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Hedge Fund Bet Tested Amid Danish Housing Rebound: Nordic Credit

Danish housing market
Pedestrians sit on the side of the harbor canal opposite residential buildings in the Christians Havn district of Copenhagen. Photographer: Freya Ingrid Morales/Bloomberg

As some hedge funds and asset managers start to question the safety of investing in AAA-rated Denmark, a string of data last week showed the nation’s housing market is mending itself and underpinning a broader recovery.

After slumping 20 percent from peak to trough when Denmark’s housing bubble burst in 2008, the property market is now growing. House prices rose 3.4 percent in February from a year earlier, Statistics Denmark said last week. The number of homeowners unable to meet their payments dropped to a half-decade low in the fourth quarter, Nordea Kredit, a unit of Nordea Bank AB, said on Friday. The Nykredit Index of Denmark’s most-traded mortgage bonds is close to a record high reached on April 16.

“Both the housing market and the Danish economy are picking up,” said Lise Nytoft Bergmann, a housing economist at Nordea. “We expect interest rates to stay low for a while yet and for unemployment to continue declining.”

Yet a number of international investors have decided to bet against Denmark on concern its home-loan market is built on an unsustainable debt mound. The nation’s biggest mortgage bank, Nykredit Realkredit A/S, says the trade is unlikely to pay off. Danish mortgage bonds, which are about 80 percent owned by domestic investors, have outperformed U.S. Treasuries since the height of the global financial crisis, according to data compiled by Bloomberg.

Beating Treasuries

The Nykredit Danish Mortgage Bond Index has returned 40 percent since September 2008, the month Lehman Brothers International Holding Inc. failed, sending the world’s financial markets into a tailspin. Over the same period, U.S. Treasuries year delivered investors 24 percent. German government bonds returned 35 percent. Danish government bonds rose 38 percent.

Still, some investors say Denmark is at risk of suffering its own debt crisis. Though government debt is less than half the average in the euro area, at about 45 percent of gross domestic product, household debt is higher than anywhere else in the developed world, at more than 300 percent of disposable incomes, the Organization for Economic Cooperation and Development estimates.

The central bank has warned that households rely too much on short-term financing to pay for mortgages as long as 30 years. It also says use of interest-only loans is too wide-spread, delaying amortization.

Investor Confidence

“We would have a difficult time coping with a shock to the economy,” said Jes Asmussen, chief economist in Copenhagen at Svenska Handelsbanken AB. “If all of a sudden there’s a drop in investor confidence in Denmark, causing rates to jump, it’ll be self-perpetuating and play in favor of those speculating against Denmark.”

Owl Creek Asset Management LP, one of last year’s best-performing hedge-fund firms, has shorted Denmark’s sovereign bonds and bought credit default swaps on its biggest lender, Danske Bank A/S, in anticipation of a debt crisis, two people familiar with the matter said in February.

Last month, Arbuthnot Latham & Co., a London-based asset manager overseeing about $1 billion in funds, said it’s betting against Denmark’s krone as part of a series of transactions anticipating declines in the Nordic nation’s currency and financial markets.

Consumer Debt

For Arbuthnot, the decision to short Denmark was largely based on the nation’s consumer debt burden.

Though the government and central bank have argued the debt is backed by home equity and some of Europe’s biggest pension savings, leaving Danes with net savings, those assets may be hard to retrieve in a crisis, according to Gregory Perdon, co-chief investment officer at Arbuthnot. He made the decision to bet against Denmark’s main markets after speaking with representatives from the government, banks and universities.

“Everyone said nothing can go wrong,” Perdon said. “Especially the leveraged players -- they presented this market as something you can leverage and get good, high single-digit returns from with no risks. That’s factually incorrect. You cannot get high returns without taking risks.”

Denmark’s central bank last month raised its deposit rate, bringing it above zero for the first time since July 2012, to defend the krone’s peg to the euro. The move ended an unprecedented period in Denmark’s monetary history that followed an influx of capital two years earlier as investors fled the debt-stricken euro area. Since then, a recovery further south and demand for yield has revived appetite for markets in Europe’s core and weakened the krone.

Sensible Danes

For now, the data suggest Denmark is in recovery mode. Its biggest bank, Danske, reported net income for the first quarter that almost doubled as bad loans dwindled and its home market rebounded. The bank also raised its forecast for the full year.

Denmark’s economy will probably grow 1.7 percent this year and 1.8 percent in 2015, the European Commission said in February. The Danish government will post a budget deficit equivalent to 1.3 percent of GDP in 2014, well within the bloc’s 3 percent limit and less than the average 2.7 percent the commission estimates the European Union will see. Denmark also boasts a current account surplus, which grew 21 percent in February from a month earlier, to 9.5 billion kroner ($1.8 billion).

What’s more, the country has a history of dealing sensibly with its economic risks, according to Asmussen.

“You have to remember that Danes historically put paying their mortgage debt in front of all other debts,” he said.

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