ARMs hit record lows on fall in supply, extension plan

Bonds to refinance ARMs have been sold at record low yields and spreads since the latest Danish auction season began on Monday, with this being attributed to lower supply and planned changes to ARMs — even though these were postponed by three months.

Regulatory and rating agency concerns about risks related to Denmark’s adjustable rate mortgages (ARMs) have spurred the country’s lenders to promote alternative products — including traditional fixed rate callables and new Cita-based products — resulting in a reduction of the proportion of their lending that is ARMs.

Meanwhile the Danish government two weeks ago announced plans for forced extension of ARMs in the event that an auction fails or interest rates rise more than 5%, and the impending change led market participants to suggest that the latest auctions would be boosted because they will be grandfathered and the last before the switch (see below for more).

Nykredit Realkredit, Denmark’s biggest mortgage lender, has sold the most one year ARMs in Danish kroner so far, Dkr24bn (Eu3.22bn) of SDOs, achieving a yield of 0.19% and bid-to-cover of 3.38 times at its first sale on Monday. It also issued a Eu500m senior secured deal on Tuesday (see separate article). Realkredit Danmark (RD) sold Dkr20bn from Monday to today (Thursday), achieving a bid-to-cover of 3.83 on the first day.

According to Lars Mossing Madsen, chief dealer at Nykredit Realkredit, the level achieved against swaps on one year ARMs bonds — 7bp over Cita in kroner and around 10bp over Eonia in euros on Monday — are the tightest since at least 2008.

“They are going extremely well,” he told The Covered Bond Report. “We are back to pre-Lehman levels relative to swaps on the major part of the bonds.”

He said that levels were also around 5bp tighter than pre-auction levels, with bid to covers also high, with the same being true in three and five year sales.

“It seems that interest in buying mortgage bonds before the coming changes is huge,” he added. “We can’t be sure that’s the reason for the demand, but since the changes were announced interest has been growing and growing.”

Uffe Kalmar Hansen, senior analyst at Nordea Markets, attributed the levels to a function of supply and demand, noting the amount of one year ARMs on offer throughout the auctions, for example.

“We are close to, if not at, all-time lows,” he said. “If we are looking for reasons for that, it is that the amount is significantly less than last year and this of course creates additional demand.”

Collectively, BRFkredit, DLR Kredit, Nordea Kredit, Nykredit Realkredit and RD have announced plans for Dkr177bn of one year ARMs sales.

Nykredit’s Madsen noted that the demand was being enjoyed by all the mortgage credit institutions that have been active so far, with BRFkredit and DLR Kredit issuing at levels closer to Nykredit and RD than in the past.

DLR Kredit sold Dkr16.8bn of one year ARMs bonds from Monday to Wednesday and achieved an estimated spread to Nykredit’s of just 0.02bp-0.03bp. The result came as the issuer moved its sales to the beginning of the auction season, having previously felt that it had encountered weaker demand as a result of coming after its peers.

BRFkredit began selling Dkr25.1bn of one year ARMs bonds on Monday until the end of next week. Anders Lund Hansen, group treasurer at BRFkredit, on Tuesday said that the issuer’s first day of sales went well.

“There were no hiccups,” he said. “There are still nine days left so it is a bit too early to cheer, but yesterday there was solid demand and we are pleased with the spread versus our peers.”

Nordea Kredit begins its auctions next Monday and Friday, 29 November will be the last day of sales across the market.

Yields fell on the one year ARMs through the week, falling from 0.19% to 0.13% in Nykredit’s sales, for example, although bid-to-covers fell to their lowest levels today for Nykredit and RD, to 2.61 and 2.25 times, respectively.

Madsen said that although the lower levels reflected a tightening versus swaps, the fall in yields reflected an outperformance of Denmark versus the euro-zone.

“We still see huge interest,” he added, “and it looks like we can give our borrowers extremely low yields.”

Coupon change to ARMs plan

The Danish government on Monday agreed to postpone planned changes to ARMs bonds from 1 January to 1 April 2014, after having last week made changes to what will happen to the interest rates of bonds that extend under the plan.

On 6 November the Danish Ministry of Business and Growth unveiled proposals whereby ARM bonds will automatically extend to match the maturity of underlying mortgages if an auction fails or if the rate on the relevant auction is more than 5% higher than previously. Under this plan, the coupon would be fixed at a level 5% higher than previously for the remaining term of the bond.

However, investors’ concerns over the proposed structure and the complexity of pricing it have led to a change in the draft legislation, whereby the coupon will be reset every 12 months to reflect the development of interest rates.

An industry spokesperson said that issuers remain broadly supportive of the change but are discussing technical details with the ministry ahead of the expected publication of proposed legislation next week. He said that the postponement of implementation until 1 April was requested by the mortgage banks to allow difficult technical considerations to be worked out, noting that 1 January is “very soon”.

Standard & Poor’s on Tuesday said that the announcement of the proposed changes by the Danish government on 14 November will not have an immediate impact on its ratings of Danish banks as it is reserving judgement until the final law and regulations are clear.