Analysis | Denmark’s Mortgage Market Is Luring Global Investors. Here’s Why

1. What’s special about Denmark?

It hosts the world’s biggest market for so-called covered bonds — debt that’s considered extra-safe because it’s directly secured by a pool of assets. Most of the roughly $450 billion in securities are backed by home loans, making them similar to mortgage-backed instruments issued, for example, in the US, but not identical. While in the US banks bundle mortgages and sell them on, in Denmark specialized lenders sell specific bonds at the request of borrowers who receive the proceeds more or less directly. If a borrower defaults, Danish mortgage banks can take over the collateral in a process that’s much shorter than in many other countries. Danish borrowers also have a much tougher time declaring bankruptcy to get rid of debt. 

2. What makes these securities unique? 

Financing a home can mean taking on — or issuing and investing in — debt for decades. For lenders, that generates risks, especially when interest rates change or investors lose interest. In most other countries, banks manage those risks. In Denmark, special mortgage institutions that cannot take deposits have been established to exclusively sell bonds secured against houses, offices, industrial buildings and the like. They keep the loans on their books while matching borrowers with bond buyers. It’s known as a “pass-through” system and minimizes lenders’ exposure by transferring interest-rate and market risks to the borrowers and bond buyers. 

3. What makes them attractive to global investors? 

A couple of decades ago, most Danish covered bonds had interest rates fixed for 30 years, and buyers were largely Danish pension funds. Owning them required special data and local knowledge, since borrowers can repurchase them at par four times a year and that creates unpredictability. Then in the early 2000s, the mortgage banks introduced short-term bonds that offered more variety and greater cash-flow security. Lenders also began marketing to foreign investors. They liked the bonds’ and the country’s AAA credit rating, particularly when Europe’s sovereign debt crisis hit in 2008-2009. The securities became a hit among Japanese pension funds, among others. In 2022, foreigners held about a quarter of the entire market.

4. How does the Danish market work?

Covered bonds can be used to fund 80% of a home purchase; borrowers have to make up the remainder with savings and more expensive loans from regular banks. The bonds come in a variety of forms: fixed or adjustable rates, and with or without delayed principal payments. One peculiarity is that a bond’s terms and the loan must largely mirror each other. Tying home loans to specific instruments enables borrowers to monitor bond prices on the secondary market and work with their banks to time the sale of securities and also their repurchase. The collateral means the debt is “covered,” ranking it among the safest for investors.  

5. What happens when interest rates change?

Linking bonds and borrowers has led to an active market where homeowners readily swap mortgages as interest rates change, generating the liquidity and depth that investors seek. When monetary policy was loosening, short-term rates plunged below zero and rates fixed for 30 years fell to as low as 0.5%, with borrowers flooding into those long-term bonds. Since central banks including in the US signaled that 2022 could mark the biggest and fastest tightening of global monetary policy in years, rates have risen and borrowers are now buying back their lower fixed-rate bonds at below issuance price to cut their debt, and are switching back to adjustable-rate products. According to Danske Bank, refinancing drove first-quarter 2022 net issuance of various short-term bonds to its highest since 2010. 

6. How does this market compare with the US?

The US system is set up differently, with government-sponsored enterprises like Fannie Mae dominating the market after the sub-prime crisis led many banks to stop securitizing. They buy loans originated by banks and other credit providers; to generate cash, they issue securities backed by pools of loans. The system differs from Denmark’s also in part because of how collateral pools are structured and maintained. In Denmark, the mortgage banks create series of bonds and sell them both on tap and at quarterly auctions. And by comparison Denmark is tiny, with a population of 5.8 million.  

7. How risky are the bonds?

The Danish bonds are considered among the safest and most easily traded securities around, because of the national regulations and the depth and size of the market. There was a rough patch during the height of the 2008 global financial crisis, as with many other assets, but the market remained open and liquid. Lenders have relatively easy access to collateral, and borrowers generally can’t walk away from their debts. That limits mortgage banks’ potential losses. They also face regulations around how much capital and liquid assets to have, in case markets freeze. In the historically unlikely event of a mortgage provider going bust, 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 without flaws: Regulators had to stop lenders from making large quantities of loans with short-term rates and principal-only options; too many homeowners were borrowing more than they could afford, and regulators worried about financial stability if investors were to exit the market in a crisis. In June 2022, the Danish central bank recommended measures to further tighten 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 laws and rules that spring up around home ownership, contracts and foreclosures aren’t easy to rewrite.

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