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Banks May Sell $230 Billion of Danish Mortgage Bonds on Tap

Nykredit Realkredit Bank
S&P cut its outlooks on four mortgage banks in July, including Danske Bank A/S and Nykredit, Europe’s biggest issuer of mortgage-backed covered bonds, citing risks posed by the one-year bonds. Photographer: Freya Ingrid Morales/Bloomberg

Denmark’s mortgage banks are looking into opening non-stop auctions affecting $230 billion in adjustable-rate covered bonds in an effort to mitigate refinancing risks.

Banks, which in 2009 extended annual bond auctions to quarterly refinancing sales, are now considering stretching the length of each auction to as long as three months and effectively creating an on-tap system, according to Peter Jayaswal, deputy director at the Association of Danish Mortgage Banks in Copenhagen.

The talks follow warnings from the central bank and Standard & Poor’s that Denmark’s adjustable-rate mortgage bonds are adding risk to the $340 billion economy. S&P in July put Danish mortgage lenders on review for downgrades, arguing their reliance on bonds as short as one year to finance mortgages as long as 30 years exposes the industry to liquidity shocks.

“All the mortgage banks agree there is more risk with adjustable-rate mortgages,” Jayaswal said in a phone interview. “If a mortgage bank has refinancing auctions four times a year and they take three months, then the mortgage bank would have continual issuance. That is one way to do it.”

Banks have so far defended the adjustable-rate mortgage bonds, arguing their performance during the financial crisis shows they can withstand liquidity droughts. Their popularity among homeowners and investors has driven up issuance since they were first introduced in 1996 to make up about half the $500 billion market.

Beating Treasuries

The Nykredit Realkredit A/S index of the most-traded Danish mortgage bonds has returned 35 percent since the end of September 2008, the month Lehman Brothers Holdings Inc.’s failure sent international capital markets into a tailspin. U.S. Treasuries longer than one year have returned 21 percent in the period, according to Bloomberg/EFFAS indexes. The figures include re-invested interest.

Given the bonds’ popularity, the industry prefers a model that cuts risk without cutting issuance, Jayaswal said.

“We will see more distribution of refinancing,” he said. “We don’t want to put a percentage on the amount of one-years that a bank can have.”

The yield on Nykredit’s 2 percent mortgage bond due April 2014 rose a basis point to 0.29 percent as of 1:44 p.m. in Copenhagen, its highest since Sept. 5, according to data compiled by Bloomberg.

Liquidity Ratios

S&P cut its outlooks on four mortgage banks in July, including Danske Bank A/S and Nykredit, Europe’s biggest issuer of mortgage-backed covered bonds, citing risks posed by the one-year bonds. Under European legislation adopted this year, banks must meet two new liquidity ratios to survive a 30-day market shutdown and to have a minimum level of funding with maturities longer than one year. The Danish central bank has urged earlier national implementation of both standards.

Talks to shift mortgage bond sales to tap auctions also follow warnings from S&P analyst Per Tornqvist that previous efforts to spread refinancings across the year weren’t enough to help the industry escape the threat of downgrades. S&P rates Danske Bank A-, and gives Nykredit an A+ grade.

Higher rates and a steepening yield curve are likely to lead borrowers to stick to adjustable-rate mortgages in December auctions, Jan Oestergaard, a senior analyst at Danske, said in a Sept. 20 note. He estimates banks will sell 192 billion kroner ($35 billion) in one-year bonds, more than three times the amount of three- and five-year securities.

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