Summer came early, SHM came late! But, at last we are back!

Given that we have been away for a while we thought it would be a good idea for a round up session to see where we currently stand. We will cover, briefly, the following areas:

– Supply

– Turnover

– First public default

– Court ruling


As we have noted before, supply is coming – the main source is completed new-builds, but also from the existing stock. The train, ie. construction that started in the past 3 years and is now completed, has already left the station and there’s nothing we can do about it. In our report (p.13) we presented some historical data on housing starts and completions. In 2016 and 2017, for example, the number of housing starts exceeded the number of completions by about 20k per year and longer-term average levels by about 30-40k units per year, almost exclusively driven by multi-family houses. This is over a third of the average number of transactions in a typical year in the housing market (ca 65k flats, 30k houses – can be estimated from booli data). Let us look closer at the magnitude of this boost in supply.

(As a parenthesis, the most reliable source for supply data seems to be The following webpages use’s data: – in Swedish – in Swedish – available in English

There is also similar data on, but that is only available to members of the press.)

(Visible) Supply – what we can see in the market

According to[1] the supply of co-ops in June was 17% higher than June 2017, for single-family homes the increase was 12%. The top line in the below graph shows the total number of co-ops for sale, the bottom one representing single-family houses. In June there were 18 505 co-ops for sale and 15 886 houses. This includes new-builds, but most of them are pre-sold and don’t hit the (visible) market. Instead, their effect is generally that some existing properties have to be sold to “make room”. However, some of these will be sold straight away, for whatever reason (profit/loss taking, buyer walking away etc.). It is evident that the levels in 2018, especially for flats, are elevated compared to 2016 and 2017 (perhaps excluding the last quarter of 2017, which is when prices started going down), although we are heading into the summer and supply should be reduced as sellers remove their ads due to vacation and reduced activity in general.


Shadow supply – supply that’s could be there but we don’t know for sure

According to data from Hemnet quoted in Privata Affarer[2] the share of sold co-ops across Sweden has fallen to 68%, i.e. 32% of all ads that are removed from Hemnet are unsold. Hence, the expression “shadow supply” – these are objects that are waiting to be sold but are not formally being offered. Up until mid-June this number was 81% (of course, there is a seasonal pattern in this as well). However, during the first half of 2016 and 2017 the numbers where 93% and 92% respectively. The graph[3] below shows this development clearly – it seems that the running difference with previous years is of the magnitude 10-20%.


Looking at Stockholm in particular, during the first half of 2016 93% of all co-ops were sold, in 2017 it was 92%. During the first half of 2018 that number plummeted to 75%.

Of course we can only speculate whether these co-ops will come to the market again or if the potential sellers have decided to not sell. However, given the function (or lack of function) of new production, where the potential buyer signs up circa 2 years before delivery while keeping their existing property, we think it’s fair to assume that some of these objects will reach the market again.

Let’s put some of these numbers together. If the typical turnover in the co-op market is 70k per year and the share of sold units goes from ~90 to 70% it means, all else equal, that 15k units are in added to the “shadow” supply every year. We suspect this number captures the excess supply of the market pretty well (it represents about half of the “excess construction” versus earlier years when construction was at a low base). Please note that this doesn’t mean that the overall market is over-supplied in number of units, but that ca 15,000 too many have been built and offered at the wrong price point. Also note that this number does not come from laws of physics, but merely serves as an estimate of the magnitude of the issue.

Turnover – going down as supply is going up

At the same time the number of transactions are decreasing which indicates that the market is not clearing perfectly inside the current bid/offer levels. The first graph[4] shows the 34-day moving average the number of sold co-ops, which is has been around 5.5k. Assuming no new supply that means it would take about 115 days to clear the inventory of co-ops for sale.


For single family houses it’s about 3k transactions (per 35 days, below). With 16k units in the market it would take about 180 days to clear the inventory, assuming no new supply.


This is a seasonal effect, but the effect is exacerbated as the transaction speed is also slowing. The following graph shows the development for co-ops in Stockholm[5]


The blue line shows the price per square meter on the left axis, the red dotted line shows number of days it takes to sell the object on the right axis. The below graph shows the data for single family houses in Stockholm, although prices seems to have stabilized, the number of days it takes to sell seems to be on an upward trend, both for co-ops and single family houses.


The first default – Axxonen

The interested reader has surely noticed the default of the small property developer Axxonen[6]. This has not had any major repercussions, yet, however we see this as a canary in the coal mine, as it is not hard to imagine other small developers facing the same fate in the near future. As a (somewhat ironic) sign of the times, this company was funded by a crowdfunding platform[7] where ca 300 retail investors invested a minimum of 50kSEK (USD5.5k). The total liability we can see is around 35mSEK (USD3.9m) while other sources report that Axxonen raised around 70mSEK in total. Axxonen offered to pay 11% annually to raise these funds, indicating the happy-go-lucky nature of the developers, as of now the recovery value is unclear (if any).

Axxonen bought one of their projects from Oscar Properties (OP), who will now resume responsibility for that project as Axxonen has defaulted. This will hardly have any major impact on OP as the consideration for this project was only around 125mSEK. It is worth noting that OP is just about staying afloat, the stock trading close to its recent low of SEK 21 (current share price ca SEK 24).

Of course there are plenty of similar projects and businesses, and we suspect they have yet to surface. The elephant in the room is, of course, the upcoming wall of bond maturities, in 2019 and 2020. If the market does not recover we have a hard time seeing investors being willing to lend to developers at low enough rates to maintain profitable businesses.

Court ruling – worst case scenario for developers

As you may recall we wrote a post a while back[8] on a few (hypothetical) scenarios for the upcoming supply of new builds. Last week we got the first court ruling[9] in one of these cases. Stockholms Tingsratt (the Stockholm District Court) ruled in favour of the buyer, essentially giving the buyer the right to walk away from a deal where delivery was delayed by 10 weeks (although, according to the ruling, 6 weeks would have sufficed to void the purchase). The developer has since appealed[10] the ruling to Stockholms Hovratt, and it is unclear when the next court date is, but probably not until late August (Swedes love their vacation).

If the current ruling stands this would put us in the “worst” scenario according to our previous post, as plenty of projects are delayed by more than six weeks. Unfortunately for developers this would mean that the purchase agreement would not worth more than the paper it’s written on (plus the “sign-up” fee we discussed in the report[11]). It opens the door for buyers to step away from delayed (and altered) deals.

However, as we noted in the previous post, the optimal solution for the buyer is often to team up with other buyers to minimize legal costs and renegotiate with the developer under maximum pressure. Whether this will play out on a larger scale is too early to tell but this court ruling certainly opens the door to a nasty scenario for the developers, and the system at large.


Supply is undoubtedly increasing, driven by both lower transaction volumes and increased number of dwellings for sale. In short the data indicates that that the market is not fully clearing at the current level of (asking) prices. We don’t see any reason why this should change in the short term, at this price level, given the (roughly constant) number of new builds coming to the market this year and next – in addition to the shadow inventory of unsold flats, some of which will come back. The increase in the time it takes to sell indicates that we will see more supply per time unit, all else equal. Furthermore, the first and second amortization requirements come into play as more and more people realize how limiting these restrictions are – we think this caps demand firmly at current levels, if not lower.

The shadow supply is hard to draw any conclusions from, the only thing we can say is that data seems to point to a higher shadow inventory compared to previous years, likely related to the pick-up in construction. If we assume that 10% is the normal level of unsold homes, the current level at 30% represents roughly 15k flats annually, which the seller would like to sell at current price but can’t. One would have to assume that the vast majority of these sales are long sales (i.e. the owner has somewhere else to live). This implies that if all new builds coming to market priced at current levels of asking prices, the excess construction would be 15k units per year. Of course, that is not entirely true, but we get a sense of the magnitude of the oversupply. Assuming a typical dwelling size of 100 sq m, at 50,000 per sq m, and a time to completion of 2 years, the value of the oversupply is about SEK 150bn. At that size it could definitely make a dent to society.

Also, the court ruling surprised us and opens up to a wide range of outcomes that we thought unlikely – we thought this would take longer time and that the buyer would be liable in some sense. We are watching this space closely. However, with summer upon us, we doubt that there will be any more information in the short term.

Overall SHM stays bearish on prices from here, as the supply-and-demand balance is (finally) pushing prices down towards fundamentally sound levels (which are still far far away – perhaps one for another post!). Beware that the Swedish housing short is no longer contrarian (perhaps, partly, thanks to us) – a lot of fundamental hedge funds can be found short in the shareholder registries. To us, shorting banks like Swedbank, that are closer to the highs than the lows, provide the best long-term hedge for anyone that feels over-invested in housing.



[3] Due to sales sometimes being reported before/after month end the share of sold co-ops can exceed 100% for a short period of time.

[4] – we adjusted the moving average to get a somewhat smooth graph

[5] Proprietary graph based on data from, 30day moving average








New kids on the (mortgage) block

There has recently been a lot of media coverage about new, “disruptive” lenders in the mortgage market. These include, Bofink, Stabelo and Hypoteket. This piece will discuss some issues around and make some general remarks that we think are relevant both for the market as a whole and, perhaps more importantly, the individual borrower. 

When it comes to credit the two most important parameters are the service cost of debt (the price, or interest) and accessibility. By accessibility we mean the general terms and conditions (such as LTV, term, amortization etc).

Let’s start with the service cost. As we know, interest rates were going down for an extended period, but mortgage rates haven’t matched this decline. Therefore, bank mortgage margins have been increasing to (what some claim are) excessive levels. This is only partially true – due to banks’ heavy use of deposits rather than wholesale funding; at negative interbank rates, deposits are actually costly (but, more on this in another post). This, combined with the oligopolistic structure of the market, has attracted opportunistic competition with new entrants cutting headline mortgage rates. At the margin, we expect to see lower mortgage interest rates going forward, from already very low levels, generally bringing down the debt servicing expense for consumers along with bank profits. However, the reality is always more complicated than theory.

With respect to accessibility, we know that the Swedish FSA (Finansinspektionen, FI) has introduced measures over the past couple of years that restrict access to credit, most importantly the first and second amortization requirements. As far as we can tell from marketing materials, it seems like the main business plan of these disruptive lenders is to poach clients from banks rather than originate new loans. If this is the case, they are not directly altering the total access to credit to the market, since it is the bank’s original credit process that provided the initial loan. We have also heard plenty of chatter that these new entrants are not legally required to enforce amortization, which only applies to mortgages provided by banks (or mortgage institutes). Thus, it might increase access to credit to lower quality borrowers. Of course, it runs counter to the spirit of the regulation and, if this is indeed the case, we assume the legal loophole will be addressed in the near future. 

So let’s look a bit closer at specifics. It seems that Stabelo and Hypoteket only offer loans with low LTVs (60-65%), meaning that their target audience is borrowers with existing loans from banks. However, due to the nature of the Swedish funding market, it is worth noting that this can, in fact, be restricting for credit to society as a whole. The reason is that these loans are typically part of the banks’ covered bond pools and, by removing low-LTV loans from the pool, the quality of the pool deteriorates, at the margin. Higher LTV-pools means higher funding cost in the covered bond market and more risk to the banks’ balance sheet which should, at the margin, lead to costs going up and banks being less keen to underwrite new higher-LTV loans. For a recap of the covered bond market, please see our report. So, although some individual borrowers will benefit from a lower mortgage rate, all consumers might not necessarily be better off.

To summarize, price of credit could go lower but access to credit seems unchanged and might even deteriorate. And, in our view, access to credit is currently the key driver for prices in the real estate market. To illustrate this point: if you pay 1 or 2% on your mortgage (or maybe even 3%, which is unheard of, for any millennials out there) doesn’t really matter. What matters is the LTV. As an example, with SEK 250k in available equity, the purchasing power for different LTVs are the following:




Purchasing power





















Leverage is called leverage for a reason; when things move they move fast. Tighter credit conditions means lower purchasing power. 

Now, with’s recent publicity stunt*, which has to be said to have been a great success, we will also give them some air-time. But, it won’t be completely free as we aim to raise some serious concerns.

At first glance, their offer looks great: 85% LTV with a sub-1% interest rate, fixed for three years. And, as we mentioned above, you might be exempt from amortization (for a period of time?). What’s the point of debt reduction, anyway?

However, there is a major flaw in Enkla’s offer: the three-year tenor applies to both the interest rate and the principal. Mortgages in Sweden typically have a legal repayment tenor of at least 10 years and, in practice, the tenor is almost infinite (especially if the rate of amortization is low). 

If you are considering this offer you need to take into account that you will be subject to a mandatory refinancing after 3 years which entails a new credit approval subject to the conditions at that time. Let us stress that this is a major risk, especially considering the current trajectory of Swedish house prices. A lower price in the future means a higher LTV, which could trigger mandatory amortization and/or a smaller available loan post refinancing, at a potentially higher interest rate! In our opinion, the improvement in debt service cost is largely irrelevant compared to this refinancing risk. Just ask anyone who was around during the great financial crisis experiencing tight financing conditions. 

An improvement of somewhere around 0.5% per year, over three years, or 1.5% of the total notional, seems like picking up nickels in front of a steamroller, given the refinancing risk. This is even more true in the current environment with (close to) all-time high prices and all-time high supply. Furthermore, taking into account tax deductibility of interest expenses, the actual pickup is even smaller.

We urge all interested borrowers to read the fine print of’s offer. We are of the firm opinion that this is not a mortgage. Due to the short tenor it’s simply a (huge) consumer credit. Borrowers beware!!

*We call it marketing stunt as the information regarding the structure of their business is more or less unknown. We think that has used this airtime to ramp up assets for the (assumed) upcoming RMBS. There are a bunch of questions regarding’s business model, and we will surely return to them as more information becomes available. Of course we would be grateful for any further insight into the T&Cs from either the company itself or our readers. 

Some scenarios for the upcoming supply of new-builds

Dear readers,

SHM is finally back! Apologies for the prolonged blackout period. Both (!) members of SHM were busy cleaning up the mess after shorting VIX on the initial spike in early February (CNBC). It ain’t easy making financial decisions of historical stupidity, but someone’s gotta do it! Hopefully the SHM is not only poorer, but somewhat wiser. We will most definitely save our trade confirmations for one to reminder the other, should he get stuck by the lethal disease called overconfidence. For the reader who thought we were the most bearish people on the planet – apparently we’re not! Now, let’s get back to business.

Scenario analysis – where do we go from here?

This post concerns upcoming deliveries of newly built apartments following recent developments in the Swedish housing market, the main ones being lower prices and new rules for amortisation. It is highly topical given the unprecedented supply coming online following record high housing starts. We like to keep things simple, and will therefore consider just three scenarios (as seen from the eyes of a property developer).

– Best case: All buyers are willing and able to take delivery at the agreed price

– Base case: Some buyers are not willing or able to take delivery 

– Worst case: Few (if any) buyers are willing and/or able to take delivery

We will investigate each of these scenarios and how it might affect the economy in a broader sense. Of course, for all new housing developments the reality will much more nuanced– but for any given housing development the above scenarios will describe reality very well. The outcome in any given development will depend on various factors – timing, type of buyers, geography, price and, of course, pure chance. By studying the dynamics on the micro level we hope to provide some insight into the broader economy.

Background: During 2016 and 2017 building starts for multi-dwelling housing totalled about 100k, roughly half co-ops, the remainder rentals. Almost all of the co-ops are said to be sold. However, we know for a fact that some buyers, and also developers, may have issues fulfilling their part of the deal. The interested reader has surely noticed the recent press interest about sale agreements that may be declared void under certain conditions, the main one being contractual uncertainty in the delivery date. This has yet to be proven in court but, given the price declines, buyers should be inclined to investigate this possibility (SSM debacle). Given that production takes roughly 18 to 24 months from start, construction started in 2016/17 should be deliverable during the second half of 2018 and all of 2019.

Pre-sale agreements: If we assume that pre-sale agreements are signed 6 months before the start of construction it seems fair to assume that the buildings currently under construction have been booked or “sold” no earlier than the second half of 2015.

Impact on available cash flow

Let’s start with a quick look at the three factors that will impact the buyer’s available cash flow:

 – Equity: Given that prices have fallen back to levels not seen since the beginning or mid of 2016 (Valueguard), it seems reasonable to assume that many buyers (not buying for the first time) will extract less equity from their current housing than they thought they would (even if they assumed constant prices), most likely leading to a higher loan component than anticipated, i.e. a higher LTV. This will most likely lead to a higher interest rate expense. Perhaps, some early buyers will still have higher equity than planned (if the purchase was made in late 2015), but most of these should already have taken delivery.

 – Credit: The first amortization requirement was put in place in June 2016, and the second, just recently, in March 2018. Given these tighter credit conditions it seems reasonable to assume that some borrowers will face a higher monthly cash outflow. This arises both from a higher LTV (as per above) and the fact that they are more likely to face an amortization requirement now than pre-2016. Now, legally, new-builds are exempt from the amortization requirement, but we argue that banks are beginning to feel the pressure, especially about new-builds and are probably less likely to waive amortization now than before. Therefore, at the margin, we think it is fair to assume that some buyers will face a higher amortization expense.

 – Co-op fee: New co-ops in general have higher monthly fees than older properties, mostly due to a higher debt burden which, on average, accounts for ca 50% of the co-op fee (more on this in the report). Given this, we think it is fair to assume that, once again at the margin, buyers of new-builds will experience higher co-op fees in their new home compared to the former.

Scenario analysis

Best case: Let’s assume that all buyers are willing and able to take delivery of their new build at the agreed price. Given our reasoning above it seems unlikely that the free cash flow of the buyer will increase post acquisition. The buyer will wear the full loss on any decrease in property prices, and the developer will not realize any loss.

Base case: As prices have declined from the peak and, according to some sources, we are back at levels seen in the beginning of 2016 we argue that some buyers will be interested in re-negotiating the price rather than accepting delivery at what is now an off-market price. We think the response of developers will depend on vacancy rates in each project:

100% sold: No real incentive for the developer to lower the price as long as the majority of the buyers are able to take delivery. 

60-99% sold: Incentive for the developer to negotiate the price as this will improve the probability of getting the final objects sold and thereby walking away from the project with a smaller profit or, perhaps, a small loss.

Less than 60% sold: According to developers and banks this scenario is hypothetical as more than 60% needs to be sold before the bank grants constructions loans to the developer. However, we will investigate this in the worst case scenario below.

In the second scenario buyers and developers share the cost of the decrease in property prices without any material effects on society. Developers book smaller profits/losses and move on, with equity investors in the developers taking the largest hit. Buyers get a better deal than in the best case scenario.

Worst case: What if “sold” doesn’t mean sold at all? The purpose of the pre-sale agreement is for the buyer to secure his future home and for the developer to secure financing from the lender. The signing of this agreement is done well ahead of time, typically 2-2.5 years before the planned move-in date. According to some experts (SvD article) these agreements may not be legally binding. If true, it opens a loophole for buyers to renege on their part of the agreement. If the developer is unwilling to lower the price to current market price there is a large incentive for buyers to investigate the possibility of walking away from the agreement (SSM debacle).

According to some sources, speculative buying has amounted to roughly 20-30% of total demand. These are the players most incentivized to engage in a legal battle as they most likely do not have the will, or the means, to take delivery at a large loss. If this happens, it is reasonable to assume that there will be contagion through-out the co-op, as each member of the co-op becomes more exposed to the economics of the co-op as the number of members decrease. And, as we know from the report, the economics of a newly built co-op is not something that you want to be exposed to.

If the speculative buyers, let’s call it 30%, walk away from the agreement, the remaining 70% now have roughly twice the exposure to the co-op than they intended to. The developer most often underwrites the cost of empty apartments, but many developers will be forced sellers of these apartments given their limited equity and, often, expensive financing*. A forced seller is rarely good for prices, meaning that the remaining 70% will most likely see the value of their property decrease further, in turn increasing their incentives to walk away from the agreement. If we assume that, in the end, all buyers walk away from their part of the deal, leaving the developer holding a proverbial bag of shit™, the developer has the following choices:

– Convert co-ops into rentals: Only available to developers with strong balance sheets and a property management organisation, i.e. the likes of Wallenstam and, also, Tobin (following the entrance of Klövern as a major owner).

– Sell at any price: The developer needs to act quickly to find new buyers so that the co-op does not default. If it does, the bank lender takes over the property. In this case the developer will most likely realize a loss, the magnitude of which could be significant. Furthermore, it could trigger significant credit losses for the bank lender, in addition to impairing investors in property developers.

In this case, buyers manage to walk away more or less unscathed (apart from their initial “booking” fee) while developers default (wiping out both equity and possibly debt) with credit losses materializing at the bank lenders. In this scenario we envision a significant tightening in credit conditions for developers and home-buyers alike, further exacerbating the downturn in property prices.

To summarize: 

Best case: Buyers bear the brunt of the price decline with reduced free cash flow as the main effect. Consumption and savings is most likely to suffer from this down the line, with implications for the broader economy. Developers are as carefree as Oscar Engelbert (of Oscar Properties fame) in the beginning of 2017.

Base case: Buyers and developers share the losses without any material effects for the broader economy. Buyers will still experience a reduction in free cash flow, but not to the same extent as in the best case. Developers live to build another co-op. Lenders do not realize any credit losses. Hopefully all involved parties realize the gravity of this near-miss event and approach the next opportunity more cautiously.

Worst case: Buyers walk away (more or less) unscathed. Developers assume the full exposure of the co-op, often with inadequate balance sheets. Forced selling leads to lower prices and eventually to credit losses for bank lenders. The lower prices and credit losses in turn lead to tighter credit conditions for society as a whole, further exacerbating the move lower.

The outcome depends very much on the legal basis for the contracts at hand. It is our view that it would be prudent for the judicial system to take the strictest possible view on the binding nature of these contracts, in order to prevent the sort of sell-fulfilling sell-off we described in the worst case, with severely negative effects on the economy going forward. It seems to us preferable to have speculative buyers suffer losses for their foolish behaviour rather than having the whole market reach a standstill, with credit freezing and risk-appetite collapsing throughout the economy. Of course, even the best case is not risk-free – if speculative buyers are forced to realize their losses in a weak market the economy will suffer too. But at least the number of forced sellers in that case is potentially limited to the speculative population, rather than a larger group involving developers, bank lenders and others. Of course, economic concerns will most likely not dictate the independent judiciary system, so the outcome remains very uncertain.

Recent price declines and tighter credit has altered the budget, at the margin for the worse, for buyers taking delivery of a newly built apartment in 2018 and going forward. While the magnitude is unclear as it depends on the exact timing of the purchase, risk appetite of banks and other factors, it is obvious that buyers will be slightly less keen to take delivery at the pre-agreed price. This, together with concerns for validity of purchasing agreements that have emerged in the last months, represents a potential major source of supply emerging from the shadows and, in turn, a big driver for prices going forward. As always, we urge everyone to tread cautiously – caveat emptor!

*Last week Magnolia Bostad AB tapped their 10/2021 bond for 200mSEK to the tune of 9.5%. Go buy some Magnolia Bostad and pick that yield!!!

Predatory lending in Sweden?

The following post is an adapted excerpt of the chapter “Lending standards” in the Notes on the Swedish housing market – 29 dec

We explained how SBAB (the government bank) has been at the forefront of easy lending. This, coupled with an overly simplistic credit approval calculation (KALP), almost non-existing amortisation, no limits on duration (i.e. maturity, and fixed vs floating rate) and, last but not least, full recourse loans enforced by the notoriously efficient Kronofogden (Debt enforcement agency) has led to a situation where banks are willing to lend large quantities of money to more or less anyone with a job. Predatory lending? Maybe. Prudent lending? Certainly not.

As we argued in our previous post, the government has exerted some control of the “banking system-rents” through SBAB, the government bank. Since the beginning of the 2000s, SBAB has aimed to increase competition in the mortgage market by easing lending standards, which has mainly been done by allowing higher LTVs (from 70% to 95%) but also reducing the interest rate and allowing for the lowest rate to be applicable on the entire loan, i.e. no tranching of the collateral. This has forced the other banks to follow suit in order to not lose market share.

This led to a rather steep increase in average LTVs between 2002 to 2010, as can be seen in graph 5 below. To curb this alarming increase, Finansinspektion (FI, the Swedish FSA) introduced an LTV cap of 85% in the fall of 2010. Following this regulation, LTVs have been fairly stable around 70%. There is speculation that this regulation also led to an increase in unsecured consumer loans, with the proceeds used for down-payment in lieu of equity. However that is hard to verify as there is no data readily available. Unsecured loans have been growing steadily since 2002, but we couldn’t observe a meaningful change in the rate of change since the 2010 LTV cap (total unsecured loans: 2002: 92bn, 2010: 172bn, 2017: 231bn).

Needless to say, before FI introduced the (first) amortisation requirement in 2016, a large part of these loans were interest only. Why use your cash flow to amortise when you can use it to get a bigger loan? Property prices can only go up, right?


If banks allow up to 95% LTV, surely they must have a very prudent way of deciding who can borrow? Unfortunately, that’s not really how banks work. They’re not really in it for you and me – they are in it for the money. And how do you maximise profits in the mortgage lending business? The answer is simple, you maximise the amount that you lend and make sure to minimise defaults. 

Swedish banks lend money based on a calculation called “KALP”, an acronym for the Swedish words “Kvar att leva på” (or, what remains of income after basic expenses). The formula’s output is the net income remaining after a borrower has paid necessary living expenses, which should cover a stressed interest rate of, say, 7%. It’s up to the bank to decide the stress-rate (typically it is the five-year fixed rate plus 3%) and, also, which costs are considered necessities, as long as it meets the definition of minimum living expense as defined by the department of consumer protection. This credit approval calculation depends only on cash flow: there is no probability of the borrower losing employment, which is the main cause of default. By only stressing cash flows, the lender effectively assumes both a zero probability of default (PD) and loss-given-default (LGD), instead accounting for all risk in terms of interest rate sensitivity. First of all, interest rate volatility is a real risk for a floating-rate loan, with default being another important risk. Perhaps one can argue that they are conservative on interest-rate risk, providing margin-of-error for default risk. We beg to differ – both that they are conservative on interest rate risk and that, even if they were, it’s a sound approach. We know for a fact that interest rates have been higher over the past 30 years than the stress rate. Also, take the example of a company providing car insurance: just because the insurance company is conservative on the risk of a road accident doesn’t mean it can ignore the risk of theft.

In the current framework, more or less anyone with a job would be eligible for a loan, and yes, Figure B2 confirms this.

B2. Debt-to-income (y-axis) vs. Loan-to-value (x-axis) for new mortgages 2016.

Banks are willing to lend at almost any DTI/LTV combination (DTI here is measured by disposable income). One may wonder why the x-axis stops at 100% LTV – we would be curious to see the full picture…

Next question, what is most detrimental to the volume of mortgages? Amortisation. Yes, they are terrible for the bank as it leads to lower (net) interest income due to a smaller notional amount. Hence, banks were very keen to issue interest-only loans, until the nosy Finansinspektionen (FCA) ruined the party with an amortisation requirement in mid-2016. But even following its introduction the actual amortisations are very low from an international perspective (Fig. 18). The new amortisation requirement, due to become effective in the spring of 2018, will force highly indebted borrowers to amortise even more (the max is 3% compared to today’s max of 2%).

18. Amortisation as a share of loan amount (y-axis) for dirrent debt-to-income values. As we can see the trend is positive for highly leveraged households.

So, how come the banks are allowed to assume PD=LGD=0? In fact it does make some sense: Sweden has one of the most rigorous social security systems in the world and each citizen is identified by a personal ID-number, used by all government agencies and throughout the economy, for identity verification. This number allows for individuals to be tracked very efficiently throughout their life. For a full-recourse loan, where the individual is fully liable, it is crucial to keep track of the borrower. Kronofogden (the Swedish Debt Enforcement Agency) is notoriously effective in collecting debts: it can even collect money directly from the company paying the debtor’s salary, also enabled by the personal ID.

So how to escape the debt if you can’t pay? There are only really three choices:

  • Death – works as expected, i.e. all debts are written off. However, not being clairvoyant we can’t say whether this choice is feasible or not.
  • Run – preferably to a country without an extradition agreement. Forget any assets in Sweden, including your state pension, i. e. be prepared to emigrate in the proper meaning of the word.
  • Spend 5 years on minimum wage. Yep, only 5 years (!), and your debts will be gone!

Maybe death isn’t so bad after all.

To conclude, we have described a system where everyone (employed) can get a loan and, because of the PD=LGD=0 framework, banks are incentivised to maximise the loan amount and duration of the loan. Furthermore, the cash-flow stress metric (KALP) gives banks further leeway to do exactly this; they have some freedom choosing their own stress parameters and can ignore real (but perhaps small) risks of default. To us, it is obvious that this is not an environment conducive to prudent lending. And we suspect, strongly, that we will see many cases of predatory lending uncovered in the next couple of years. Of course, with full employment, interest rates at an all-time-low and permanently increasing house prices we have yet to see them. The recent amortisation requirements, although not necessarily perfect, certainly mitigate these risks in the future although we suspect they are too late for the existing stock of loans. 

Some thoughts on regulation

Some thoughts on regulation

First of all, we would like to notify our readers that we are now on twitter @swehousingmafia. As we still use fixed-line telephones to buy and sell securities, we expect it to take a while for us to get used to this modernity, but we will do our best! Now to our first-ever blog entry.

Having written “The Swedish Housing market notes” (Notes on the Swedish housing market – 29 dec) we thought we should use it to provide further analysis of policy and other issues, which might also provide the added benefit of summarising some of our ideas in a shorter (?) format. 

We claimed that the extreme rally in house prices can largely be explained by excessive propensity for consumers and banks to increase mortgage debt (beyond the optimum level in a free, unencumbered market), driven by policy errors such as poor regulation of mortgage underwriting, rent controls, tax code (deductibility of interest and capital gains deferral) and market intervention through the government mortgage bank SBAB. In addition, animal spirits such as greed, recency bias and myopia further amplify the effects. (We must provide a disclaimer by saying that we are not convinced that a fully unencumbered market is ideal either, mainly due to psychological weaknesses in market participants – but we must consider all effects to make the best choice.)

In this post we try to describe the source and interaction of such policy errors. To summarise, the argument goes roughly as follows: by capping rents to protect the lowest income households (and not adjusting for the true value of location etc.) the government limited supply of rentals; existing units were less likely to be let and there were no incentives to build new ones. As a result, supply couldn’t meet demand in the rental market at the given price. Instead, people were forced into “buying” properties. But, a lot of households cannot afford to buy a property, or pay off a normal fixed-term (say 30-year) mortgage, so the government had to allow for infinite (no amortisation) mortgages to accommodate those households; they are the ones that would prefer to rent but can’t due to the limited supply. In essence it created a parallel rental market, with the banking system as the landlord. Full recourse debt, shielding banks from credit losses, coupled with greed, myopia and other psychological biases work together with no strict regulation of mortgage underwriting (KALP) to provide leverage to just about anyone, mostly with ultra long-duration and floating-rate.

Of course, easy money and high risk appetite generally push asset prices higher, which increased profit margins for banks, both through increased mortgage balances and cheaper funding (by higher collateralisation levels on covered bonds and general risk appetite), and all participants get confirmation that leverage in the housing market is a profitable activity. This feedback loop keeps on going, until it stops. We suspect strongly that we are at that point. That was roughly that narrative of the report.

Our recommendations for policy can be distilled into the following points, which will be described in greater detail below:

– Market rents should be allowed for all rental properties, phased in over a long period of time

– The above needs to be accompanied by stricter amortisation requirements for mortgages

– Strict KALP (borrower stress test), with a stationary and consistent stress-rate across banks, accounting fully for co-op debt

– Introduce some degree non-recourse for mortgages (for example, on part of the loan)

– Standardized depreciation and amortisation for (both existing and newly built) co-ops 

Rent controls 

We explained briefly in the report that Sweden has a system where existing rental properties are tied to a rent-schedule which depends on “utility value”, a rather poor reflection of market value. In order to incentivize new construction of rental units the government has recently waived this criteria for 15-years, allowing for market rents for such units during this period.

By restricting both current supply and new construction of rentals through rent controls, the government has pushed some households into assuming more debt that they would otherwise take on in an unrestricted market. In essence, this policy has also made it more or less necessary to allow no (or low) amortization of mortgages because a lot of households which would otherwise rent are forced to “buy”. Of course, rational consumers would choose their optimal loan duration depending on their economic situation. However, we all know that rationality is a very unrealistic assumption and that preferences fluctuate wildly throughout the economic and debt cycles. In reality, given the natural upwards-sloping shape of the yield curve and the fact that leverage has been profitable, consumers have shown a strong preference for floating-rate debt, which generally has lower interest which enables greater leverage under the KALP-metric. Banks have typically not objected either as greater loan notionals typically mean greater profits. Therefore we have ended up in the rather bizarre situation where the banking system is the eternal landlord to a large part of the population, with a floating-rent contract.

By tweaking lending standards through the government bank SBAB politicians can exert some of control of these “banking system-rents”. Furthermore, tax deductibility of interest rates is another lever to control these rents. These policies, together with low interest rates following the financial crisis which brings down the cost of floating-rate mortgages, have turbo-charged the system with leverage, leaving little margin of error for consumers at the opposite end of the cycle. Needless to say, lowering the cost of housing is generally a popular strategy so it has been used by politicians irresponsibly. We all know that the economy rarely offers everyone a free lunch, although it might have seemed like it in the last 20 years or so.

As mortgage debt increases, dislocations start appearing and risks to consumers increase. The most obvious one is that debt is spread out across individuals who would rather prefer to rent their property rather than, say, a few property companies that provide rentals, who are generally more qualified to manage this debt.  

And, while an individual living in a rental can generally break the lease at short notice without severe consequences, we have seen that the strong loan recourse makes it almost impossible for an individual to break his “lease” with the bank. That is, if house prices drop meaningfully, and the individual is forced to move, he is on the hook for the loss. Nobody gets hurt as long as prices increase, but pricing driven by leverage cannot increase ad-infinitum – debt-to-income ratios are already elevated while taxes are closer to the lows than the highs. So, at some point, someone is bound to get hurt by this policy.

At that point, policy inhibits economic mobility and the speed of recovery in a crisis. In fact, one could argue that while the intention of controlling rents was noble, i.e. to benefit less fortunate groups, the effect has really been the opposite. Without a liquid market for rentals, which tenants can vacate easily, the government has forced consumers, generally not the most economically rational agents, into quasi-rental contracts which holds them hostage for life!

Hopefully, we will never see the worst-case scenario play out; one where a large part of the population is suffocated by debt, unable to escape the burden without living on minimum wage for five years. It is worth noting that the US housing crisis was solved rather quickly partly because there was no loan recourse (correction: in some states)! There, homeowners simply left their houses (and mortgages) to the banks (and the shadow banking) system, which took massive losses upfront, got recapitalised quickly, and then recovered within a few years. In contrast, the Swedish situation of sticky debt is much more likely to lead to prolonged asset deflation, similar to Japan. It is also worth noting that, in the current environment, the manoeuvre of lowering interest rates to bring down interest expenses for households is also limited because we are not far from the absolute lower bound (Riksbank repo rate at -0.5%).

So what to do? Most obviously, the cheap political trick of lowering housing costs needs to end, as the real cost is merely transformed into opaque risks which the average consumer is unable to manage. The process of enabling free rents for new-builds during a defined period is clearly a step in the right direction. However, the period needs to be extended towards infinity, and the existing stock also needs to be moved towards market-rents, else we get a two-tiered market. This would be hugely controversial politically due to the strength of rental-associations, and the long history of the system, but could be phased in over a period of, say, 50 years to ease the blow. The government should focus on the construction of affordable housing in order to help lower income households. Simultaneously, with the increased availability of rentals with market pricing the regulators need to alter mortgage regulations towards the international model of fixed-duration loans where buying a property actually means buying a property.

Of course, this is wishful thinking and we are merely describing the “ideal” for readers (and hopefully policymakers!) to understand the choice in the continuum of outcomes between the status quo and this ideal. And it also allows us to understand the regulatory choice in terms of two, closely related, paths to the end goal. A less restricted rental market is directly related to tighter restriction of mortgage duration (i.e. more amortization). As we are moving towards the first goal (by allowing market rates for new rentals in the first step) we also need to move towards the second goal (by enforcing stricter amortization requirements) in order to prevent dislocation.

Bank lending  

If we are to maintain floating rate mortgages with low amortisation, the latter closely tied to a liquid market for rentals as described above, we need to maintain a strict KALP-requirement with a constant stress rate across banks. Of course, for >50-year loans, the stress rate (i.e. the worst case interest) is unlikely to change much throughout time and should therefore never change (or, if anything, only upward). And it needs to be stipulated as a strict rule because otherwise a marginal player can always gain market share by lowering its stress rate, which is what has likely happened. Also, the KALP-calculation needs to include total co-op debt (both fixed and floating components).

This, once again, needs to apply equally to all lenders. The reason is quite simple: would you sign a 50-year full-recourse lease on a property, with a floating rent, without knowing the worst-case payment you would be liable to? Of course one shouldn’t, and one should ideally make sure that this worst-case gives ample room to cover living expenses. The KALP stress-rate can be lowered with increased amortisation as the de-facto risk goes down with loan duration. More simply, the faster the loan is paid back, the lower the “weighted” loan balance throughout a full interest rate cycle. Regulation should take this into account, but we skip the details of such a calculation.

A well-known issue with banks is that they are prone to myopia; letting short term incentives (such as quarterly earnings, annual bonuses, market share etc.) get in the way of a longer term evaluation of profitability and risks. And, even when the bankers are well-incentivised the evaluation of risk is usually based on some historical measure of risk which, often, especially at the end of a multi-decade bull market, does not capture the full distribution of outcomes, and therefore frequently underestimates risk (we are of the opinion that it is very hard to over-estimate). As a result, a wide range of regulations have been designed to manage the banking system, such as Basel. While we think regulation generally moves in the right direction on a global basis, we think regulations specific to the Swedish housing market needs to be developed with this in mind. That’s why we think general recommendations such as the current KALP, where the stress-rate is not set in stone and co-op debt is not necessarily accounted for, are prone to fail. 

Another important defect in the Swedish system, which we have reiterated many times, is that banks have full recourse on mortgages, ie. the can pursue the individual borrower for as long as necessary. This means that their (perceived and actual) credit risk is rather low, which brings down their funding cost and increases their risk appetite. Imagine what happens in a negative scenario where asset inflation reverses and a large part of the population get stuck in negative equity (i.e. owe the bank money they don’t have). We believe the most likely (and humane) solution is that the government will be forced to take these loans from the banks, restructure them (or write them off) in order to prevent a large part of the population from becoming debt-zombies. By this train of thought, the economic cost of this full recourse is likely implicitly underwritten by society, and is therefore an implicit subsidy to banks. We believe that, for interests to be aligned, the cost should be borne by the beneficiary, i.e. the banks, and that the easiest way is for (part of) mortgages to have recourse only on the property. It is up to politicians to determine the probability of bailing-out of such loans in case we end up in that situation, and adjust the proportion of recourse accordingly. We suspect it should be in the 10-50% range.

Newly built co-ops 

New co-ops has become a vehicle for real estate developers to extract excessive profits by hiding the true cost from consumers in the form of co-op debt. Some banks don’t account for this debt properly, and education among home buyers is insufficient to guarantee informed choices. Therefore, the price tag needs to clearly specify the total price (including co-op debt), as suggested by government report on the subject that we mentioned in our paper. Furthermore, co-ops should be required to publish an income statement, using standardised depreciation and amortisation periods, and not just a cash flow statement. To be clear, this should apply to existing cooperatives as well. This would enable the tenant to see the actual economic cost of their tenancy, making it easier for them to see what level of “co-op equity” they are buying into. That is, they can make a more informed decision with respect to the expected level of future investments required for the building to function as a going concern. This will also mitigate the conflict of interest between the developer and the financial planner in new co-ops. We keep this section brief as it seems that the regulator is already aware of these issues, as mentioned in our report, and changes seem to be on the way.

Unfortunately, we haven’t spent much time researching construction regulation or zoning laws, so we will refrain from commenting on those in any depth. It seems like limits on construction did constrain supply further for a long period, but this imbalance seems now to have been reduced. We will simply note that this is obviously important for the supply side of a functioning market, but doesn’t strike us as the main obstacle to equilibrium in the rental market; price controls being much more important in our (perhaps uninformed) view.


P.S. We very much welcome feedback, especially of the negative kind. We are always trying to improve our understanding of the world and, as such, need to remind our readers that our ideas are definitely not laws of nature, but rather work in progress based on our research thus far. Also, this list of policy recommendations is by no means complete, but are the most obvious ones from the perspective of our report D.S.

The Swedish Housing market notes

Allow us to introduce ourselves. We are RP and JN, collectively the Swedish Housing Mafia. We have been following this market closely for a long period and have accumulated a fair amount of information and data that we felt compelled to share with the world. When we are not researching macro economic issues (or going to fitness classes) one of us spends his time in the investment banking division of a large Scandinavian bank, while the other replaced investment banking for life as an investor at a global hedge fund.

SHM have spent the past few months researching and writing the document “Notes on the Swedish Housing Market” which has gone out by e-mail to select readers for feedback-gathering purposes. This WordPress site is mainly for users to keep track of the latest version of the document, share their views, provide feedback and, perhaps, post the occasional original article by the authors.

We have recently (Dec 29th) changed the title from earlier versions into “Notes on the Swedish housing market” (from “.. Housing market primer”) in order to reflect the fact that it contains some speculative ideas, and is not merely an academic introduction to the subject.

Notes on the Swedish housing market – 29 dec

Feedback is highly appreciated and will be incorporated to the best of our abilities (remember we have jobs, too!).

Finally, we would like to wish our readers many positive higher-order effects in 2018!

/RP & JN