Danish households, which already have the world’s biggest debt load relative to incomes, are about to use a real estate recovery to go further into the red.
Five years after the country’s real-estate crash ripped through home equity and drove up the number of borrowers owing more than their properties are worth, homeowners are ready to take on bigger loans amid the first signs prices are rising, according to Nordea Bank AB (NDA), Scandinavia’s largest lender.
Outstanding home loans reached a record 1.44 trillion kroner ($262 billion) in August, 78 percent more than a decade ago, the central bank estimates. The development suggests a recovering housing market risks turning into a mixed blessing as Danes add to a debt load that the Organization for Economic Cooperation and Development estimates is a world-beating 310 percent of disposable incomes.
“Danes’ memories aren’t infinite,” said Lise Bergmann, a Copenhagen-based housing economist with Nordea Kredit, the Stockholm-based lender’s Danish mortgage unit. “Not only will we see more borrowing to buy homes, but people will begin to take out loans against their equity.”
Denmark’s stable AAA credit ratings by Moody’s Investors Service, Standard & Poor’s and Fitch Ratings are underpinned by a public debt ratio that’s less than half the average in the euro area. That’s helped keep interest rates low and supported borrowing.
Yet, adding to the world’s highest private debt burden would exacerbate risks that the International Monetary Fund says are lurking in Denmark’s $500 billion mortgage system, the world’s biggest per capita. The Danish Systemic Risk Council, created this year to guard against financial instability, says it’s responding to international warnings by investigating whether new constraints should be imposed on banks.
One avenue the council is exploring is whether banks should be required to allocate loans based on income as well as property values. That would limit the potential of real estate bubbles to give borrowers access to funds they can’t repay if the value of their home tanks in a subsequent bust.
“We should go into it with an open mind,” said Lars Rohde, central bank governor and head of the Systemic Risk Council, in an interview. He’s also cautioning the Social Democrat-led ruling coalition against fiscal easing after a government-appointed committee found lax policies going into the financial crisis contributed to Denmark’s housing bubble.
Denmark should explore introducing loan-to-income standards because the European Systemic Risk Board recommends the requirement as part of a toolbox to prevent excessive credit growth and leverage, according to Rohde.
“It may come as part of regulation from outside,” he said.
The government and mortgage industry have cautioned against reading too much into Denmark’s record private debt load, arguing it’s backed by some of the world’s highest pension savings. Still, those funds can prove difficult to access in an asset-price slump when households are mostly likely to need to tap them, according to the IMF.
In a Sept. 13 report, the Washington-based IMF said Danish household asset levels, as a share of disposable income, are lower than in “many other” economies, including the Netherlands and the U.K., and that a large part of Danish assets also are vulnerable to price fluctuations and illiquidity. Excluding housing and pensions, Danes have “negative” liquid assets, the IMF said.
“Continued low default and loss rates cannot be taken for granted,” the fund said.
Danish mortgage banks are legally required to limit bond-backed loans to 80 percent of a property’s value. If loans crawl above that threshold because home values sink, banks must provide supplementary collateral. In a boom cycle, homeowners have traditionally used rising property values to increase leverage.
Denmark’s most recent boom-to-bust cycle has exposed the model’s weaknesses. Loan-to-value ratios fell in 2006 to their lowest in at least two decades as Denmark’s real estate bubble inflated, according to a September review by the Institute for Business Leadership and Budget at Syddansk University in Odense, Denmark. The same review found that at least 1 in 10 Danish homeowners owe banks more than their homes are worth more than five years after the country’s bubble burst.
“If you look at the LTV ratios in 2006, then everything looks good,” Morten Skak, who co-wrote the review published by Syddansk University, said in an interview. “So we have the problem that many of these indicators of the institutions may look bright when the future is gloomy.”
House prices dropped an average of 20 percent after Denmark’s property bubble burst in 2008, with some areas of the country suffering even sharper declines. The IMF estimated in September that homes still remain 10 percent overvalued.
Most indicators suggest prices are recovering, led by apartment prices in the capital Copenhagen.
“Optimism among Danes and not least homeowners is back,” Joachim Kristensen, a housing economist at Nykredit Markets, a division of Nykredit A/S, Europe’s biggest issuer of home-loan covered bonds, said in an Oct. 2 note.
Danish house prices climbed in June to their highest in two years, the national statistics agency said Oct. 2. The number of properties for sale also has increased, while the average length of time on the market declined, according to the Association of Danish Mortgage Banks.
About 46 percent of all prospective home buyers were outbid, according to a September survey by EDC, Denmark’s largest independent real estate agent franchise. Two years ago that figure was 40 percent, EDC said.
Danish mortgage bonds have outperformed U.S. Treasuries (USGG10YR) even as the housing market slumped. A Nykredit A/S index of the most traded Danish mortgage securities has returned 35 percent since October 2008. U.S. Treasuries with maturities longer than one year returned 22 percent in the same period, according to the Bloomberg/EFFAS index.
Demand for mortgage loans is rising along with prices. Banks made 23 percent more offers in September than in August, the mortgage association said Oct. 9. The figure was down from a year earlier, as many borrowers had already refinanced to take advantage of record low rates, the Copenhagen-based industry group said.
According to Bergmann at Nordea Kredit, prices now “better reflect macroeconomic fundamentals.” Though households are unlikely to go on a similar borrowing spree to the one that presaged the latest crisis, households’ growing optimism means “there’s a limit on how much of a buffer households think they need,” she said.
General consumer spending climbed fourfold last month to its highest since the financial crisis’s start, according to the Danish Bankers Association. The Copenhagen-based industry group said today its payment index, which dates back to January 2008, climbed from 0.21 in August to 0.87 in September. The index includes debit card use and bank transfers.
Meanwhile, the mortgage industry is trying to defend itself against warnings from the IMF, the central bank, S&P and Moody’s that its business model is adding risk to the $340 billion economy.
Adjustable-rate loans, introduced in 1996, require borrowers to tap bond markets as often as annually. Interest-only mortgages, available since 2003, have added to debt burdens by slowing the rate of amortization, the central bank says.
The industry says it’s working hard to curb those risks and additional constraints such as a loan-to-income ratio are unnecessary. Mortgage banks “already are making very detailed credit and income assessments,” Peter Jayaswal, deputy director at the Association of Danish Mortgage Banks, said in an interview. “Responsible lending is in everyone’s interest.”
A government-appointed committee examining the causes of the financial crisis in Denmark recommended last month that the country’s financial regulator set stricter mortgage lending guidelines.
According to Jesper Rangvid, the committee’s chairman, “there should be alarm bells ringing.”
To contact the reporter on this story: Frances Schwartzkopff in Copenhagen at firstname.lastname@example.org