Longer dated share up in ARMs auctions, with several reasons cited

Adjustable rate mortgage bonds being sold by Denmark’s mortgage banks during end-of-year auctions starting on Monday will include a greater share of three and five year bonds than ever, according to analysts, although this is only partly due to borrowers recently taking out loans with longer fixed interest periods.

Nordea Kredit and Realkredit Danmark will kick off the refinancing auctions on Monday, with BRFkredit joining in on Wednesday, albeit via a tap sale rather than auctions, and Nykredit Realkredit starting its auctions on Thursday. DLR Kredit will auction Danish krone adjustable rate mortgage (ARM) bonds on three days, starting 3 December. The auctions will be held over 16 trading days in total, stretching from this Monday to Monday, 10 December, according to Bjørn Sebastian Olesen, analyst at Nykredit Markets.

He said that the share of one year ARM bonds is lower than in previous years, and that the share of three year and five year ARM bonds is higher than ever, with the refinancing rate overall lower than in the past few years.

“The proportion of three year and five year RTLs [Danish fixed rate mortgage bullets funding ARMs] offered has risen to 14% and 8% from around 7% and 5% the past two years,” he said. “A significant reason for this is that the number of loans with three year and five year interest reset periods is higher this year.”

Of Dkr405bn Danish krone-denominated RTLs maturing in January, around Dkr60bn are three year RTLs and Dkr17bn five year, he said, equal to 15% and 4%, respectively.

Danish mortgage banks have been trying to encourage borrowers to take out loans with longer fixed interest periods, in part in response to regulatory concerns about refinancing risk in relation to large volumes of one year ARM bonds.

However, Olesen attributed the large amount of three year bonds being offered at these auctions mainly to there having been a larger than usual issuance of bonds with this interest period three years ago, with these loans now up for refinancing.

“There is a small increase in five year bonds’ share of the expected issuance amount in the forthcoming auctions,” he said, “but it wouldn’t qualify as a change of behaviour, where borrowers in general opt for loans with longer fixed interest periods.

“That is yet to come.”

Jan Weber Østergaard, senior analyst at Danske Bank, said that the overall amount of ARM bonds being auctioned is in line with his expectations, adding that although some borrowers moved out from one year FlexLoans to an ARM with a five year refinancing period there was no big move in this direction.

Jacob Skinhøj, chief analyst at Nordea Markets, said that the overall amount of ARM bonds being auctioned is less than in the past, with the biggest change coming from a reduction in the volumes of one year bonds up for sale.

“Usually around 93% of the total ARM bond auction amount is for one year bonds,” he said, “but this year it’s only around 77%. This shows that quite a few borrowers decided to take out longer dated mortgages, moving out to three year and five year refinancing periods.”

However, the take-up of three and five year ARMs is less than he expected, he added.

Østergaard said that one year ARM bonds are likely to meet with very high demand because volumes are lower than they used to be, with spreads having tightened over the past couple of months.

“Three years should sell well, too,” he said, “although it is a bit more uncertain what the spreads will be on five year bonds because there is a bit more duration, which fewer investors go for.”

Realkredit Danmark and Nykredit one year ARMs are expected to be auctioned at the same spreads, he said, with Nordea one year bonds expected to trade 5bp-10bp tighter than Nykredit, and BRFkredit and DLRkredit one year ARM bonds 2bp-5bp and 5bp-10bp wider than Nykredit’s, respectively.

Nordea one year bonds typically trade the tightest, and according to Nordea’s Skinhøj these were trading at around 28bp-29bp over Cita.

“We expect auction spreads to reflect market levels,” he said, “but for spreads to tighten during the auctions.”