Bond market in denmark

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Bond market in denmark

  1. 1. Divya Mehra Roll no. 771
  2. 2.  Bonds are instruments of indebtedness of the bond issuer to the holders. It is a debt security, under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest at fixed intervals  Usually a maturity date of more than 12 months.  At the time of issue of the bond, the interest rate and other conditions of the bond will have been influenced by a variety of factors, such as current market interest rates, the length of the term and the creditworthiness of the issuer.  Examples: debentures, asset-backed bonds and unsecured bonds.  Bonds are recorded at their face value. The market price of a bond is the present value of all expected future interest and principal payments of the bond discounted at the
  3. 3.  The Denmark mortgage industry has proved very effective in providing borrowers with flexible and transparent loans on conditions close to the funding conditions of capital market players.  Simultaneously, the covered mortgage bonds transfer market risk from the issuing mortgage bank to bond investors.  Lastly, strict property appraisal rules, credit risk management by the mortgage banks, and tight regulations including the so-called 'balance principle', have also historically shielded mortgage bonds from default risk. The Danish Mortgage Credit Act imposes strict matching rules between the assets (e.g., mortgage loans) and the liabilities (e.g., mortgage bonds) of mortgage credit institutions. Each new loan is in principle funded by the issuance of new mortgage bonds of equal size and identical cash flow and maturity characteristics, dubbed the balance principle  High industry concentration and automatic stabilizers also play a role in maintaining stability.
  4. 4.  The Danish and German covered bond markets are Europe's oldest. The first Danish mortgage bonds date back more than 215 years to the period after the Copenhagen Fire of 1795, which left a huge finance need for reconstruction. Throughout its long history, the Danish mortgage regime has never caused bondholders any losses as a result of a payment default. This underscores the high degree of security built into the system. Due to the long Danish tradition of using mortgage loans to finance real property, the Danish covered bond market is with an outstanding amount of more than EUR 320bn one of the largest in Europe – second only to the German Pfandbrief market.
  5. 5.  Compared with most other European mortgage systems, the Danish system stands out in a number of areas. The biggest difference that leaps to the eye is the close link between lending and funding in Denmark.  Despite the liberalization of the balance principle in July 2007, Danish issuers are still subject to very strict ALM rules, and Danish mortgage banks continue offering only true pass-through products.  Danish mortgage banks thereby completely eliminate market risk as the issued bonds match the loans granted. The match between lending and funding has made the Danish mortgage system unique compared with other European mortgage systems.
  6. 6.  The Danish system contains several special features designed to support and enhance the credit strength of Danish covered bonds.  In many ways, the legal and institutional framework has been the basis for the efficiency and success of Danish mortgage finance and is probably the foremost reason for the notably long and unblemished history of specialized lending in Denmark.  In the wake of the global mortgage lending crisis, the Danish system has received international acknowledgement, and several countries are considering implementing parts of the Danish mortgage market structures and mechanisms.
  7. 7.  Danish covered bond issuers are subject to licensing by the Danish FSA. Formerly, only specialized mortgage banks could obtain a license, but after 1 July 2007 commercial banks were also eligible for licensing as covered bond issuers. Mortgage banks account for nearly all Danish covered bond issues, and the mortgage bank market is characterized by a relatively small number of issuers: Nykredit Realkredit A/S (NYK), Realkredit Danmark A/S (RD), Nordea Kredit Realkreditaktieselskab (NDA), BRFkredit A/S (BRF), DLR Kredit A/S (DLR) and LR Realkredit A/S (LR). At July 2010, Danish mortgage banks had issued covered bonds worth EUR 320bn.  With a market share of 42%, Nykredit is the leading issuer followed by Realkredit Danmark and Nordea Kredit
  8. 8.  Danish covered bonds are generally issued in three different ways, either on tap, by auction or as pre-issuance. The recent turmoil in international financial markets has not had a significant impact on issuance in the Danish covered bond market. One reason for this is no doubt the extensive use of tap issues.  Tap issues satisfy day-to-day funding needs, and issuers thereby avoid having to sell large amounts in the market in one single day. Furthermore, as nearly all lending is based on pass throughs, higher funding costs do not affect issuers but are passed directly onto borrowers. Finally, the range of loan products is determined by the development in the funding market.  Covered bonds under the pass-through system are usually issued on tap. Long-term callable bonds and long-term capped floaters typically have an opening period of three years with tap issuance on a day-to- day basis. The relatively long opening period enables issuers to build sizeable bond series.
  9. 9.  Danish covered bond issuers are all rated by Moody's Investors Service. The covered bond programmes of the three largest mortgage bond issuers (Nykredit, RD and Nordea) are all rated Aaa. In addition to their Aaa ratings of the largest covered bond programmes, the Danish issuers are the only ones in Europe that are also categorised as "Very High" in terms of Moody's Timely Payment Indicator (TPI).  The TPI is Moody's assessment of the likelihood that timely payment is made to covered bond holders following Sponsor Bank Default. The TPI determines the maximum rating a covered bond programme can achieve with its current structure while allowing for a reasonable amount of over- collateralisation.
  10. 10.  Outstanding amount of more than EUR 320bn.  The market falls into three major segments: callable bonds, fixed-rate bullets and floaters. Callable mortgage bonds and fixed-rate bullets constitute the greater part of the market. EUR denominated bonds make up about 10% of the Danish mortgage bond market, with the highest volume in the fixed-rate bullet segment.  The buyback option is a unique Danish feature. Due to the pass-through principle, Danish mortgage borrowers may terminate their loans by buying back the mortgage bonds funding their loans in the bond market and delivering them to their mortgage bank. The option is referred to as the delivery option or the buyback option and applies to all mortgage bonds whether callable or non-callable.
  11. 11.  Danish mortgage legislation dates back to 1851, and together with Germany, Denmark has the oldest mortgage legislation in the world.  In Denmark covered bond issuance is regulated by the Danish Mortgage- Credit Loans and Mortgage-Credit Bonds etc. Act (mortgage banks) and the Danish Financial Business Act (commercial banks) and a number of Executive Orders on eg ALM and property valuations.  Danish legislation was last extensively amended in the summer of 2007, in part to ensure the continued eligibility of Danish mortgage bonds as covered bonds under the stricter CRD definition. In this connection, the Danish balance principle (ALM requirements) was adapted to European standards, and commercial banks gained access to issuing covered bonds.  The Danish Financial Supervisory Authority (FSA) supervises compliance with current legislation and regularly conducts on-site inspections.
  12. 12.  The Danish FSA has issued an executive order containing rules on the valuation of properties provided as security for covered bonds. The key principles are: 1. The value of a mortgage must not exceed the open market value of a property which may reasonably be achieved within a selling period of six months (open market value), regardless of whether the property has just been traded at a higher price. 2. Inspection and valuation may only be carried out by professional valuers who possess the experience relevant to the property type and market in question, and who are independent of the credit granting process of the mortgage bank. 3. Residential properties must be valued at least every three years to ensure LTV compliance. 4. Commercial properties must be valued annually. 5. Approved statistical models may be used for this purpose.  Issuers must also apply market value principles in determining obligations to bondholders. The value of the cover assets must at any time exceed the value of the obligations to bondholders
  13. 13.  Danish covered bonds are secured by mortgages on real property. Persistent demand in Denmark for mortgage finance has rendered the Danish bond market the largest in the world. As of January 2013, the volume of Danish covered bonds (denominated in DKK and EUR) issued by specialist mortgage banks stood at EUR355bn.  The covered bond market in Denmark has experienced a rapid and profound transition over the past decade. Traditionally, callable annuity bonds predominated, mirroring the dominance of callable fixed rate mortgage loans in the Danish property market. Non-callable bullet bonds were introduced to fund interest-reset loans, which were launched in 1996. Since then, a sustained demand for interest-reset loans has shifted the Danish covered bond market to such an extent that non-callable bullet bonds as at the end of 2012 made up almost 46% of total market volume.  Floating rate covered bonds (FRNs) with an embedded cap structure have met increasing demand. As a result, mortgage banks introduced a line of products in 2004 that were funded by issuing floating-to-fixed covered bonds or capped floaters. In 2005, FRNs without a cap were introduced, targeting corporate clients, and, in 2007, FRNs with a ratchet coupon were launched.
  14. 14.  The Danish mortgage banks provide information to investors via the NASDAQ OMX Nordic Exchange (OMX). The OMX publishes data on Danish covered bonds according to specified guidelines. These data are released on specific dates and at specific times. If one of these specific dates falls on a non-business day, publication generally takes place on the next business day.  The OMX publishes cash flows for each individual bond. These specify principal and interest payments for all coming payment dates until the bond expires. For open series, cash flows are calculated according to the principles of the OMX, while actual cash flows for the closed series are published by the mortgage banks. Details concerning debtor distribution are provided by the mortgage banks and separate the underlying loans into borrower groups, remaining debt groups and loan types.  Mortgage banks publish on a weekly basis data on preliminary prepayments comprised of nominal extraordinary repayments for coming, non-published payment dates. Data are based on registered loan terminations for coming payment dates, including immediate prepayments but excluding repayments by delivery of bonds. On a quarterly basis, mortgage banks publish data on published prepayments (ordinary as well as extraordinary) for the next payment date comprised of nominal repayments as well as total repayment and prepayment percentages.
  15. 15.  The NASDAQ OMX stock exchange introduced a bond future on a basket of underlying Danish covered bonds in October 2009 and at the same time established a market maker scheme in the future (initial spread of DKK0.10 for DKK50m). The future is settled daily on a marked-to-market basis and the settlement amount is fixed by the NASDAQ OMX as the difference between the current future price and the future price of the previous trading day. Settlement is made via the NASDAQ OMX, which is where netting of positions between market makers is carried out.  The Danish covered bond futures (MBF) expire every third month at the end of March, June, September and December and settlement day is 1 April, 1 July, 1 October and 1 January (or the first business day thereafter). New future contracts are opened about a month before the existing contract expires; thus positions in one future contract can always be rolled into the next future contract.  The Danish covered bond future offers non-Danish investors – who have been reluctant to invest in the Danish market due to various inexpediencies – an easy way to invest in Danish covered bonds.

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