Billionaire George Soros’s assertion that Denmark’s $480 billion mortgage credit system can weather any crisis better than any country where mortgages are bought and sold is proving the rule for international investors.
The Nykredit Mortgage Bond Index (NYKRINDX), which includes the largest, most-traded of the securities, rose to a record this month, holding up through a real estate slump, a banking meltdown and Europe’s debt crisis. Home-loan bonds have gained 29.2 percent since 2007, beating U.S. Treasuries.
“The Danish mortgage system works as advertised under very special conditions as the rest of the world shuts down,” said Alan Boyce, a former bond trader at $25 billion Soros Fund Management LLC, before becoming chief executive officer at Absalon Project, a joint venture with VP Securities A/S to promote Denmark’s mortgage system. Soros first established a partnership to champion the Danish market model in 2005.
Denmark’s benchmark mortgage bonds have gained almost as much since the U.S. subprime collapse triggered the global credit seizure in 2007 than in the prior five years. Demand is surging even as home prices are projected to fall 25 percent by 2013 since the crisis, economic growth slows and unemployment rises, with investors gravitating to a country that’s one of only 12 nations in the world with AAA ratings at Standard & Poor’s, Moody’s Investors Service and Fitch Ratings.
The Danish mortgage bond market differs from other countries in several key respects. When a homeowner in Denmark takes out a loan, the mortgage is immediately converted into a security of the same amount. A homeowner can then retire a mortgage either by paying off the loan or by purchasing an equivalent face value of the bonds at the market price.
Danes call this the balance principle. Mortgage issuers take all the credit risk, providing reserves in case a borrower defaults. Investors face a risk only on interest-rate fluctuations. Another difference with the U.S. is there are no government-sponsored companies involved in the market.
“Mortgage banks don’t take interest rates risk, the bond market does,” said Boyce. “Borrowers are benefiting from that. If you look at the U.K., Ireland, all over Europe, the borrowers are paying way higher rates.”
Foreclosure rates in Denmark also signal its mortgage credit system can protect borrowers from losing their homes even after a property bubble has burst.
Though the country is still in the middle of its real- estate slump, foreclosures account for just 0.2 percent of the total housing stock, according to Karsten Beltoft, the head of the Mortgage Banker’s Federation, which represents the home-loan arm of Danske Bank A/S (DNSKY), the largest bank in Denmark.
House Price Drop
U.S. house prices have slumped about 32 percent since a 2006 peak, according to an S&P Case/Shiller Index (SPCS20), which tracks 20 major metropolitan areas. About 1.4 million properties nationwide were in the foreclosure process or bank-owned, representing 1.07 percent of housing units, according to RealtyTrac Inc., an Irvine, California-based data vendor.
There are also plenty of differences outside the mortgage market, including a more extensive welfare system that provides for basic needs, including housing.
The U.S. unemployment rate swelled as high as 10 percent in late 2009 from an average of 4.6 percent in 2006. It’s since declined to 8.5 percent. In Denmark, joblessness will rise to 6.9 percent next year from 6.5 percent in 2012, Danske Bank estimated in a Jan. 9 report.
“This is deflating without collateral damage while the rest of the world is blowing up,” Boyce said. “In the U.S., the collapse is probably blowing up a quarter of the households with mortgages while in Denmark it will blow up about 1 percent, that’s a difference.”
Soros, whose Quantum fund famously bet $10 billion that the Bank of England would be forced to devalue the pound, started a joint venture with VP Securities in 2005 to establish the mortgage model in Mexico (MXBLMORT), and has subsequently argued that a similar system should be adopted in the U.S.
The Nykredit Mortgage Bond Index climbed to a record on Jan. 2, and has hovered at about that level since, slipping only 0.2 percent through Jan. 18. The bonds returned 29.2 percent since the end of 2007, beating the 27.9 percent return for U.S. Treasuries, that includes reinvested interest.
“We have a large holding because we think they’re a good investment, they have a higher interest rate than government bonds and they’re secure,” said Henrik Henriksen, chief investment strategist at PFA Pension A/S, Denmark’s second biggest pension fund with $45 billion in assets.
Foreign Bond Ownership
Foreign ownership of Danish mortgage bonds surged 28 percent last year to 365 billion kroner ($63 billion) in November, central bank data show. Non-Danish residents now make up about 13 percent of the total, versus 10 percent a year ago, the central bank estimates.
The success of the bonds with investors isn’t translating into stabilizing home prices or purchases.
Home loan offers fell 30 percent in 2011 to the lowest in 15 years, the Association of Danish Mortgage Banks said Jan. 9. Economic uncertainty is prompting home buyers to delay purchases and homeowners to refrain from borrowing against their equity, Beltoft said in a statement.
The yield on Nykredit’s 3.5 percent mortgage bond maturing in 2044 rose one basis point to 3.82 percent as of 10:14 a.m. in Copenhagen. The spread to the benchmark 10-year Danish government bond narrowed one basis point to 213 basis points.
Falling house prices are “a challenge to the system, but we think the Danish housing market is supported by falling interest rates and an underlying demand for the bonds,” said Henriksen. The fund, which is based in Copenhagen, held about $13 billion in mortgage securities at the end of June.
House prices will decrease 13 percent until 2013, bringing total losses since the market peaked in 2007 to 25 percent, the government-backed Economic Council said in November.
The $300 billion economy will grow 1 percent this year and in 2013, after contracting 0.5 percent in the third quarter.
Adding to stresses in the housing market is an increase in the personal debt rate. Danes have the world’s highest ratio of debt at 310 percent of incomes in 2010, Exane BNP Paribas estimates. Household debt has swelled from 158 percent since 2000 as mortgage banks developed cheaper loans to attract borrowers. BNP says such imbalances will ultimately take their toll.
“There will be a point when something happens and people will pay attention to what’s happened with house prices to focus on the risk,” said Andreas Hakansson, an analyst at Exane BNP based in Stockholm.
Hakansson says the evolution of Danish mortgages in the past 15 years to include riskier products will be a problem.
Denmark’s mortgage-bond market has moved away from traditional fixed-rate, callable-at-par securities into more varied debt instruments. Adjustable-rate mortgages were introduced in 1996. Interest-only loans, which the central bank has criticized for exacerbating volatility in the country’s property market, were sold starting in 2003. So-called capped floaters, which offer a floating interest rate with a ceiling on how high borrower costs can rise, came in 2004.
Because of these changes, Moody’s Investors Service has warned the bonds are growing riskier. Adjustable-rate loans now make up almost half the country’s mortgage market, meaning there’s a growing mismatch between 30-year home loans issuers give to borrowers and the shorter-term bonds investors buy to fund the mortgages. The rating company in June cut the so-called timely payment indicator on the securities and told lenders to increase the amount of collateral they set aside to offset refinancing risks.
“In the old days, with 30-year mortgages, it was a great system,” said Hakansson. We are far away from that system. It remains to be seen where we are headed.”
Nykredit Realkredit A/S, Europe’s biggest issuer of mortgage-backed covered bonds, and Realkredit Danmark A/S, the mortgage arm of Danske Bank, have dismissed criticism and argue Moody’s doesn’t understand the market. Realkredit Danmark terminated its contract with the rating company, while Nykredit adjusted its business to address the concerns.
Mortgage lenders can’t issue enough bonds to satisfy demand, said Boyce. While the securities have in part been buoyed by the haven status of Denmark’s AAA government debt market, it’s their liquidity and tradability that appeals, he said. There is more than three and a half times the amount outstanding in mortgage securities versus Denmark’s $130 billion in sovereign debt, central bank figures show.
“The European bond market fell apart and what happened is that the Danish mortgage market and the government issued like crazy and still couldn’t make enough,” Boyce said. “Nobody should be worried about this right now, the worry should be what happens when the issuance stops.”
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