The Danish mortgage market is attracting international investors. Here’s why

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A century ago, a quarter of Copenhagen’s disastrous fire ended. Desperate to rebuild but with private loans so hard to come by, wealthy Danes banded together to support a new way of raising money: issuing bonds on property. Since then, the Scandinavian country has developed a unique approach to home loan financing and the sale of home loan-backed bonds. Even this period of inflation has made the securities a magnet for international investors.

1. What is special about Denmark?

It hosts the world’s largest market for so-called covered bonds — debt that’s considered safe because it’s backed directly by a stock of assets. Most of the nearly $450 billion in securities are backed by home loans, making them similar, but not identical, to mortgage-backed instruments issued in the US. While banks in the United States collect and sell loans, in Denmark special lenders sell special bonds at the request of borrowers who receive the money more or less directly. If the borrower refuses, Danish mortgage banks can take over the mortgage in a much shorter process than in many other countries. Danish debtors have a harder time declaring bankruptcy to avoid debt.

2. What makes these guarantees unique?

Financing a home can mean taking on debt for decades — or giving up and investing. It creates risks for lenders, especially when interest rates change or investors lose interest. In most countries, banks manage those risks. In Denmark, special mortgage institutions have been established that exclusively sell bonds secured against housing, offices, industrial buildings, etc., and cannot take deposits. They match borrowers with bond buyers and place the loan on their books. By transferring interest and market risks to borrowers and bond buyers, known as a “pass-through” system, it reduces lenders’ exposure.

3. What makes them attractive to international investors?

A few decades ago, most Danish covered bonds had fixed interest rates for 30 years, and buyers were mostly Danish pension funds. Because borrowers can repurchase up to four times a year and this creates uncertainty, their ownership requires specialized information and local knowledge. Then, in the early 2000s, mortgage banks introduced short-term bonds that offered more variety and greater cash flow security. Lenders also began trading for foreign investors. They particularly liked the bond and the country’s AAA credit rating when the European sovereign debt crisis hit in 2008-2009. The securities have become popular with Japanese pension funds and others. In the year By 2022, foreigners will account for a quarter of the total market.

4. How does the Danish market work?

Covered bonds can finance up to 80% of home purchases; Borrowers have to fill the balance with savings and expensive loans from conventional banks. The bonds come in different forms: fixed or adjustable rates, and with or without deferred principal payments. One exception is that the terms of the bond and the loan must mirror each other. Linking home loans to specific instruments allows borrowers to monitor the bond’s price on the secondary market and to work with their banks to sell and repurchase the securities. The collateral means that the debt is “secured”, which is classified as one of the safest for investors.

5. What happens when interest rates change?

Linking bonds and borrowers has created an active market where homeowners can easily switch loans, generating the liquidity and depth that investors need when interest rates change. As monetary policy loosened, short-term rates fell below zero and 30-year fixed rates fell to 0.5%, and borrowers flocked to those long-term bonds. Central banks, including the United States, As 2022 marks the biggest and fastest tightening in global monetary policy, inflation has risen and borrowers are buying low-cost bonds to cut their debt. Return to fixed-rate products. According to Danske Bank, refinancing in the first quarter of 2022 saw the issuance of various short-term bonds reach the highest level since 2010.

6. How does this market compare to the US?

The US system is set up differently, with government-backed enterprises like Fannie Mae forced to foreclose on many banks in the wake of the subprime crisis. Buy loans from banks and other loan providers; They issue securities backed by loan pools to generate funds. The system also differs from Denmark in part because of how catch pools are structured and maintained. In Denmark, mortgage banks create a series of bonds and sell them both through the pipeline and through quarterly auctions. And by comparison, Denmark is tiny with a population of 5.8 million.

7. How risky are bonds?

Danish bonds are considered among the safest and most easily traded securities due to national regulations and the depth and size of the market. In the year During the height of the global financial crisis in 2008, the market, like many other assets, remained open and liquid. Creditors have relatively easy collateral rights, and borrowers generally cannot get out of their debts. This limits the potential losses of mortgage banks. They also face regulations on how much capital and liquid assets they must have if markets freeze. In a historically unthinkable event, bond investors would be among the first to get their money back.

8. Is the Danish market a model for others?

The Danish model is not flawless: regulators have had to stop lenders from lending large amounts with short-term rates and principal-only options. Too many homeowners were borrowing more than they could afford, and investors were worried about financial stability if regulators pulled out of the market during the crisis. In June 2022, the Danish central bank recommended measures to further strengthen lending. For all that, the market is still considered a model for countries looking to improve their systems. But adopting the Danish model is complicated, because the rules and regulations around home ownership, contracts and restrictions are not easy to rewrite.

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