Irish new mortgage lending rises by 29% in 2017 but affordability is deteriorating

Irish mortgage providers lent €6.4bn for house purchase in 2017, the strongest figure since 2008, with top-ups and re-mortgaging bringing the total to €7.3bn, a 29% increase on the previous year The final quarter was particularly strong, when adjusted for the usual seasonal effects , and we expect further growth in 2018, although affordability is deteriorating and the Central Bank’s modifications to its mortgage controls will no doubt have some impact on First Time Buyers , as Loan to Income is the main constraint for that segment of the market. Indeed, there was a notable slowdown in approvals in the last few months of the year, perhaps indicating that lenders are already adjusting to the rule changes.

Drawdowns were very strong in the final quarter, nonetheless, with over 8,700 mortgages for house purchase including over 5,000 to FTB’s, some 60% of the total. For 2017 as a whole 29,400 mortgages for house purchase were drawn down, still a far cry from the boom figures in excess of 100,000 but significanttly above the low recorded in 2011 (11,000) and 18% above the total in 2016. The value of lending for house purchase implies an average mortgage of over €217,000, against €200,000 in 2016, and a cycle low of €174,000 five years ago.

Interest rates on new loan have not materially changed over that period and household incomes have risen but the increase in mortgage size is such that affordability, the ability to service a mortgage, has deteriorated. Our own model compares  the annual cost of a new , 25-year repayment mortgage to our estimate of gross  borrower income, and shows that the ratio rose to 30% in 2017, the highest since 2009 and above the long run average (back to 1975)  of  29.5. The ratio is still well below the heights recorded at the peak of the boom ( over 40%) but our forecast is for a further deterioration in 2018, to 31.2 , and this assumes no change in interst rates, so any rise in the latter  would indicate a greater deterioration.

At the moment a rate rise looks unlikely until 2019, at least, and the affordability change expected does not look material enough to have a significant impact on lending, given the prospect of further gains in employment, an acceleration in wage inflation and stronger house completions. Against that, the Central Bank’s changes to mortgage controls are undoubtedly a policy tightening, in our view, although not  sufficient to prevent further growth in new lending, and we anticipate a figure around €9bn in 2018. Net lending has also started to grow in recent months, so the coming year will probably see the first rise in Irish mortgage debt in a decade.

 

 

State’s strange move into higher risk, high leverage mortgage lending

First Time buyers accounted for 11,896 transactions in the Irish housing market in the first eleven months of 2017, which is 1700 up on the same period in 2016 but still only around 20% of total turnover. The Government has sought to support that segment of demand via a tax rebate to help those seeking to buy or build a new home (the Help to Buy scheme) and has just announced a fresh initiative, this time in the form of State mortgage lending ( Rebuilding Ireland Home Loan) , although the scheme has a number of odd features and appears a strange step to take.

To qualify, would-be borrowers have to have been rejected by at least two lenders, which immediately implies that the State would be taking on if not sub-prime then certainly higher risk loans. The lending decision will be taken by local authorities, so someone in those authorities will be making credit risk decisions, raising the issue of the criteria that will be used to decide which applicant is successful.

Third, the State is driving a coach and horses through the Central Bank’s mortgage controls and one wonders what the Bank makes of it and whether it was consulted. Lending institutions are required to limit mortgage loans to  a maximum of 3.5 times  the borrowers income , with 20% of lending to FTB’s  per annum allowed above that. The  specific limit  for FTB’s has just been introduced and represents a de facto tightening of standards, as 24% of lending to that segment exceeded the limit in the first half of 2017. Yet the State scheme allows a LTI range from 3.8 to 5.0, which is much higher leverage than deemed acceptable  to private lenders, and therefore higher risk.

The scheme does have a loan to value limit ( 90%) and a maximum property price, so putting a cap  on a given loan, although it does differentiate by location; properties in the major cities and in the counties surrounding Dublin carry a  maximum loan of €288,000 as against €225,000 elsewhere. Over 60% of transactions are in the former areas so the €200m allocated implies that less than 800 loans could be granted in 2018. Total mortgage lending for house purchase this year is likely to be around €8.5bn so the scheme is not material in terms of the overall market.

Finally, we have the issue of funding costs. Successful borrowers will have three options, two fixed rates and one floating, all well below current market rates. For example, a 25-year mortgage would cost 2% fixed, and a fixed rate for that term is not available from Irish banks- in general, banks can’t borrow at that maturity, so 3-5 year fixed  is the most common (although some 10-year is now available). The State can and has borrowed for 25 years and longer, with a bond maturing in 2045 trading at around 1.8%, implying a very small margin if that was tapped to fund this initiative.

Successful borrowers will be getting a cheap loan with the State taking on a level of risk that the private sector is unwilling to bear, at least at that cost, and indeed  what the Central Bank is also unwilling for borrowers or lenders to countenance.

Irish Central Bank tightens mortgage controls

The Central Bank introduced macroprudential controls on Irish mortgage lending in early 2015 with a focus on Loan to Value (LTV) and Loan to Income (LTI). The controls are subject to annual review and were initially amended  in January 2017 with  another set of ‘refinements’ just announced , to take effect from 2018.The latter includes quite a significant modification to the way the LTI control operates and in our view represents a tightening of credit controls, although one does not get that impression from the Central Bank release.

Currently, 20% of Principal Dwelling House (PDH) lending can exceed the 3.5 LTI limit. Data released by the Central Bank  shows that  PDH lending for the first half of 2017 amounted to €2,770m and that €487m exceeded the limit, or 17.6%, indicating that the limit is being observed, at least for that six month period  (  it  actually applies over a  full year).  Yet the data reveals a marked divergence between FTB’s and other buyers; over 24% of lending to the former was in excess of the 3.5 LTI limit, while for the latter the figure was only 10%.

Clearly the LTI limit is a much bigger issue for FTB’s in an environment of scarce  supply, strong house price inflation and where around half of house sales are going to non-mortgage buyers . As the controls currently stand there is no specific constraint on the amount of  FTB lending in excess of the LTI limit , as long as the overall lending figure is within the 20% exemption.

The Central Bank has responded by amending the LTI exemption. From January the overall 20% limit no longer operates, with  a 20% exemption  limit allocated to FTB lending and 10% to other lending. Had these applied over the first half of the year FTB lending would have been €61bn lower, with no material impact on other lending.

Just over half of PDH lending is currently to FTB’s so the implication is that there is now a 15% overall exemption limit in practice, given a 20% allocation to FTB’s and only 10% to other buyers. The Central Bank argues that FTB lending is less risky than to second or subsequent buyers ( although credit agancies seem to have a different view) , so justifying differential LTV’s and now LTI exemptions, but the changes would appear to mask an effective tightening in overall lending standards. The Bank notes that ‘the refinement is not expected to have a significant impact on the functioning of the market’  but it clearly will limit overall exemptions relative to the  current postion.

QE is fuelling Irish House Prices

Irish residential property prices have risen 60% since the lows of early 2013 but  this cycle is investor rather than credit driven. Gross mortgage lending for house purchase has picked but the average new loan has risen by just 28% over the past four years, implying a fall the average loan to value ratio, while data on transactions (recently revised up by the CSO) indicates that mortgage loans  still appear to be accounting for less than half of turnover in the market. New lending is also now constrained by the Central Bank’s mortgage controls.Moreover, net mortgage lending ( i.e new lending minus repayments) has been falling now for over seven years, although there are recent signs that it may finally be bottoming out.

Nothing here then to indicate that credit is playing a strong role in driving prices and it is curious that little attention has been paid to the impact of the ECB’s monetary policy  on the housing market, and, more specifically, its  non-standard measures including the asset purchase programme. The latter, QE, is designed to boost bond prices and hence lower yields so that ‘ investors may choose to take the funds they receive in exchange for assets sold to the ECB and invest them in other assets. By increasing demand for assets more broadly, this mechanism … pushes prices up and yields down, even for assets that are not directly targeted by the APP’.

QE is generally perceived as having a significant impact on equity markets and it would be odd if it did not therefore impact other  asset markets, including property, and we  can readily  see this at play in the Irish data on transactions. In 2011, investors (here defined as Buy to Let individuals  plus non-household buyers) accounted for 16% of residential transactions rising to 24% by 2012 and averaging a third of the market or more since 2014.

The yield on ‘risk-free’ assets , such as Government bonds, plays a big role in investment decisions and so the plunge in Irish Bond yields has been  a very significant backdrop for the Irish residential and indeed commercial property market : 10-year Irish yields peaked at double digit rates in mid 2011 but really started to fall sharply following Draghi’s ‘whatever it takes’ speech in 2012, and fell below 1% , where they still reside, following the commencement of QE in early 2015.

In contrast, the gross yield on residential property ( average rent/ house price) has not declined significantly in our rental model, and is still at 4.8%, having peaked at 5.4% in 2013. The rental yield fell to  a low of 2.75% during the last cycle, and is still well above the post EMU average (4.25%) and of course extraordinarily high relative to the ‘risk free’ rate available on Irish bonds, let alone Bunds.

The scale of investor interest in Irish property is therefore not surprising given the yield on offer and  is unlikely to disappear any time soon. Higher bond yields would make a difference, no doubt, and in that context the future of QE plays a part; the ECB will soon decide whether to scale back its asset purchases or indeed cease any additional buying. Yet it is likely to reinvest the proceeds of maturing bonds for a while at least, therefore maintaining the stock of QE, so absent an inflation shock bond yields may well stay low by historical standards. If so investor interest in Irish property will continue to be a big driver of the market.

Irish Mortgage Lending crimped by supply and competition from non-debt buyers.

The latest data from the BPFI on  Irish new mortgage lending shows that 6,781 loans  for house purchase were drawn down in the second quarter, with the annual increase at 17.6%, providing further evidence that the year as a whole is likely to see a substantial increase on the 2016 total of some 25,000. Yet the annual pace is slowing, following a 26% increase in q1, and on our seasonally adjusted model  lending actually fell on the quarter. What is more striking though is the unusually large divergence between mortgage approvals and actual drawdowns ; approvals for house purchase in the second quarter amounted to 10,250. Looking at the picture over the first six months, approvals stood at 18,576 against a drawdown total of 12,634 , which is a wide gap even allowing for the usual lags between approval and purchase.

Buyers with approval may delay purchase if they are nervous about the market but survey’s suggest that price expectations have risen of late so that would normally bring forward the timing of transactions. The alternative explanation is that buyers with approval are being squeezed by the limited supply of property for sale and the prevalence of would-be purchasers not reliant on debt finance. The ECB’s QE is compressing yields on financial assets, making residential property a more attractive alternative. Judging by the CSO figures on transactions (executions) in the first quarter, mortgage loans are still  only accounting for around 50% of the total ( the q2  transaction data have  yet to be published).

The BPFI data also reveals that the average mortgage for house purchase is now just under €214,000. 8.1% above the previous year and at levels last seen in early 2010. In cash terms mortgage lending for house purchase  in the quarter amounted to €1.45bn and overall lending rose to €1.65bn when top-ups and re-mortgaging is included, bringing the total for the half-year to some €3bn. Our forecast for the full year is currently €7.2bn but we are likely to revise that down, given the  slowing momentum in the numbers drawdown.

Nonetheless, new mortgage lending is growing and it now appears is finally close to offsetting repayments, with the latest Central Bank data on net lending showing  that the  monthly decline in that series is now extremely small. Irish household deleveraging started  in mid-2008 and one doubts if few or any thought it would last this long.

New Mortgage lending stabilising after Central Bank controls

Mortgage lending is generally driven on the demand side by demographics, household income, mortgage rates and expectations about house prices, which implies that demand in Ireland should be growing strongly given that all these factors are supportive.  On the supply side, the number of institutions able and willing to supply  housing loans  in Ireland has fallen, but the remaining players are in much better shape than they were , and keen to offset debt repayment, which is putting ongoing downward pressure on their assets. So we have a ‘mortgage war’ of sorts, with strong competition among a  limited number of players.

The number of new loans for house purchase did rise strongly in 2014, albeit from very low levels, increasing by 50%, to just over 20,000. The BPFI has revised the 2015 data down but the year still saw another strong rise, to 23,664 , although there was a significant slowdown in the second half, culminating in a year over year fall in the final quarter. That change in trend presumably reflected the Central bank’s new controls on Loan to Value and Loan to Income, introduced in late January of that year, and the first quarter of 2016 saw a much sharper annual decline, of 9.4%. The approvals data then pointed to some recovery in the second quarter and the number of drawdowns for house purchase did indeed pick up on an annual basis, by 6%  to 5767, albeit flattered by the downward revision to 2015. However, the total for the first half of 2016, at 10,401,is still slightly down on the same period of 2015 (10,550) although indicating some stabilization. The lending data is seasonal so comparisons with the previous quarter are not that meaningful; indeed, on our seasonally adjusted model lending in q2 was actually weaker than in the first quarter.

One unusual feature of  mortgage lending in recent years is that it appears to account for only around 50% of housing transactions, and the available data shows that still to be the case in 2016. According to the Property Price Register there were  over 20,800 residential transactions to end-June, which given the mortgage figure of 10,401 still implies  only a 50% share for transactions funded by domestic mortgage providers.

The value of new lending  for house purchase showed much stronger growth in q2 ( 14%) and at €2.bn  for the half-year is actually slightly ahead of the same period in 2015. Even at a constant Loan to Value the average loan will rise in an environment of rising house prices and the second quarter saw the average new mortgage for house purchase rise by 7.7% to just under €198,000 , the highest figure in five years. Other forms of mortgage lending (top-ups and re-mortgaging) are growing again, with the result that the value of total mortgage lending rose by 18% in q2, and amounted to €2.3bn for the first half of the year. For 2016 as a whole we expect the latter to emerge at €5.2bn or some €400mn ahead of 2015, and the figure for house purchase at €4.7bn, with broadly flat numbers for house purchase offset by a rise in the average mortgage.

Dublin property prices fall amid general market slowdown

The Irish housing market has slowed in recent months on a variety of metrics, including turnover, mortgage lending and prices. Research published by the Central Bank indicated that its mortgage controls, introduced in early 2015, would likely depress lending and dampen prices, albeit modestly in the latter case, and the evidence of late would indicate that the measures are indeed biting. The Dublin market has been most affected, with prices falling in four consecutive months, by a cumulative 3%, although the annual change is still positive, at 4%.

Turnover in the Irish market as a whole, as measured by the Property Price Register, picked up sharply in 2014,  with  the number of transactions rising to over 43,000 , and last year saw a further increase, to over 48,000. That masked a pronounced change in trend , however, with the final quarter witnessing a 12.7%  annual decline. In December alone transactions were some 27% below the same month a year earlier, and the available figures for January show a 24% annual fall. That figure is likely to improve somewhat as more January sales are added but the general picture is unlikely to be materially altered.

Credit has not played a defining role  in  the housing  market over the past few years ( mortgage drawdowns accounted for 47% of transactions in 2014 and 50% last year) but a significant change in lending would obviously have some impact. The number of mortgage loans for house purchase rose by 20% last year, to over 24,000, but again the later part of the year saw a marked slowdown, with the final quarter recording an annual decline. That fall was very modest but data on approvals points to a much sharper decline in the months ahead; approvals for house purchase fell by an annual 20% in the final quarter of 2015 and the data for January shows a similar pace of change.

House prices are still rising on an annual basis, but the more recent data points to a slowdown, and not just in Dublin. Prices excluding the capital rose very strongly in the latter part of 2015, by 4.8% in q3 and 3.6% in q4, perhaps indicating a switch  by prospective buyers from Dublin to outlying counties, but prices rose by just 0.2% in the first two months of 2016. Nevertheless, the gap between prices in the capital and the rest of the country is continuing to narrow; on our estimate, Dublin prices exceeded those elsewhere by over 70% in late 2014 but that premium has now fallen to 55%, which is still above the long term average (48%) but  converging.

The Central Bank may well welcome the slowdown in house price inflation but it might be concerned if  mortgage lending did indeed fall sharply, particularly as the ECB is now offering euro zone banks money at zero or even negative rates, so desperate has it become to generate credit growth.

Irish mortgage controls having big impact on credit and Dublin prices

The Irish Central bank introduced controls on mortgage lending a year ago, including an 80% loan to  value limit on most owner-occupied properties , alongside a 3.5 loan to income ceiling. First Time buyers can borrow up to 90% loan to value for a property below €220k, which implied that the partial exemption would only be relevant outside the Capital; prices in Dublin probably average around €300k, against €175k across the rest of the country. The Bank’s own research suggested the controls would dampen credit growth and reduce housing supply, with a limited impact on prices. There is undoubtedly a case for such controls, particularly in an era of historically low  interest rates, but the timing appeared questionable given that credit has been contracting in Ireland since early 2010, with any new lending more than  offset by repayments.

The latest data, just published, indicates that the controls are having a pronounced affect on  new lending and are impacting house prices. Mortgage approvals for house purchase had been rising strongly (by an annual 40% in q1 2015 for example), albeit from a very low base, but that growth has stopped and approvals are now falling sharply; the annual decline in the final quarter was 20.3%, with December alone showing a 23.7% fall. There is not a consistent relationship between approvals and drawdowns but the trend in the former implies around 6,000 loans for  house purchase  in q4 against over 6,900 a year earlier.

One would expect the controls to bite harder in Dublin than elsewhere and the December data on residential property prices supports that view. Prices in the Capital , having risen by over 22% through 2014, fell in the first quarter of 2015 before regaining some momentum over the summer months and then fell again in the final quarter, by 0.7%, leaving the annual increase in December at just 2.6%. Prices ex-Dublin also fell marginally in the first quarter, implying an expectation  effect from the controls, but  picked up strong momentum in the latter months of the year. Indeed, the 5.8% rise in the three months to October was the strongest recorded by the CSO index, which starts in 2005, and other evidence shows that one has to go back to the late 1990’s for comparable gains. The pace of growth has slowed a little, with prices rising by  3.6% over the final three months of the year, leaving the annual increase in December at 10.2%, the same as in 2014. Some slowdown in Dublin prices was no doubt inevitable but the contrast between the Capital and elsewhere is striking, indicating that  would-be buyers in Dublin may be looking further afield.

The Central Bank has indicated that it will assess the impact of the controls in mid-2016 although the pace of contraction in new lending may prompt a speedier review, as one doubts it was anticipated.

Mortgage market sags and Dublin price inflation slows

It is now nine months since the Central Bank introduced limits on mortgage lending, designed to prevent the re-emergence of another housing bubble. Controls on Loan to Value and Loan to Income ratios make sense , in our view, but not in an environment where net mortgage lending has been contracting for over six years and where the supply of new housing is running far below estimates of medium term demand. The Bank’s research on the topic concluded that the policy would dampen credit growth , have a limited impact on prices and a negative effect on housing supply and that indeed appears to be the case. An unintended consequence is that the pressure on rented accommodation has grown, pushing private sector rents  to an all -time high. It would be foolish to blame the Central Bank for  all the rental growth  but if there is excess demand for housing it will emerge in either house prices or rents  and measures to put a lid on the former will merely spill over to  the latter.

According to the CSO, residential rents rose by an annual 10.3% in the third quarter and the increase in the three months to September was 3.2% so pressure is clearly upwards. The CSO figure is national  and the data on  Daft.ie, which broadly tracks  that of the CSO, shows that rents are rising faster in the Capital, with a 10% annual increase in Dublin City in q2, against an 8.6% figure nationally.

Calls for rent controls in Dublin have been heard (and indeed are not uncommon in cities elsewhere, including New York) but that would be equivalent to dealing with the symptom rather than the underlying cause. The demand for housing is growing, reflecting rising employment, a resumption of growth in disposable incomes, and a sharp fall in net emigration(in fact migration may be turning positive again) with an annual requirement of some 25k seen as a reasonable estimate, including up to 8k in the Capital. On the supply side the collapse in completions bottomed out in 2013, at 8.3k and 2014 saw a pick up, to 11k. Over the first nine months of this year the national figure was 8.9k, including just over 2k in Dublin (city and county) , consistent in our view with an annual total of around 3.2k in Dublin and under 13k for the whole country.

The low base of completions means that modest absolute levels of house building still translate into impressive percentage gains and that is the case with  gross mortgage lending for house purchase, with the number of loans rising by 50% last year. The pace of growth has slowed this year, to 29% in the second quarter, following a tightening of credit standards, and the latest approvals data shows a very rapid change in trend; approvals in the three months to August  were just  1.1% above the same period in 2014 while the figure for August alone was  4% down on the previous year. The average new mortgage , at €191k, is also virtually unchanged on a year earlier and our earlier estimate of 23k new mortgage loans in 2015  and lending of €4.3bn may be too high.

One would expect the Central Bank’s controls to have a bigger impact  on credit and  house prices in Dublin  than elsewhere, given the large price differential in favour of the capital. That does seem to the case; Dublin prices rose by over 22% last year, more than double the pace in the rest of the country, but this year has seen a marked deceleration, with the annual increase slowing to 6.5% in September, the weakest pace  in over two years. In contrast, house price inflation ex Dublin has picked up , rising to  11.4% on the CSO figures.

The Central Bank has therefore precipitated a slowdown in mortgage lending and  helped to dampen house price inflation in the Capital but given the rate of house completion there is little prospect of a change in the trend for residential rents, absent a severe demand shock to employment.

Irish Mortgage Regulations impacting housing market

In late January the Irish Central Bank announced a set of macro-prudential controls on mortgage lending, Similar regulations have been introduced elsewhere, in line with the new orthodoxy in central banking, which  seeks measures to influence credit growth outside the traditional interest rate channel, particularly as rates are currently at historically low levels. The Irish version imposed a loan to value limit of 3.5 on Personal Dwelling Home (PDH) mortgages, but in the current Irish context the  second limit, on Loan to Value (LTV) was seen as a more binding constraint. A  maximum LTV of 80% is now in operation on PDH  mortgage loans, with first time buyers allowed 90% on properties up to €220k. Banks are allowed some discretion , but it is limited in that only 15% of loans can exceed these LTV ceilings.

Contrary to some commentary (and expectation), the controls were not seen as having a material impact on prices, and the Central Bank’s research showed that the  main effects would be on mortgage lending and the supply of new housing. Of course the controls would be pointless absent some effect on credit creation and in the Bank’s base case lending falls by 9% on the introduction of the new regulations and subsequently recovers some ground, although remaining below the benchmark case ( i.e. absent any controls) for over seven years.  In simple terms the new rules will require prospective buyers to save for longer, which also implies greater pressure on the rental market for any given level of housing demand.

Six months in, there is some evidence that the measures are having an impact across the housing market. Mortgage credit standards tightened appreciably in the first quarter and the latest Central Bank data shows that mortgage demand eased considerably in q2, from very buoyant levels over the past year.  That change is also evident in terms of mortgage approvals, with the annual increase slowing sharply in the three months to May, to 17%, from 41% in q1 and 56% in the final quarter of 2014 ( the latter  was probably affected by expectations ). Indeed, the annual rise in approvals in May alone was less than 8% and our own  mortgage models points to drawdowns for house purchase of 5.2k in q2, unchanged from the previous quarter.  New mortgage lending is still growing strongly on an annual basis but at a much slower pace.

Turnover in the housing market , which picked up very sharply in 2014, also appears to be slowing, based on data from the Property Price Register. Transactions amounted to 10.5k in the first quarter of 2015 and  also exceeded  10k in q2, but the annual rate of growth slowed to 13% from over 55%. The June figure was actually 7% down on the previous year and although late additions to the  Register are common the broad picture is unlikely to be seriously altered.

What about prices?  An unusual feature of the current upturn in residential values is the relatively high share of transactions (over 50%) driven by cash and so it would be surprising if the mortgage controls did have a very significant impact in that area. Dublin prices did fall in the first three months of the year, by 1.6%, but rose by 2% in q2, with a similar pattern evident in the rest of the country (a 2% rise following a 0.3% fall). The market has certainly cooled relative to the first half of 2014, but smaller price gains rather than outright falls appears to be the order of the day.

What about private sector rents?  Here, data from the CSO does point to an acceleration in what was already a buoyant market; rents rose by 1.7% in the three months to December but then picked up by 3% in the first quarter of 2015, followed by a 2.4% advance in q2. That means rents nationally are only 2% below the all-time highs recorded in 2008 and are therefore likely to surpass that figure by the final quarter of 2015.  As for housing supply it is too early to tell. although with only 2,600 completions in q1 the base figure is already very low by historical standards.

The central bank model predictions are therefore panning out in broad terms; mortgage demand has slowed, approvals have eased and transactions have  been affected , although  the impact on prices has not been dramatic.  In addition, the  upward trend in rents shows no signs of abating and that  perhaps  best illustrates  the real issue in the market- the shortage  of housing supply in the areas people want to live.