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.

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.

Bit early to blame Central Bank for house price fall

The CSO’s  residential property index   for February showed a fall in Dublin prices for the second month in a row, the 0.7% decline bringing the fall over three months to 2.4%. This still left the annual rise at over 21% but the market in the capital has clearly lost some momentum over recent months and some have claimed that the Central Bank’s new macro-prudential controls on mortgage lending are responsible. Prices excluding Dublin were flat in February but also fell on a three month basis, albeit by only 0.3%, so adding to the perception that there is a common factor at work across the country.

The evidence is not persuasive, however, at least not yet. The rules only came into operation in late January , for a start, and there does not appear to have been a significant shift in the recent pattern of mortgage approvals ahead of the decision. Mortgage approvals in the three months to January rose by an annual 55,5%, and as such not materially different from the 56.5% in the three months to December. Housing transactions in January were actually very strong, according to the Property Price Register(PPR), rising by an annual 68% . The available February data does show a marked deceleration in the pace of annual growth in transactions, to 35%, but that figure may be quite different when all the filings are included, which does take time.

The Central Bank’s own research (1) also suggests that the mortgage limits on Loan to Value and Loan to Income will have little impact on prices but a more significant  effect on mortgage lending and on the supply of housing, which they suggest will be some 2-3% lower per annum for a number of years ,resulting in a loss of some  2000  units  after 4 years relative  to an unchanged policy forecast. That  reduction in supply will put upward pressure on prices , so dampening any downward effect from tighter credit standards.

Any such simulation depends on the housing model used of course, and the ESRI (2) has just come out with some findings of its own. These also point to a significant effect from the new mortgage rules on house completions, with a supply fall of some 4%-5%, although they predict a larger effect than the Central Bank on prices, albeit  still a modest 4%-5%.

Another problem inherent in linking recent price trends in residential property to the Central Bank regulations is that not all housing is behaving the same way. Apartment prices nationally rose by 1.9% in February and by 2.5% on a three-month basis. Apartments in the capital also rose strongly on the month, by 2%, and by 1.8% over three months. The price series on apartments is extremely volatile but apartment prices in Dublin have now risen faster than houses over the past year (by 24.5% versus 21.1%).

Perhaps a better explanation for the most recent slowdown in house prices is simply that a market which appears to be primarily  driven by cash buyers is likely to lose momentum. That’s not to suggest that prices are likely to fall sharply but that annual house price growth in excess of 20% is unlikely to be repeated for long in the absence of excessive credit growth. New mortgage lending is picking up , and showing very strong percentage growth given the low base, but it is still accounting for less than 50% of housing transactions. Indeed, the latest PPR figures show transactions of over 15,600 in the final quarter of 2014, with the number of new mortgages drawn down for house purchase amounting to less than 7,000 , or 44% of the total.

(1) ‘Assessing the Impact of macro-prudential measures’ Central Bank of Ireland, Economic Letters , Vol. 2015, No.3

(2) ‘Quarterly Economic Commentary’, Spring 2015, ESRI

Odd Timing for Proposed Irish Mortage Restrictions

Interest rates are extraordinarily low in many parts of the world; the ECB refinancing rate is 0.05%, in the US the equivalent is less than 0.25% and in the UK the Bank rate is 0.5%.Rates are expected to rise next year in both the UK and the US but the respective central banks have made it clear that any increases are likely to be moderate and that  the cost of borrowing may well settle at levels below previous cyclical highs. In the euro area the economic  outlook is bleaker and most observers expect rates to remain at current levels for a number of years. This low-rate environment carries potential risks for asset bubbles and excessive credit growth so central banks have embraced the idea of macro-prudential tools i.e. measures that can be implemented to protect against systemic financial instability. The housing market is often seen as a specific stability risk and a number of countries have introduced restrictions on mortgage lending, the latest being the UK, where only 15% of new mortgages can be above a Loan to Income (LTI) ratio of 4.5.

The Irish Central bank has now entered  macro-prudential territory with proposals on mortgage lending designed to ‘increase the resilience of the banking and household sectors to financial shocks’ .Like the Bank of England there is a restriction relating to LTI, but in the Irish case the limit is lower , at 3,5, although 20% of lending can be above that limit. In addition, the Bank is also proposing restrictions in terms of loan to value (LTV ) with only 15% of lending allowed above an LTV of 80%. For Buy -to Let loans the LTV limit is 70% with only 10% of lending above that. The LTI restrictions only apply to principal dwelling homes (PDH).

The Bank refers to international evidence supporting the view that LTI restrictions can slow mortgage lending growth and ‘reduce the potential for a housing bubble to emerge‘ although the impact on house prices is less clear, with the Bank of England claiming that there is ‘some evidence of a modest and lagged effect on house price growth’. The latter conclusion is not surprising as credit is only one variable in most house price models, with income, interest rate, the user cost of housing and price expectations also playing important roles. The Central Bank also notes that LTV restrictions are more important after a crash, in limiting losses for the lender.

The proposals have generated debate, of course, with some welcoming the move as important in dampening house price inflation (despite the caveat noted above) while other have argued it will hit  the First Time buyer (FTB) particularly hard and dampen housing supply.Indeed, the LTV limit would appear to be binding now, with 44% of new PDH lending  last year above 80%, while only 7% of lending was above 4.5 LTI, with 77% at 3.5 or below.

Another issue is the timing of the proposals. House prices in Dublin have certainly risen sharply of late and are now over 40% above the cycle low but outside the capital prices have recovered by just 9% and most observers, including the Central Bank and the ESRI, still conclude that prices are not excessive relative to fundamentals such as income or rents. A greater puzzle on timing relates to the credit cycle, given that the restrictions are designed to directly impact lending.The stock of outstanding mortgage debt in Ireland has been falling now for five years and the latest figure, for September, showed a 3.1% annual decline. New mortgage lending for house purchase is picking up but amounted to  just €1.3bn in the first half of 2014 and is still being swamped by redemptions and early repayments. Ireland is therefore hardly swimming in new mortgage lending so restrictions at this time seems premature, particularly as the secondary aim of the moves is to ‘dampen pro-cyclical dynamics between property lending and housing prices’ . That might suggest that restrictions would be better served if actually adjusted for the cycle, with  the LTI limit  reduced if credit growth is deemed too rapid and  the LTV limit reduced if house prices are deemed in excess of fundamentals.

The proposals may indeed dampen  future housing cycles but also have broader societal implications. The Government  was not consulted  and is now reported to be considering some form of mortgage insurance scheme to help FTBs secure a higher LTV.The Governor of the Central Bank in a recent speech also  appeared to be more comfortable  than indicated in the proposal document with the idea of  FTB insurance although with the caveat that who provides the insurance is important. Insurance protects the lender , not the borrower of course, and has to be paid for.A broader conclusion from the Governor’s speech may be that  the proposals will see further modification before implementation, or a longer lead-in time. As it stands the restrictions do have significant implications for  young Irish households, with a longer period of saving in store and therefore a later age for home ownership, at least for some.