Swedish Residential Real Estate Overvalued 25%, S&P Says

Swedish housing is overvalued by as much as 25 percent after prices accelerated at a faster pace than disposable income, Standard & Poor’s said.

The divergence, which resembles an imbalance before a property slump 20 years ago, may either require prices to decline or salaries to rise at a faster pace, S&P analysts Sean Cotten and Alexander Ekbom said in an interview in Stockholm two days ago.

“Looking at the crisis in the early 1990s, prices rose much faster than incomes before there was a correction,” Ekbom said. “Looking at the situation now, prices have gained more than the increase in disposable income, even though real income has had a good development.”

Sweden has taken a raft of measures to stem growth in mortgage lending and house prices amid concerns a bubble is developing. The steps include limiting mortgages to 85 percent of property values and tripling risk-weighting, or the cash banks must set aside to protect against mortgage defaults. While the steps have helped slow loan growth, house prices are still surging and consumer debt has risen to a record high of more than 170 percent of disposable income, according to central bank data.

Risk Weighting

The country’s financial regulator said this month that it may start forcing households to pay down their mortgage debt should credit growth continue accelerating. Central bank Governor Stefan Ingves and Finance Minister Anders Borg have called for risk weighting on mortgages to be increased further after the regulator tripled the ratio to 15 percent this year.

Ekbom said a risk weighting of 24 percent to 30 percent would be a more suitable level, taking into account the performance of the economy and housing market developments.

A real estate crash in the early 1990s led to surging loan losses for banks. Nordea Bank AB, now the Nordic region’s largest lender, was created as the government nationalized Nordbanken and Gota Bank after credit losses wiped out their equity. In neighboring Denmark, banks have needed emergency support after a slide in house prices in 2008 wiped out 62 community lenders in the following five years.

Sweden is different than Denmark because new building projects in cities such as Stockholm aren’t as numerous as those that were seen in Copenhagen, Ekbom said.

Price Surge

Apartment prices, which more than doubled since 2000, increased 14 percent in the 12 months through August, according to data from Svensk Maeklarstatistik, which publishes monthly data on Swedish real estate. The price of single-family houses advanced 4 percent since August last year, it said.

The central bank estimates private debt will grow to 177 percent of disposable income in 2015.

While credit growth slowed to 4.5 percent last year from a pace of more than 10 percent from 2004 to 2008, borrowing is accelerating. Lending grew 4.8 percent on an annual basis in July and August versus 4.7 percent in May and June, according to data from Statistics Sweden, the nation’s statistics office. The expansion was 4.5 percent at the start of the year.

Higher household debt means S&P may lower Sweden to “3” in its banking industry country risk assessment from “2”, Ekbom said. A rating of “1” denotes lowest risk and “10” the highest.

Consumption Decline

Smaller businesses, rather than the nation’s banks, will probably be hurt the most by any correction in the housing market, Ekbom said.

“Household sector losses wouldn’t explode if there isn’t a very extreme shock, but consumption is likely to decline and that would hit small and medium-sized companies that don’t have that much of an endurance capability,” he said. “If you look at Denmark, that is exactly what happened. Household mortgage losses were very small but SMEs were very badly hurt.”

Last month, Danish companies with sales of 15 million kroner ($2.7 million) or less constituted 94 percent of declared bankruptcies, according to the Danish statistics agency.

Data from SEB AB, Sweden’s fourth-biggest bank by market value, shows its residential mortgage lending jumping to 373 billion kronor at the end of June from 273 billion kronor in late 2010. Still, stress tests of its mortgage book showed that losses, even in an extreme environment, “would be manageable,” according to a presentation published on its website this week.

With high levels of indebtedness, Sweden is “in unchartered waters,” S&P’s Cotten said.

“Debt levels were nowhere near 175 percent during the crisis in the early 1990s, and the social welfare system was more generous then than it is now,” Cotten said. “However, it is important to point out that interest rates were much higher in the 1990s, which contributed meaningfully to the sharp correction then.”

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