increased 31 percent, to 18 billion kroner, according to the bank.

Borrowers who took out five-year adjustable rate loans in 2008 saw their rates drop by three quarters at the latest auction, to 1.2 percent from 4.63 percent, according to Nykredit. That translates into annual savings of as much as 70,000 kroner on loans of 2 million kroner.

“With further momentum we could eventually see a twisting of the flexloan curve simply due to supply and demand technicals,” Mierau said. “From the standpoint of an investor, the combination of improving secondary liquidity in the longer tenors and a steeper flexcurve loan would make the maturity extension a more compelling trade.”

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