Hedge Funds Betting on Danish Crisis Face Losses, Banks Say

The biggest banks in Denmark’s $550 billion mortgage market say hedge funds looking for ways to bet against the industry are setting themselves up for losses.

Europe’s largest issuer of mortgage-backed covered bonds, Nykredit Realkredit A/S, says speculation the AAA-rated Danish economy may be headed for a debt crisis ignores some basic facts. Near record-low yields at mortgage bond auctions that started last week are proof that most investors agree, according to the bank.

“Funds can speculate on whatever they want,” Soeren Holm, chief financial officer at Nykredit, said in a telephone interview. “But I don’t think it’s good business to speculate against Denmark.”

The comments follow reports earlier this month that Owl Creek Asset Management LP, a $3.2 billion New York-based hedge fund, was betting against Danish government debt and buying credit default swaps on Danske Bank A/S, the country’s biggest bank and owner of its second-largest mortgage lender. It’s not possible to purchase default swaps on closely held Nykredit, Denmark’s biggest mortgage bank.

Owl Creek

According to a Bloomberg Ranking of the top 100 hedge funds with assets of $1 billion or more, Owl Creek was sixth-best, delivering its investors 38.1 percent in the first 10 months of 2013. Founder and investment chief Jeffrey Altman revealed his fund’s position on Denmark during a panel discussion in Florida last month, according to two people familiar with the matter who asked not to be identified because the information is private. Owl Creek declined to comment for this article.

Danes indulged in “excessive debt-taking” in the years leading up to 2008, when the nation’s property bubble burst, the financial regulator said last month. Household debt is 321 percent of disposable incomes, a world record that the Organization for Economic Cooperation and Development said in November demands a policy response.

Most of the debt is in mortgages, of which about two-thirds are financed using short-term bonds. That’s made households vulnerable to interest rate swings and created “special demands” on fiscal policy, the government said last month.

Krugman’s Question

Denmark’s FSA is now working with the government on plans to cap bank sales of interest-only loans and mortgages that need to be refinanced annually to help the economy deleverage. Legislation is pending that will extend bond maturities if markets freeze or if rates climb more than 5 percentage points between auctions.

Speculation on how Denmark will manage its private debt load has intensified since Nobel Laureate Paul Krugman said last month the level of indebtedness was grounds for concern.

“You wonder if that’s a crisis waiting to happen,” Krugman said in a Jan. 9 interview in Copenhagen. “I’m not sure, but it’s nervous-making.”

Yet high household indebtedness is only half the story, according to Nykredit and Nordea Bank AB, Scandinavia’s biggest lender.

“It’s true private debt is large -- and you can argue it’s too large -- but it has nothing to do with systemic risk in Denmark,” said Anders Aalund, chief analyst for fixed income research at Nordea Markets, a unit of Nordea Bank. “There are a lot of offsetting things, like the high pension savings.”

Speculative Attacks

Denmark has faced speculative attacks twice before since the global financial crisis started. In 2008, the central bank raised its main lending rate to an eight-year high to defend the krone’s peg to the euro. In 2011, credit-default swaps on bonds sold by Danske Bank and the government soared after Denmark became the first nation in Europe to force losses on bondholders in bank failures. A year later investors sought refuge in Denmark from Europe’s debt crisis.

“It surprises me that they’re trying again,” Aalund said. “I don’t think they’ll succeed. The take-away from the last time is that they’ll fail.”

Danish households enjoy cheap funding in part because their government emerged as a haven during Europe’s debt crisis. Denmark’s public debt burden is less than half the average in the euro area, and will reach 42 percent of gross domestic product in 2014, the European Commission estimates. Households have assets that are four times their disposable incomes, government figures show. Denmark also boasts a current account surplus equivalent to 7.2 percent of GDP, Nykredit estimates show.

Default Insurance

“The Danish economy is doing better than the euro zone, and since euro zone rates are what determine rates in Denmark, I think we’re home safe there,” said Jacob Skinhoj, head of fixed income and derivatives research at Nykredit.

It costs about the same to insure against a default on Danish government bonds as it does to guard against losses on debt sold by Germany. Five-year credit-default swaps on Denmark cost about 24 basis points after falling by as much as 6 percent today in intraday trading, according to data compiled by Bloomberg. Danish government debt has returned investors about 2 percent this year, matching gains on Swiss bonds.

Homeowners rolling over one-year bonds to refinance their mortgages paid as little as 0.33 percent in auctions this month, according to Nordea.

“The fund perhaps forgot that not only do households have a lot of debt, but they also have bought the bonds through their pension accounts,” Holm said. “It’s not worrisome.”

It’s not only Denmark’s banks that have questioned talk of betting against the nation’s debt markets.

“It underscores the traditional view that no matter who you are, investors should see the entire picture and make their own decisions when it comes to deciding where to invest,” Economy Minister Margrethe Vestager said in an interview. “And not be guided by people who have one perspective instead of the entire picture.”

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