COPENHAGEN/STOCKHOLM : Never before have interest rates in the world’s biggest covered- bond market been this low. And rarely has investor demand for the debt been so high.

Pacific Investment Management Co. is among investors embracing Danish mortgage-backed covered bonds, even as negative interest rates mean investors face built-in losses on some bonds. Data provided by Danske Bank, the country’s biggest lender, show issuers are offering up to six times as many fixed-rate bonds a day as during a more normal cycle.

Given the intense issuance, “normally you would see a spread widening," said Jens Peter Sorensen, chief analyst at Danske Markets in Copenhagen. Instead, investors are comfortably absorbing the much bigger issuance.

The development is remarkable as interest rates on the bonds keep dropping. This month, Jyske Bank made history when it started offering a 10-year callable mortgage bond with a coupon of minus 0.5%.

Nordea Bank’s Danish mortgage arm is offering 20-year bonds at 0%, and has laid the groundwork to sell 30-year bonds at negative rates. But investors have yet to balk.

“We like the asset class," said Peder Beck-Friis, a portfolio manager and economist at Pimco in London. “We are overweight, as we have been for a long time. And that certainly hasn’t changed now that some of them have turned negative in terms of yield."

Testing the Limit

Investors in Denmark’s $500 billion mortgage-bond market are proving more loyal than their counterparts in the German government debt market. A recent auction of 30-year bunds drew thin demand, with the negative yield seeming to deter potential buyers.

And with the longest government bonds from top-rated European sovereigns trading at negative yields, the slightly higher return that Danish mortgage bonds still offer makes all the difference.

The bonds are “a triple A rated high quality asset with fairly good liquidity," Beck-Friis at Pimco said.

“Given that profile, it actually offers a very good return," he said. “So I don’t think there’s anything special about the zero. As an investor you are looking for the highest returns given risk profile. The level of that may shift over time but ultimately you need to place your money somewhere."

Nykredit Realkredit, Denmark’s biggest mortgage bond issuer, says a lot of demand for the debt is from foreign investors. But domestic buyers are also beefing up their holdings.

David Hellemann, chief financial officer at Nykredit, says investors are drawn to the “safe haven" that the bonds provide.

“A strong Danish economy, no unemployment, so it’s a stable market. You don’t see any losses. It’s a well-functioning model."

Sorensen at Danske says demand has been particularly high in recent weeks, as investors look for somewhere safe amid worries about trade tensions, Brexit and the risk of a global recession. According to his estimates, lenders are offering as much as 3 billion kroner ($446 million) in callable bonds each day. That compares with normal daily issuance of 500 million kroner to 750 million kroner.

The Mechanics

Mortgage lenders act like brokers, selling bonds on behalf of borrowers and passing through interest rate changes. When investor demand for a security sends it above par, banks can’t issue the bond any longer and open a new series at a lower coupon.

Persistent investor demand could drive coupons on Denmark’s mortgage bonds even lower. The big question is whether rates on 30-year bonds will go negative.

According to Sorensen at Danske, lenders have a few options before resorting to negative rates on the longest mortgage bonds.

These include offering interest-only products, which typically sell for less. Banks could also start cutting coupons in smaller steps than the half-percentage-point increments that have been traditional so far.

“We still have a long way to go on the 30-year before we get a negative coupon," Sorensen said. bloomberg

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