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 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
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.
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.
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.
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.
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
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.
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-
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.
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
The Danish Financial Supervisory Authority (FSA) supervises compliance
with current legislation and regularly conducts on-site inspections.
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
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.
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
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.
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.