Foreign investors returning to Denmark’s mortgage-bond market may bolster demand as banks sell a record $115 billion of the securities at annual auctions beginning today.

Investors based outside the Nordic nation likely will buy about 15 percent of the securities maturing in one to five years, up from 5 percent last year, the smallest amount in at least a decade, according to Nordea Bank AB, Scandinavia’s biggest lender. Prices in the $460 billion mortgage-bond market, the largest after the U.S. and Germany, have risen almost 9 percent since last year’s sale, the Danske Bank A/S Mortgage Bond-Market Index shows.

Pacific Investment Management Co., manager of the world’s biggest bond fund, said the gains may continue as high relative interest rates, a slowdown in home price declines and a global economic recovery attract investment. Denmark’s mortgage bonds haven’t suffered a default since they were introduced after the great Copenhagen fire of 1795, according to Danske Bank.

“Given the history, structure and valuations of the Danish mortgage market, they are an attractive investment,” said Andrew Bosomworth, an executive vice president and head of portfolio management in Munich at Pimco, which is based in Newport Beach, California. “We intend to prolong our existing exposure to the market. There’s no other mortgage security quite like them in the euro area.”

Default Risk

Mortgage lenders can’t take customer deposits, so they raise money by selling bonds backed by every home loan in the nation of 5.5 million people. Lenders also must balance loans with bonds that carry similar terms. Unlike in the U.S. and Germany, they must also retain the risk that borrowers will default by continuing to provide such functions as collecting interest payments.

Denmark’s mortgage market has exceeded its gross domestic product, which was $325 billion last year, since 2006. It is almost four times as large as the government bond market, which totals about $117 billion, according to central bank figures.

Adjustable-rate loans are reset once a year when investors such as pension funds bid for mortgage securities. The prices they pay determine the rates lenders can charge. The auctions will help lower the yield on a one-year loan to 2.25 percent, from 5.2 percent, adding $2.8 billion to household and business income next year, said RealKredit Danmark, the nation’s second- biggest lender.

Great Expectations

“We have great expectations for this auction,” said Jacob Skinhoj, the Copenhagen-based chief analyst at Nordea. “Danish mortgage bonds are attractively priced.”

The benchmark lending rate in Denmark is 1.25 percent, compared with 1 percent for the European Central Bank and zero to 0.25 percent for the U.S. Federal Reserve. It will increase to 1.75 percent next year and 2.5 percent by the end of 2011, Danske Bank and Nordea predicted.

Adjustable-rate loans will represent about a third of the market this year, up from 20 percent in 2008. Joblessness will increase to 5.8 percent of the population by the end of next year and 6.5 percent in 2011, from 4.1 percent in September, a Bloomberg survey of economists showed.

“It’s not a show stopper,” Pimco’s Bosomworth said. “I would welcome other countries in the European Union adopting the same Danish structure in their mortgage markets.”

Interest Rates

Prices of three-year Danish notes rose 5.4 percent since last November, compared with 4.1 percent for similar German mortgage debt and 2.6 percent for U.S. securities. The Danske Bank Mortgage Bond-Market Index rose to 116.9, from 107.3 a year earlier.

Last year’s $68 billion auction was held amid a sell-off in Danish securities by foreign investors with the economy mired in the worst recession in at least four decades. The central bank raised interest rates to an eight-year high of 5.5 percent in October to protect the currency’s peg to the euro after foreign reserves shrank to 132.4 billion kroner ($26.4 billion), the lowest level since 2001.

The backdrop is better now. Reserves rose to 376.1 billion kroner in October, about the highest level in at least 22 years. Declines in house prices slowed to 0.7 percent in the second quarter, from 6.1 percent in the first, while apartment prices rose 1.2 percent, Statistics Denmark said on Nov. 16.

Different Situation

The economy will expand 1.2 percent next year and 1.7 percent in 2011, according to the Paris-based Organization for Economic Cooperation and Development. It will shrink 3.60 percent this year, the median forecast in a Bloomberg survey of five economists shows.

“The situation is totally different this year,” said Gustav Smidth, a covered-bond strategist with Danske Bank in Copenhagen. “We can safely rule out any more uncertainty about the krone and that takes away a lot of the risk of the auction.”

Improvement in the economy is giving investors the confidence to buy bonds at lower yields. The yield on the benchmark RealKredit Danmark three-year note was at 2.41 percent on Nov. 16, down 229 basis points, or 2.29 percentage points, from 4.7 percent a year ago. Comparable U.S. note yields fell 183 basis points in the period, with a 146 basis-point decline for German yields.

The one-year yield will settle at 2.1 percent at the auction, the three-year at 3.1 percent and the five-year at about 3.6 percent, according to Nordea and Danske Bank. The sale ends Dec. 14.

Denmark’s government will buy about $8.8 billion of mainly three- and five-year mortgage notes, almost twice as much as last year. It also extended a financial-aid package for pension funds, which hold about 25 percent of outstanding mortgages, until the end of next year to “ensure market stability and prevent the systematic sale of Danish mortgage bonds,” the Ministry of Economic and Business Affairs said on Oct. 27.