Investor Backlash Yields New Danish Mortgage Plan: Nordic Credit

Denmark will adjust a planned intervention in its $530 billion mortgage bond market following signs the original proposal risked driving away investors.

A draft unveiled by the Business Ministry in Copenhagen on Nov. 6 to change maturities on one-year mortgage bonds to as long as 30 years will probably be changed to limit the maturity extension to as little as 12 months, said Karsten Beltoft, head of the Danish Mortgage Bankers’ Federation. Business Minister Henrik Sass Larsen in an opinion piece in newspaper Borsen today confirmed the new plans.

“For investors it’s extremely important to know what they’re buying,” Beltoft said yesterday in an interview. “A bond with a one-year maturity or a 30-year maturity? Even if the risk is extremely low, they still have to know that.”

The government is adjusting its proposal after mortgage banks warned that investors were balking at the intervention and threatening to drop the securities, which account for about one-third of the total market. Under the original measure, all short-term bonds would have converted to maturities matching the loan they fund. Under the amended plan, bond maturities can be extended one year at a time. The yield under both plans would be set at the coupon plus 5 percentage points.

“Investors won’t automatically be tied to the remaining life of a loan,” Larsen wrote. The change excludes bonds of a lender that goes into default, which would be converted to match the loan’s maturity, he said.

Maturity Jump

PFA, Denmark’s biggest commercial pension fund, has already said it would demand a higher return to compensate it for the original maturity change, which is triggered if interest rates rise 5 percentage points or if an auction fails.

“It could be a big jump in maturities that might matter for some investors,” Peter Jayaswal, deputy head of the Association of Danish Mortgage Banks, said by phone. “We have said to the authorities that they have to be aware that there could be different investor segments. Today we have a huge investor segment in the short end that is very happy about” using the bonds as “money market instruments,” he said.

Larsen said Nov. 6 the government needed to intervene after industry efforts to address refinancing risks posed by the short-term bonds proved inadequate.

The one-year bonds, which are used to finance mortgages as long as 30 years, have come under scrutiny from ratings companies and the central bank after they soared in popularity since their introduction in 1996.

Destroying Liquidity

Borrowers have been reluctant to switch back to 30-year, fixed-rate bonds after interest rates in AAA Denmark sank to record lows at the height of Europe’s sovereign debt crisis. That helped cushion the blow to homeowners of a 20 percent slump in property prices since their 2007 peak.

Mortgage bonds also have come to serve as an important money market instrument for Denmark’s financial industry. The securities make up as much as 80 percent of the liquid assets banks are required to hold, Beltoft estimates.

“In the short run, there are likely to be many investors that could run into problems with their investment mandates,” said Jesper Berg, head of regulatory affairs for Nykredit A/S, Denmark’s biggest mortgage bank. “This is a big operation and I am sure the authorities are considering how to implement changes in a way that reduces risks.”

Finding Balance

Yields on one-year mortgage bonds may be as low as 0.55 percent in auctions this month to refinance loans with a Jan. 1 interest reset date, according to Christian Heinig, chief economist at Realkredit Danmark A/S.

Lawmakers need to be careful that their proposals don’t “destroy the very liquid market that we have today,” Jayaswal said. “It is a balance between addressing the refinancing risk on the one hand and investors on the other.”

The Danish government still needs to convince European regulators the new maturity profile satisfies stable funding rules intended to protect against market freezes. The Financial Supervisory Authority in Copenhagen, which deems funding shorter than 12 months as unstable for commercial banks, said the original proposal would fulfill stable funding requirements.

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