It could be that there’s such a thing as too much love. And that might be what Denmark is getting right now, since the influx of foreign investors buying Danish covered mortgage bonds has introduced an element of risk that wasn’t present before.
That’s according to Fitch Ratings, which has stated that if the proportion of foreign investors holding the covered mortgage bonds increases from an already substantial range of 19–20% to, say, 25%, the ratings agency might have to downgrade the two top issuers of the products, Danske Bank A/S and Nykredit Realkredir A/S.
Danish covered bonds have a long and safe history. They came into being over 200 years ago, to facilitate rebuilding after a massive fire in 1795, the second great fire in the century, destroyed a great part of the city of Copenhagen.
In fact, the bonds also helped Denmark weather the global financial crisis, as international investors ditched unsecured bonds in favor of bonds backed by assets. From 2008 to 2012, according to the European Covered Bond Council, the amount of such bonds outstanding doubled; in 2012, they reached their highest amount, 2.25 trillion euros ($2.79 trillion).
Denmark’s own history with covered mortgage bonds lured investors after the crisis, when investors determined to seek safety liked what they saw. A triple-A rating, combined with a history of more than two centuries and bondholder protections provided by Danish law, all combined to drive up foreign ownership from around 13 percent to the current level of approximately 19 percent.
Central bank data indicate that, at the same time, ownership of the bonds by Danish pension funds and insurers was falling, thanks to the decreasing return that the bonds provided. While before the crisis Danish institutional investors held approximately 26 percent of covered mortgage bonds, that proportion has fallen with interest rates so that now, after seeking sources of better returns, those investors only hold about 17 percent.
While domestic investors can hardly be said to have deserted the bonds, foreign investors don’t have the loyalty to them that Danish investors do. And therein is the risk. While Denmark’s central bank increased its benchmark rate after the Lehman collapse to keep investors from outside the country from dumping Danish holdings, those foreign investors are the most likely to jump ship should anything happen to rock the Danish investment boat. And a new law could possibly do that.