Reading the Markets Sweden - Danske Analyse - Danske Bank

Reading the Markets SwedenIt could also have a positive effect on the net stable funding ratio (NSFR) if the 1Ybond with extension can be included in the NSFR. We would not expect that a 1Ybond could be included but we do not know this. This is probably up to the regulators.However, there are also a number of possible negatives.There will be more ISIN codes, as mortgage banks will open new bonds – henceliquidity will be ‘diluted’.The knock-in option has a cost for the borrower. Some market participants estimate acost of 5bp but the premium is highly uncertain, as it is dependent on the shape of theyield curve, the volatility, the credit spread/risk, and the risk of going from a 1Y bondto a 30Y.There could be a possible negative effect on the existing 30Y callables. There is anincreased risk premium given the risk of a sudden increase in the supply of 30Y fixedratecallable bonds. The effect is difficult to price given the very low risk of a rise inrates of more than 5%.Finally, who will buy the new bonds? This is a major issue, as there are a number offoreign investors in the existing 1Y bonds. It is uncertain whether they can and/or willbuy the new bonds. Similarly for funded investors, will they buy the bonds given theextension risk. It is also uncertain whether mutual funds with a maturity target around1Y will be allowed to buy the bonds.So, could this have repercussions for the Swedish covered bond market? Theuncertainties surrounding the new setup in Denmark might dent demand for flex bonds, assome investors might be less keen on having such uncertainty in their portfolios. Willthey buy a short-term bond that could possibly be extended into a 30Y fixed-rate callablebond? Hence, Swedish covered bonds might stand out as more attractive on a relativebasis, at least until the dust has settled in Denmark.In addition, with a more fragmented Danish mortgage bond market, the Swedish market,which relies on a few benchmark bonds with bigger volumes, might be easier for someinvestors to grasp. Hence, as existing Danish flex bonds mature, a few investors mightgradually move into Swedish peers instead. Thus, long term, this might be supportive ofthe Swedish covered bond market. The step taken in Denmark is probably positive but, inour view, it is likely to give rise to some uncertainty for investors.6 | 7 November 2013www.danskeresearch.com