Bond Investment
Denmark has one of the largest mortgage markets in Europe – and the mortgage system makes up a substantial part of the financial sector in Denmark. Covered bonds are purchased and sold daily, mainly by domestic institutional investors, which constitute a very stable investor base. Covered bonds are traded as liquid and secure securities – even in times of financial unrest. This is evidenced in a survey by Danmarks Nationalbank.
Issued covered bonds total nearly DKK 2,400bn (end-2010). The amount exceeds Denmark's annual GDP of about DKK 1,700bn by nearly 50% and is roughly four times higher than the sovereign debt of around DKK 700bn. Mortgage lending represents two thirds of total lending by financial undertakings.
The figures illustrate that the Danish mortgage market makes up a substantial part of the financial sector in Denmark. Consequently, the mortgage system is of decisive importance to the Danish economy and financial stability. The Danish mortgage market is also remarkably large compared with other countries. Even though Denmark is a small country, we have the third-largest bond market in Europe.
The largest is in Germany with issues worth around DKK 5,360bn followed by Spain (DKK 2,628bn), Denmark (DKK 2,434bn), France (DKK 2,155bn), the UK (DKK 1,524bn) and Sweden (DKK 998bn). Together, these six countries account for 85% of the total European market, according to data for 2009 from the European Covered Bond Council (ECBC).
The mortgage market in Germany differs in the way that a quite substantial amount of the outstanding bonds are issued for the purpose of funding public loans. In terms of bonds issued solely for the purpose of funding real property, Denmark has the second-largest mortgage market in Europe.
Broad and stable investor base
For decades, the Danish mortgage market has had a broad and stable investor base.
52% of the Danish covered bonds are held by financial undertakings, typically commercial banks headquartered in Denmark. Domestic pension and insurance companies hold 20 %. This means that close to 75% of the covered bonds are held by Danish institutional investors.
Financial undertakings in Denmark use covered bonds a material instrument in their liquidity management. The investor base has been fairly stable for decades. This makes for a liquid and deep mortgage market.
Foreign investors account for around 15%. This share decreased during the financial crisis, but has since grown.
Figure 1: Ownership of Danish covered bonds in August 2011
Source: Danmarks Nationalbank
Liquidity and turnover
The outstanding amount of bonds changes hands frequently, although in some bond series there is little trading. According to Danmarks Nationalbank, typically 10% of issued fixed-rate covered bonds are traded each month. As regards short-term fixed mortgage bullets funding ARMs, around 20% is traded monthly.
According to NASDAQ OMX, covered bonds worth close to DKK 25bn were purchased and sold daily in 2010, equivalent to around DKK 6,300bn annually, including the large refinancing auctions.
Given the considerable trading volumes on the stock exchange, the official prices – except in illiquid series – reflect the current market conditions. Ultimately, it helps ensuring that borrowers, for example, obtain a fair price when raising mortgage loans or prepaying existing loans.
Furthermore, Danish mortgage banks issue new covered bonds on an ongoing basis, the so-called tap issues. We consequently have a mortgage market with daily new issues in existing bond series.
Covered bonds during the financial crisis
Danmarks Nationalbank has examined the liquidity levels in the Danish bond market before, during and after the financial crisis. The conclusions were published in a working paper in September 2010. The study covers both covered bonds and government bonds.
Generally, Danmarks Nationalbank concludes that the financial crisis quite naturally resulted in wider price spreads between covered bonds and government bonds. However, covered bonds remained largely as liquid as government bonds. Also, price spreads quickly tightened and returned to normal. Under normal circumstances, there is a price spread between government and covered bonds, albeit a moderate one.
Historically, the prices of Danish covered bonds have been quite close to the prices of government bonds from Denmark, the US and the UK. The price spreads widened during the financial crisis, but only to a limited extent and for a short time.
