Danish Mortgage Bonds Buy non-callable bullets at interest-reset auctions

Transcription

1 Investment Research 26 November 21 Danish Mortgage Bonds Buy non-callable bullets at interest-reset auctions Highlights: focus remains on eurozone peripheral countries We continue to recommend underweighting (callable) mortgage bonds against government bonds, as we see the recent increase in yields as overdone and expect a fall going forward. The spotlight has once again shifted to the eurozone peripheral countries, with the EU/IMF s financial aid package for Ireland and renewed uncertainty surrounding Portugal in focus. Supply: focus on interest-reset auctions The decline in the prices of fixed-rate 3Y 4% bonds in recent weeks does not encourage a change of profile. The pattern of issues has changed accordingly, with the ratio of noncallable (interest-reset) bullet issues to callable issues now running at 6:4. Relative value: Buy 1Y non-callable bullets at the interest-reset auctions and 3Y and 5Y non-callables now The December refinancing auctions are fast approaching and we generally recommend that investors buy non-callable bullets at the auctions. For long-only investors we recommend buying non-callable bullets against DGBs, while for funded investors we recommend hedging DKK or CITA swaps. This year Danske Bank can provide investors the opportunity of entering CITA swaps with a term to maturity of more than 1 year. Portfolios and strategies: underweight callable mortgage bonds We maintain our portfolio composition and our overweighting of government bonds vs mortgage bonds particularly callable mortgage bonds, reflecting the outlook for a continued decline in yields, with mortgage bonds (particularly callable 5% mortgage bonds) lagging govies. Within the non-callable mortgage bond segment we underweight short-term and overweight 3Y-5Y non-callable bullets. However, we recommend that investors close down the underweighting on short-term non-callable (interest-reset) bullets at the forthcoming auctions. Please see our other mortgage recommendations in the box on the right. Recommendations We maintain our underweight on mortgage bonds vs government bonds. In our long-only portfolio, we: - Overweight government bonds (DGBs) vs mortgage bonds. - Underweight callable mortgage bonds. - Overweight CFs. - Maintain a neutral weighting on non-callable bullets. - Underweight floating-rate notes. Within the non-callable (interestreset) mortgage segment, we recommend buying 3Y and 5Y bullets against short-term bullets. However, we recommend investors close down the underweighting on short-term non-callable bullets at the forthcoming auctions. Chart 1. Breakdown of return over past two weeks Spread Vol Curve Coupon Theta Residual Return 2.% 1.%.% -1.% -2.% -3.% CF 5'18 CF 6'38 CF 5'38 3'31 4'28 4'38 4'38io 4'41 4'41io RTL 2'12 RTL 2'14 RTL 4'16 Senior Analyst Christina Falch chfa@danskebank.dk Chief Analyst Jens Peter Sørensen jenssr@danskebank.dk Important disclosures and certifications are contained on page 19 of this report.

2 Highlights Focus remains on eurozone peripheral countries The spotlight has once again shifted to the eurozone peripheral countries, with the EU/IMF s financial aid package for Ireland and the renewed uncertainty surrounding Portugal in focus. Read more about the EU/IMF package for Ireland in Flash Comment: Ireland applies for bail-out package. The market had generally prepared itself for a relief rally in the wake of the Irish application for financial assistance. However, reports of a general election in Ireland, a critical credit report on Ireland from Moody s and, most recently, S&P s downgrade of Ireland s short- and long-term credit rating sparked a U- turn that sent Irish bond yields higher and quickly sapped risk appetite. Fears of contamination hit other debt-ridden nations such as Portugal and Spain. Confidence is a long way from returning to the market, posing a clear risk that the crisis escalates further. Thus the stage is set for yield spreads to remain high and volatile in the coming weeks. If the debt crisis does escalate and risk aversion generally increases, this could have a negative effect on the pricing of the mortgage bond segment in general. Given this, we are sticking to our overall underweight on callable mortgage bonds vs government bonds. Chart 2. Movements in the 1Y yield spread between Portugal, Ireland and Spain relative to Germany Ireland Spain Portugal Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Yield increases mainly driven by the US 1Y swap rates in Denmark and Euroland have with the exception of the past couple of days risen quite strongly over the past two weeks, driven mainly by rising swap rates in the US. The increase in yields is due, among other things, to solid data, suggesting some improvement in the US economy. We are also inclined to believe that much of the increase in yields in recent weeks has been driven by position closing, as there are signs that investors increased their long positions in government bonds ahead of the announcement of QE2 by the FOMC on 3 November (see Weekly Focus). In our opinion, the recent increase in yields has been overdone and yields are likely to fall going forward. Thus we maintain our general underweight on mortgage bonds (particularly callable mortgage bonds) vs government bonds November 21

3 Chart 3. Movements in 1Y swap rates 4.5% 4.% 3.5% 3.% 2.5% 2.% 1Y USD SWAP 1Y EUR SWAP 1Y DKK SWAP Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Mortgage bonds outperform The yield increases seen in recent weeks have benefited Danish mortgage bonds, and the segment has performed well relative to swaps. Looking at the price-yield correlation for RD 4 41 and RD 5 41, respectively, relative to the 1Y swap rate, it can be seen that 4 41 has traded with a lower empirical duration in November than previously, so the bond has performed well relative to swaps (see graph below-left) RD 5 41 has traded with a duration of close to zero in November, and so the bond has tread water price-wise despite the general increase in yields (see graph below-right). Chart 4. Price-yield correlation - 4'41 Chart 5. Price-yield correlation - 5' From Jan. Nov. Current From Jan. Nov. Current 9 2.% 2.5% 3.% 3.5% 4.% 98 2.% 2.5% 3.% 3.5% 4.% Turning to the other segments of the mortgage market capped floaters and non-callable bullet (interest-reset) bonds we see positive relative performance in these segments vs. swaps. As can be seen in the graph below-left, the ASW spread on capped floaters especially 3Y capped floaters has narrowed in recent weeks November 21

4 Chart 6. ASW on capped floaters Chart 7. ASW on non-call. mortgages CF 5'18io CF 5' Nov-9 Mar-1 Jul-1 Nov-1 RD 2'12 RD 2'14 RD 4' Nov-9 Mar-1 Jul-1 Nov-1 The non-callable Flex loan bond segment has also seen decent relative performance by the longer Flex bonds (3Y and 5Y), which has benefited our general buy recommendation on 3Y and 5Y Flex bonds. In contrast, the ASW spread on short (1Y) Flex bonds has generally widened in recent weeks. We expect the spread to continue to widen until the December auctions, which kicked off today. General mortgage bond recommendations maintain government overweight There is still some way to go to our target prices of DKK11 on 4 41 and 2% on DGB 4 19, which we set in early October. We see no reason to change this even though the latest macro data from the US have been better than expected. We therefore maintain our target of DKK11 on We also stick to our recommendation of overweighting 3Y and 5Y non-callable bullet (interest-reset/flex) bonds and recommend buying 1Y Flex bonds at auction (see Relative Value) We maintain our recommendation to underweight mortgage bonds vs government bonds in the belief that the recent increase in yields has been overdone and that yields will fall going forward. We remain underweight callable mortgage bonds, primarily 5% bonds, but are overweight capped floaters, especially 1Y capped floaters (see Portfolio). Limited effect of Ministry of Social Affairs loan refinancing The Ministry of Social Affairs issued a press statement on Thursday, 11 November 21 announcing the refinancing of loans for state-owned housing for around DKK3bn at the coming refinancing auction. This is considerably less than last year, when the Ministry refinanced for DKK44bn. The loans will be refinanced according to the following distribution of maturities: Approximately DKK5.6bn in the 1Y segment Approximately DKK11.8bn in the 3Y segment Approximately DKK12.6bn in the 5Y segment In connection with the auction, the Ministry will change the maturity profile of loans totalling close to DKK11bn, such that around DKK.8bn will be converted from the 1Y to the 3Y interest-reset period, while around DKK1.1bn will be converted from the 1Y 4 26 November 21

5 to the 5Y interest-reset period. In addition, the refinancing date for mortgages from Nykredit that were to be refinanced in December will be pushed to March or September. The Ministry of Finance announced in a press statement on 19 November that the Social Pension Fund would maintain its holding of mortgage bonds totalling around DKK45bn at the coming refinancing auctions. This equates to the fund reinvesting around DKK22bn in mortgage bonds. Realkredit Danmark regularly updates its expected auction amounts for the coming auction in December. In its fifth estimate, the amount of F1 bonds to be sold at auction was cut from DKK134.5bn to DKK123.9bn (see table below). At the same time the share of F5 bonds was raised from DKK8.bn to DKK1.8bn. Some of this maturity extension among borrowers may be due to the Ministry of Social Affairs loan refinancing. Table 1. Announced auction amounts from Realkredit Danmark F1 F2 F3 F4 F5 F1-EUR ( bn) 1st estimate nd estimate rd estimate th estimate th estimate Final estimate Source: Realkredit Danmark We observe a similar shift in auction amounts at Nykredit, some of which may be due to the Ministry s refinancing. If we compare the auction amounts announced by Nykredit on 15 November with the numbers from 8 November, we can see the following changes: Auction amount for SDO 4% Jan-12 falls from DKK66.3bn to 65.75bn. Auction amount for SDO 4% Jan-14 falls from DKK6.3bn to 4.3bn. Auction amount for SDO 4% Jan-16 falls from DKK1.7bn to 1.1bn. Auction amount for SDO 2% Apr-16 rises from to DKK.7bn. Auction amount for SDO 2% Oct-14 rises from DKK1.1bn to 2.1bn. KommuneKredit to issue bonds totalling DKK5.5bn On 23 November KommuneKredit announced that it would issue bonds at auction to refinance subsidised loans for social housing at year-end 21. In addition, KommuneKredit will issue bonds to refinance ordinary loans without state subsidies. The bonds to be issued are AAA/Aaa rated and will be issued by KommuneKredit as senior debt. KommuneKredit s bonds have a risk weighting of %. The auction will be held on 9 December 21. The expected auction amounts are concentrated in the 5Y segment (see table below). This is very probably part of the Ministry of Social Affairs refinancing activity from the 1Y to the 5Y interest-reset period. The final auction amounts from KommuneKredit will be published by 3 November 21 at the latest November 21

6 Table 2. Expected auction amounts from KommuneKredit ISIN Bond Amount (DKKbn) DK KOM 4. 1/1/212.2 DK KOM 4. 1/1/213.1 DK , KommuneKredit 324s 4 INK DK , KommuneKredit 325s 4 INK DK KOM 4. 1/1/ Source: KommmuneKredit General graphs and tables Chart 8. Swap curve and changes in swap rates and spreads 4% 3% 2% 1% % -1M Change in Govt-swap spread -2W 22/11/21 1Y 2Y 3Y 4Y 5Y 6Y 7Y 8Y 9Y 1Y 12Y 15Y 17Y 2Y 25Y 3Y Table 3. Yields, swap spreads, vol and OAS movements in past 2 and 4 weeks 22 Nov-1 Since 8 Nov-1 Since 25 Oct-1 2yr swap 1.96% 7 1 5yr swap 2.58% yr swap 3.19% yr swap spread DKK-EUR 1yr Swap spread 19 DKK 1yr Swap-govt. spread yr1yr DKK Swaption Vol 21.6% -1.2%.2% 3m5yr DKK Swaption Vol 3.1% -.8%.6% OAS yield spread November 21

7 Supply Average day-to-day issues of 4 41 (ord. and io) have plummeted as yields have moved upwards, with the price of 4 41 down by almost two points over the past few weeks. Total issues have declined from DKK7-8m to just under DKK4m a day. In the coming weeks, attention will focus on the interest-reset auctions, where the profile of loans has changed only slightly from F1 (1Y) towards F3 and F5 loans. Indeed, recent movements in the prices of fixed-rate 3Y 4% bonds do not encourage a change of profile. The pattern of issues has changed accordingly, with the ratio of non-callable (interest-reset) bullet bond issues to callable mortgage bond issues now running at 6:4 (see the chart below). Meanwhile, the mortgage yield curve has steepened a little due to the recent increase in yields. This has prompted a modest rise of DKK1, on average, in monthly mortgage payments on a DKK1m 3Y 4% loan, while payments on a 1Y interest-reset loan have remained broadly unchanged. Mortgage payments on 3Y and 5Y interest-reset loans are up by just under DKK5, on average. Table 4. Monthly payments on a DKK1m mortgage Loan type Monthly payment a/tax Flex loan F1 3,443 Flex loan F3 3,559 Flex loan F5 3,697 3y 6% Closed 3y 5% 3y 4% Closed 4,21 Interest-only Flex loan F1 1,15 Flex loan F3 1,48 Flex loan F5 1,736 3y 6% Closed 3y 5% 3y 4% Closed 2,711 Source: Realkredit Danmarks website Chart 9. Prices - 4'41 (ord. and io) RD 4'41 RD 4'41io Spread (rha) Jan Mar May Jul Sep Nov Chart 1. Daily issues (1 day moving avg.) '41 4'41io Jan Mar May Jul Sep Nov Chart 11. Distribution of issues (1-day average) 1% 75% 5% 25% % Flex Callable CF Floater Chart 12. Refinancing rates 8% 1Y rate 7% 3Y fixed rate 6% 5% 4% 3% 2% 1% % November 21

8 Table 5. Recent issues/buybacks of Danish mortgage bonds Outstanding Bond volume 5-nov-1 4-Jan-1 Price/yield 5% 241 io 25, , % , % 231 5, % 238 ord. + io 118, , % 238 ord. + io 61, , % 235 ord. + io 83, % 235 ord. + io 93, , % '21 and '26 3,675 1, % 231 7, , % 241 io 35,318 3,2 35, % ,752 3,887 55, CF 5'18 (ord. + io) 31, ,268 CF 19, ,411 CF io 91, ,234 FRN 173, , Apr+Oct 176,313 2, , % 213 Apr+Oct 25, , % 215 Apr+Oct 19,969 1,64 17, % Appendix: Current mortgage bank recommendations Realkredit Danmark: It is currently attractive for many homeowners to refinance their mortgage loans. We continue to recommend remortgaging 6% and 7% fixed-rate loans to 4% fixed-rate loans. Other attractive refinancing options include: Interest-reset loans to 4% fixed-rate loans. 5% fixed-rate loans to 3% fixed-rate loans (2Y). Nykredit/Totalkredit: 4% fixed-rate bond loans recommended. 4% loans are also recommended to borrowers who prefer interest-only loans. Borrowers are recommended to remortgage fixed-rate bond loans with coupons of 6% or above to 4% fixed-rate bond loans. Recommend that borrowers lock in current prices when taking out fixed-rate loans. Interest-reset borrowers should consider F5 (5Y) loans. Euro-denominated loans are not recommended to retail borrowers. BRF: Borrowers with interest-reset loans and fixed-rate loans with coupons of 6-7%, as well as borrowers intending to take out new loans, should consider 4% fixed-rate loans with principal payments. With interest rates likely to move up in the medium term, the option to take out 4% fixedrate loans at attractive prices will probably only be available for a short period. Borrowers could ask for a loan offer or contact BRF for further information November 21

9 Relative value Buy non-callable (interest-reset) bullets at the auctions The December refinancing auctions are fast approaching and we generally recommend that investors buy non-callable bullet (interest-reset) bonds at the auctions. For long-only investors we recommend buying non-callable bullets vs Danish government bonds, while for funded investors we recommend hedging in DKK or CITA swaps. This year Danske Bank can provide investors the opportunity to enter CITA swaps with a term to maturity of more than 1 year. At the present time we do not recommend investors hedging euro government bonds or EUR swaps/eonia swaps, as we see a risk that Nationalbanken (the Danish central bank) may increase the rate spread vs Euroland in the coming months. We have for some time now been positive on the 3Y and 5Y bonds, as these bonds have been trading at an attractive spread relative to swaps and equivalent government bonds. In contrast, we have been negative on the 1Y bonds, which have been trading expensively. The spreads on the 3Y and 5Y bonds have, as described in the Highlights section, narrowed in recent weeks, but this does not change our general buy recommendation on 3Y and 5Y bonds. We still hold the view that these bonds are trading at attractive spreads especially against government bonds. 1Y Flex loan rates remain at the expensive end of the scale, but ASW spreads on short non-callable bullet (interest-reset/flex) bonds have widened in recent weeks and we expect to see a further weakening in relative prices in the final days leading up to the auction. Hence, we estimate that the bonds will become more attractive once the auctions kick off, and so we recommend that investors wait to buy the bonds at auction. Chart 13. Movement in ASW spread RD 2'12 RD 2'14 RD 4' Nov-9 Mar-1 Jul-1 Nov-1 Chart 14. Movement in spread to DGB RD 2'12 RD 2'14 RD 4' Nov-9 Mar-1 Jul-1 Nov-1 ASW spreads to narrow after auction Given the current levels of ASW spreads, which are generally lower than last year s levels, a relevant question is whether it is still possible to earn money by buying non-callable bullet (interest-reset/flex) bonds at auction. This question is particularly relevant for the funded investor. Looking at the history of previous auctions, the answer is yes. The graphs below show a clear trend: the ASW spreads on non-callable bullet (interest-reset/flex) bonds (our graphs are based on a 5Y generic bond) generally widen up to the auction and then with the exception of 27 narrow in the months following the auction. This was also the case at the beginning of the decade, when ASW spreads were generally lower than now November 21

10 Chart 15. Developments in 5Y Flex yields and ASW spread 6.% ASW (rhs) 5.5% 5Y flex-rente 5.% 4.5% 4.% 3.5% 3.% 2.5% 2.% ASW spreads on a generic 5Y non-callable bullet (interest-reset/flex) bond have with the exception of the 27 auction narrowed by between 2bp and 34bp in recent years when the bonds are bought at auction and held for the next six months (see graph belowright). Moreover, the investor benefits from a positive roll on the ASW curve. The graph below-right shows the current ASW curve. Chart 16. Change in ASW spread from Dec-Jun Chart 17. ASW curve In recent years the funded investor has, furthermore, achieved an additional positive carry contribution due to a significant positive spread between the CIBOR and repo rates (see graph below). Hence we estimate that there will again be value in buying Flex loan bonds this year November 21

11 Chart 18. Carry on CIBOR against funding rate on Flex bonds 6M CIBOR 6M Cita Spread (h.a.) Long-only investors: Buy non-callable bullets as an alternative to govies We have, as mentioned, been very positive in recent weeks on 3Y and 5Y non-callable bullet (interest-reset/flex) bonds as an alternative to govies. This remains the case, even though spreads have narrowed. However, it is mainly long-only investors we would recommend non-callable bullet (interest-reset/flex) bonds to as an alternative to govies. We are also more positive on very short bonds, as they have cheapened in recent weeks. As the table below shows, a long-only investor can achieve excess carry of between DKK.23 and DKK.37 over six months by buying non-callable bullet (interestreset/flex) bonds as an alternative to govies. This assumes a market-value neutral hedge. The calculation assumes an unchanged ASW spread after six months. Hence, we do not take into account the ASW curve for non-callable bullet (interest-reset/flex) bonds being steep, which means a positive return contribution due to the bonds rolling down the curve. It is also assumed that the bonds are traded on a forward basis (settlement date 3 January 211). Table 6. Carry calculation (6M horizon) when buying Flex bonds against government bonds (Long-only investor) Buy bond Forward price buying Carry Flex DKK Sell bond Forward price selling Carry Govt. DKK Excess carry (Flex Govt) RD 2' DGB 6' RD 2' DGB 5' RD 4' DGB 4' Note. The stated prices and money market rates are indicative and may deviate from actual traded prices. We thus recommend that long-only investors buy non-callable bullet (interest-reset/flex) bonds as an alternative to Danish government bonds. The risk with the purchase is that swap spreads may widen for example, if the debt crisis in Euroland continues. Funded investors: Hedge Flex bonds via Cita swaps/dkk swaps For the funded investor, we recommend buying non-callable bullet (interest-reset/flex) bonds against DKK swaps or CITA swaps. We do not recommend that funded investors buy non-callable bullet (interest-reset/flex) bonds against government bonds. This is because there is a considerable funding spread that has to be deducted from the expected excess return compared to the return a long-only investor can expect. The calculation is based on a 6M repo rate. Funding costs can probably be reduced if funding is via short maturities that are regularly rolled though there is a risk that the repo rates could rise November 21

12 The table below shows the excess return for the funded investor when buying noncallable bullet (interest-reset/flex) bonds as an alternative to government bonds. As can be seen, the excess return for the funded investor is considerably lower than that for the long-only investor. Table 7. Carry calculation (6M horizon) when buying Flex bonds against government bonds (Funded investor) Buy bond Forward price Buying Carry (inc. funding) Flex DKK Sell bond Forward price selling Carry (inc. funding) Govt. DKK Excess carry (Flex Govt) RD 2' DGB 6' RD 2' DGB 5' RD 4' DGB 4' Note. The stated prices and money market rates are indicative and may deviate from actual traded prices. If the funded investor hedges against swaps instead of, e.g., government bonds, and we take into account the positive spread between CIBOR and repo, the investor can achieve an excess return of between -DKK.4 and DKK.51 over six months by buying noncallable bullet (interest-reset/flex) bonds against forward-starting swaps (BPV-neutral hedge) see table below. The start date for the swaps is 3 January 211. As can be seen in the table, the excess return for the 1Y Flex loan bond is negative relative to swaps. We thus recommend that investors do not buy the bond now, but instead wait for the auction. Table 8. Carry calculation (6M horizon) when buying Flex bonds against swaps 6M fixing (Funded investor) Buy bond Forward price buying Carry (inc. funding) Flex DKK Swap Swap rate Carry Govt. DKK Excess carry (Flex swap) RD 2' Y DKK swap 1.74% RD 2' Y DKK swap 2.15%.42.3 RD 4' Y DKK swap 2.55% Note. The stated prices and money market rates are indicative and may deviate from actual traded prices. Danske Markets will be trading CITA swaps with maturities greater than 1Y at this year s auction. Funded investors can thus hedge 3Y and 5Y bonds using CITA swaps. The advantage of using CITA swaps rather than plain vanilla swaps is that the investor eliminates the basis risk between CIBOR and CITA (which is close to repo) rates. If the funded investor hedges the rate risk using CITA swaps when buying non-callable bullet (interest-reset/flex) bonds, the investor will have a small, negative rate spread against him between CITA and the repo rate. Despite this the investor will have an excess return of between -DKK.8 and DKK.43 over six months (assuming a BPV-neutral hedge). In our calculations we have used the 6M CITA rate as the value of the T/N rates for the coming six months. This, combined with the CITA curve having basically the same slope from 6M onwards as the swap curve, is one of the reasons why the carry in the calculations below is only reduced marginally compared to a hedge using plain vanilla swaps. The CITA swaps are forward-starting with a start date of 3 January November 21

13 Table 9. Carry calculation (6M horizon) when buying Flex bonds against CITA (Funded investor) Buy bond Forward price buying Carry (inc. funding) Flex DKK Cita Cita rate Carry Govt DKK Excess carry (Flex Cita) RD 2' Y Cita 1.17% RD 2' Y Cita 1.62% RD 4' Y Cita 2.8% Note. The stated prices and money market rates are indicative and may deviate from actual traded prices. Another big auction DKK533bn in all Realkredit Danmark, Nykredit/Totalkredit, Nordea Kredit, BRF and DLR have published their respective expected amounts for the December refinancing auctions. BRF, as is its practice, will not be holding an auction of its bonds like the other mortgage institutions, but will instead be holding a tap sale. We can get an idea of how much will be auctioned in total in December based on the announcements by the mortgage institutions. As stated in the table below we expect a total auction amount of DKK533bn (EUR72bn). Of this, we expect DKK49bn (EUR55bn) in DKK-denominated bonds and DKK125bn (EUR17bn) in EUR-denominated bonds. LRF has not as yet published its expected auction amounts thus the LRF numbers are estimates. Table 1. Auction amounts for Jan SD(R)O and RO bonds in billions Bonds F1 F2 F3 F4 F5 F1 EUR RD NYK/TOT NDA BRF DLR LRF Total Amounts given in local currencies. We do not expect to see much change in the announced auction amounts in the coming weeks. The deadline for profile-shifting Flex loans from Realkredit Danmark was the end of October, and thus it is now too late for borrowers to change the profile of their Flex loans. Nykredit/Totalkredit and BRF s deadline for changing profile is the end of November, but again we do not expect to see any great shift here, as it has previously proved difficult to move F1 borrowers to loans with a longer period of fixed rates. This was apparent last year, for example, when the majority of F1 borrowers remained in F1 despite massive campaigns by the mortgage institutions in which they recommended that borrowers extend the fixed-rate period to three or five years. Nykredit/Totalkredit will be supplying as well as January s interest-reset bonds bonds maturing in April/October, when Nykredit will be selling, for example, DKK.7bn in 2% Apr-16 and DKK2.1bn in 2% Oct-16. You can read more about Nykredit s auction in its press release from 24 November 21. Nykredit will also be selling floaters and capped floaters for around DKK33bn (see table below) November 21

14 Table 11. Nykredit will be selling floaters and capped floaters ISIN Bond Currency Bond type Capital centre Amount (bn) DK Cibor 6 Jan-14 DKK SDO E.8 DK ,5% Bolig XV Jan-16 DKK SDO E 3.5 DK Cibor 6 Jan-13 DKK RO D 21. LU Euribor 6 Jan-12 EUR RO D 1.1 Kick-off, Thursday 25 November The December auctions will run from Thursday 25 November to Monday 13 December. The table below gives the auction dates of the different institutions. As can be seen from the table, the auction dates are quite concentrated this year. Table 12. Announced auction dates Auction date RD Nykredit Nordea BRF DLR 25 Nov Nov Nov. 1 3 Nov Dec Dec Dec Dec Dec Dec Dec Dec Dec. 21 Total auction amount marginally lower than last year The total estimated auction amount of DKK534bn is marginally lower than the total amount last December (see graph below). Hence the outlook is for a large auction again this year. Chart 19. Total auction amounts in DKKbn since EUR DKK e November 21

15 CRD rules mean that RO should trade cheaper than SDO Nykredit and BRF will be selling both SDO (covered bonds) and RO (mortgage bonds) interest-reset bonds although the announced amounts of RO bonds are low. BRF has, meanwhile, chosen only to issue EUR-denominated F1 bonds as RO bonds. LRF is only issuing RO bonds around DKK4.7bn in 1Y F1 bonds. Table 13. Nykredit and BRF will also issue RO interest-reset bonds Bond Nykredit BRF SDO RO SDO RO F F F F F F1 EUR We estimate that RO bonds should, all else being equal, trade cheaper relative to equivalent SDO bonds. This is because RO bonds issued after 31 December 27 will not meet the capital requirement directive (CRD) and are therefore capital-weighted 2% for banks and mortgage institutions. The equivalent SDO bonds, which meet CRD, are capitalweighted 1%. For mortgage institutions that elect to keep their own RO bonds on their books, the RO bonds are capital-weighted %. Furthermore, the new CRD rules come into force from the New Year, when RO bonds for large loans and commitments may weigh up to 1% on the balance sheet. This is expected to have particular significance for Nykredit s RO issues, as Nykredit accounts for a major share of the Danish mortgage market. Also, Nykredit RO issues may constitute a major commitment for certain banks and financial institutions. RO bonds should therefore generally trade cheaper relative to SD(R)O bonds due to the higher capital weighting. Assuming an ROC of 16%, funding rate of 2% and a solvency of 8%, recalculating with a shift in the BIS-weighting of 1% (2%-1%) would imply an increased spread requirement of 11.2bp. In addition, ROs are generally more illiquid, meaning a liquidity premium should have to be added. Nykredit s 1Y (Apr-12) RO interest-reset bond trades with an ASW spread of 15-17bp relative to Nykredit s equivalent SDO interest-reset bond. We see this as a fair premium November 21

16 Portfolios and strategies Performance Our long-only portfolio has underperformed the benchmark by 16bp over the past two weeks, reflecting our overweight on duration/government bonds and the general increase in yields. The accumulated year-to-date excess return on the portfolio is now 15bp (see the chart below). We maintain our overall portfolio composition. Chart 2. Portfolio performance Benchmark Portfolio Excess return (rhs) Oct-7 Mar-8 Aug-8 Jan-9 Jun-9 Nov-9 Apr-1 Sep-1 2.% 1.5% 1.%.5%.% -.5% Unchanged portfolio composition As discussed in the Highlights section, we still have a negative view on the mortgage bond segment, so we recommend overweighting government bonds relative to mortgage bonds particularly callable mortgage bonds. We maintain our over/underweight positions within the various bond segments, which are as follows: Overweight government bonds. We maintain our overweight on government bonds, reflecting the outlook for a continued decline in yields, with mortgage bonds lagging behind govies. We take the overweighting in 1Y and 3Y government bonds. Underweight callables. We are generally negative on callable mortgage bonds. We choose to take a large part of the underweight position in callable 3Y 5% bonds. Neutral weighting on non-callable (interest-reset) mortgage bullets. We continue to recommend a neutral weighting on non-callable bullets. Within the segment, we underweight short-term and overweight 3Y-5Y non-callable bullets. However, we recommend that investors close down the underweight on short-term noncallable (interest-reset) bullets at the forthcoming auctions. Overweight capped floaters. We maintain our overweight position on capped floaters. Within the segment, we overweight 1Y CFs. Underweight floating-rate notes. We maintain our underweighting on FRNs, reflecting mainly our wish to overweight duration in the portfolio. Our portfolio is significantly overweight duration (.7 years) relative to the benchmark November 21

17 Portfolio setup Table 14. Portfolio composition - callable mortgage bonds Chart 21. Asset allocation-benchmark Asset Series Market-Value Weight Key Figures Benchmrk Portfolio Difference Mod Dur Mod Conv HPR-12M MBS 4' % 1.38%.7% % 4'28.83%.88%.5% % 4' % 5.29%.32% % 4'35io 1.8% 1.14%.6% % 4' % 2.8%.12% % 4'38io 1.88% 2.2%.14% % % 3.22% -1.85% % 441io.8%.47% -.33% % 5'28.4%.43%.2% % 5'35 4.3% 4.54%.24% % 5'38 3.8% 2.48% -1.32% % 5'38io 4.36% 3.7% -1.29% % 5'41 2.1%.69% -1.41% % 5'41io 1.8%.37% -1.43% % Benchmark 34.64% % 5.3% GOVT Portfolio 28.5% % 5.5% 3% Difference -6.6%.2.1.1%.2% GOVT 24% FRN 7% RTL 21% CF 13% MBS 35% Chart 22. Asset allocation - portfolio MBS 28% Table 15. Portfolio composition - capped floaters Asset Series Market-Value Weight Key Figures Benchmrk Portfolio Difference Mod Dur Mod Conv HPR-12M CF CF 4.75'12.39%.43%.3%.1..9% CF 5.15'13.39%.42%.3% % CF 5.68'15.84%.91%.7% % CF 5'16 1.4% 1.12%.8% % CF 5'16io.67%.72%.4% % CF 5'17io.9%.96%.6% % CF % 1.71% 1.2% % CF 5'18io 2.43% 3.52% 1.8% % CF 5'37.41%.44%.3% % CF 5'37io.38%.4%.3% % CF 5' % 1.7%.12% % CF 5'38io 2.58% 2.76%.18% % CF 6'38.61%.66%.4% % CF 6'38io.56%.61%.5% % Benchmark 13.48% % Portfolio 16.36% % Difference 2.88% -.1..% FRN 5% RTL 21% Chart 23. Key figures CF 16% Benchmark Portfolio Difference Mod Dur Mod Conv Dur. 6M Dur. 2Y Dur. 5Y Dur. 1Y Dur. 15Y Dur. 3Y November 21

18 Table 16. Portfolio composition - non-callable mortgage bonds Asset Series Market-Value Weight Key Figures Benchmrk Portfolio Difference Mod Dur Mod Conv HPR-12M RTL RTL 2'12 Jan 1.64%.3% -1.6% % RTL 213 Apr 1.38% 1.27% -.11% % RTL 2'13 Jan 5.22% 5.55%.33% % RTL 2'14 Jan.56% 1.53%.97% % RTL 215 Apr 1.8% 1.4%.32% % RTL 2'15 Jan 1.6% 3.73% 2.13% % RTL 4'12 Apr 1.3% 1.38%.8% % RTL 4'12 Jan 3.39% 1.7% -2.33% % RTL 4'12 Oct 1.82% 1.89%.7% % RTL 4'13 Jan 1.4% 1.5%.1% % RTL 4'14 Jan 1.78% 1.9%.12% % Benchmark 21.16% % Portfolio 21.23% % Difference.7%.4..2% Table 17. Portfolio composition - floaters Asset Series Market-Value Weight Key Figures Benchmrk Portfolio Difference Mod Dur Mod Conv HPR-12M FRN % 2.74% -.3% % FRN %.41% -.3% % FRN %.81% -.44% % FRN %.42% -1.45% % Benchmark 6.59%.. 1.6% Portfolio 4.38% % Difference -2.21%.1..% Table 18. Portfolio composition - government bonds Asset Series Market-Value Weight Key Figures Benchmrk Portfolio Difference Mod Dur Mod Conv HPR-12M GOVT DGB 6' % 1.91%.2% 1...9% DGB 4'12 3.9% 3.13%.4% % DGB 5' % 3.51% -.8% % DGB 4' % 3.55%.5% % DGB 4' % 2.37%.3% % DGB 4' % 6.33% 2.65% % DGB 7' % 1.38%.2% % DGB 4.5' % 7.79% 2.95% % Benchmark 24.12% % Portfolio 29.97% % Difference 5.86% % November 21

19 Disclosure This research report has been prepared by Danske Research, which is part of Danske Markets, a division of Danske Bank. Danske Bank is under supervision by the Danish Financial Supervisory Authority. The authors of this report are Jens Peter Sørensen, Chief Analyst and Christina Falch, Senior Analyst. Danske Bank research reports are prepared in accordance with the Danish Society of Investment Professionals Ethical rules and the Recommendations of the Danish Securities Dealers Association. Danske Bank has established procedures to prevent conflicts of interest and to ensure the provision of high quality research based on research objectivity and independence. These procedures are documented in the Danske Bank Research Policy. Employees within the Danske Bank Research Departments have been instructed that any request that might impair the objectivity and independence of research shall be referred to Research Management and to the Compliance Officer. Danske Bank Research departments are organised independently from and do not report to other Danske Bank business areas. Research analysts are remunerated in part based on the over-all profitability of Danske Bank, which includes investment banking revenues, but do not receive bonuses or other remuneration linked to specific corporate finance or debt capital transactions. Danske Bank is a market maker and may as such hold positions in the financial instruments mentioned in this research report. Please go to for further disclosures and information. Disclaimer This publication has been prepared by Danske Markets for information purposes only. It has been prepared independently, solely from publicly available information and does not take into account the views of Danske Bank s internal credit department. It is not an offer or solicitation of any offer to purchase or sell any financial instrument. Whilst reasonable care has been taken to ensure that its contents are not untrue or misleading, no representation is made as to its accuracy or completeness and no liability is accepted for any loss arising from reliance on it. Danske Bank, its affiliates or staff may perform services for, solicit business from, hold long or short positions in, or otherwise be interested in the investments (including derivatives), of any issuer mentioned herein. The Equity and Corporate Bonds analysts are not permitted to invest in securities under coverage in their research sector. This publication is not intended for retail customers in the UK or any person in the US. Danske Markets is a division of Danske Bank A/S. Danske Bank A/S is authorized by the Danish Financial Supervisory Authority and is subject to provisions of relevant regulators in all other jurisdictions where Danske Bank A/S conducts operations. Moreover Danske Bank A/S is subject to limited regulation by the Financial Services Authority (UK). Details on the extent of our regulation by the Financial Services Authority are available from us on request. Copyright (C) Danske Bank A/S. All rights reserved. This publication is protected by copyright and may not be reproduced in whole or in part without permission November 21