World’s Largest Covered Mortgage Bond Market Lures Japanese

  • Nikko Asset sold banks 80 billion yen of Danish covered notes
  • ‘A lot of new investors are buying these bonds:’ Danske Bank

Japanese banks are flocking to Danish mortgage bonds that offer outsized yields in the European country where interest rates have been negative for the longest time in the world.

Nikko Asset Management Co. has sold about 80 billion yen ($784 million) in Danish covered notes backed by mortgages to Japanese banks since May, said Masato Mishina, an institutional sales head in Tokyo at the money manager. Such notes are attractive to banks because they offer yields of about 2 percent, and yen investors can hedge against currency swings at almost no cost or even get paid for doing so, he said.

While Japanese sovereign debt has slumped ahead of the central bank’s meeting later this month, the 10-year government bond yield is still below zero and the average Japanese corporate note yield is 0.22 percent according to Bank of America Merrill Lynch data. Interest in investing in Denmark’s covered debt market, the world’s largest in terms of mortgages, has increased in the last year as global yields have slid, according to Danske Bank A/S, the nation’s biggest bank.

“A lot of new investors are buying these bonds,” said Jan Weber Oestergaard, a senior analyst at Danske Bank in Copenhagen. “The reason is you have a fairly high coupon in Danish mortgage bonds if you compare them to European covered bonds or in this case Japanese government bonds where you get hardly any positive yield at all.”

Yields on Danish covered mortgage notes that are callable exceed those on local sovereign debt because they let the borrower refinance the loan early, according to Oestergaard. While Denmark’s key interest rate is at minus 0.65 percent, market expectations are for that rate to normalize in coming years, he said.

Yen investors could have received a premium of as much as 9 basis points for swapping currencies to buy krone mortgages this week, according to calculations by Bloomberg. Nikko Asset sells the mortgages to Japanese banks in a yen-denominated fund that it started offering in May, according to Mishina.

Japanese bought a net 133.7 billion yen in Danish long-term debt in July, the most since at least 2014, according to data from the Bank of Japan. Denmark ranked fourth behind the U.S., Canada, and France for such purchases by Japanese investors in the month, Ministry of Finance data show.

Denmark’s covered mortgage bond market dates back to the 18th century and outstanding issuance exceeded $420 billion at the end of 2015, according to data from the European Covered Bond Council. Such debt funds virtually all of the country’s real estate transactions and is an integral part of the financial system, making up the lion’s share of bank liquidity buffers.

The mortgage system of Denmark has never caused bondholders any losses as a result of a payment default, according to Nykredit Realkredit A/S, one of Europe’s biggest covered bond issuers.

For a story on rising hedging costs for Japanese investors, click here.

With dollar hedging costs increasing and European Central Bank stimulus pushing down yields in the Euro area, Mishina said the amount of Danish covered bonds sold by Nikko Asset may grow to about 200 billion yen by the end of Japan’s fiscal year in March. If Japanese investors in U.S. 10-year Treasuries want to hedge back yen to avoid currency swings, yields on the dollar notes fall to near zero, according to Bloomberg calculations.

Mishina sees no let-up in Japanese banks taking yen funds overseas in search of yield. Japan’s benchmark 10-year sovereign yield was at minus 0.025 percent on Friday in Tokyo, after falling to a record minus 0.3 percent in July.

“While it depends on the bank, there will still be a lot of Japanese government bonds maturing in the second half of the year,” said Mishina. “They are not going to be able to buy JGBs if rates remain negative, so even if not all, a significant portion of that money is going to go overseas.”

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