Dr Friedemann Roy highlights the growing opportunities available for mortgage lenders in central and south-eastern Europe.
Macroeconomic policy geared towards stabilising inflation, as well as a sound institutional and legal framework, has initiated higher economic growth in central and eastern Europe (CEE) and south-east (SEE) Europe. Inflation rates have reached single-digit levels (see table 1) – except in Serbia with 17.7% and Russia with 10.9%. With average gross domestic product (GDP) growth of 6%, the whole region outpaced western Europe by 2-3 percentage points. The resulting rising income of households has become one of the main drivers for prosperous banking markets. Since 1989, living standards have increased by nearly 40%. To benefit from this trend, many banks have moved into mortgage lending.
Although all the region’s mortgage markets have been developing rapidly, progress within the markets differs, breaking down into two groups of countries (see chart 1): the first encompasses all the new EU member states of central Europe (including Croatia). The second consists of the Balkans and Russia.
Two-speed development
One reason for the gap between the two groups is the time difference in the starting point of the transition process, which commenced in the CEE countries in the early 1990s and in the SEE countries about 10 years later. Consequently, legal and institutional framework reform was adopted earlier in CEE countries. Moreover, foreign banks, whose presence has a great impact on market development, entered at an earlier stage.
In relation to western Europe, however, these markets are still in the early stages of development. With an average of 7.2%, the mortgage debt-GDP ratio for the whole region is low compared with the EU average of 47.5%.
Further growth in these markets depends on greater penetration by lenders. As yet, many households do not have a bank account, which is typically the basis for the sale of other bank products such as mortgages. In Poland and Hungary, the share of bank accounts/ bank relationships to households amounts to about 70%, whereas in Bulgaria and Romania it accounts for 33% and 35% respectively. The EU average is 98%.
More growth barriers
Another barrier is limited housing affordability. The decline in interest rates has often led to increased demand for housing, which has resulted in higher house prices because of inflexible housing supply. For example, in Serbia the volume of mortgage loans grew by 244% in 2005. Despite this remarkable rise in supply, most people cannot afford to buy into housing. The price for an apartment measuring 55 square metres is about €69,000. However, the average annual salary is about €3816.
In Bulgaria, the ratio of mortgage lending to GDP rose by 1.4% in 2004 and 2.1% in 2005. During the same period, house prices surged by 47.6% and 36.5% respectively.
Foreign banks have been the main drivers of market development across the region. In particular, Austrian (such as Erste Bank and Raiffeisen Group) and Italian banks (UniCredit and Banca Intesa) have built up strong networks through which they offer mortgage loans. Among the specialised housing finance providers, the German and Austrian Bausparkassen have established subsidiaries in the Czech Republic, Slovakia, Hungary, Romania and Croatia. Their activities have been favoured by specialised legislation and savings subsidies, which are paid to their customers.
The most common product in the region is a mortgage loan for purchase or construction. In SEE, home improvement loans have also become a popular product (though it is slowly replaced by cash loans due to simpler loan processing procedures). Interest rates are fixed or variable. Loans are often denominated in a foreign currency (typically euros or dollars) or in the local currency but indexed to the euro (most common in the Balkans). Table 2 provides an overview of mortgage loan conditions in selected countries of the region.
In Lithuania, interest rates were below the EU average as a result of increased loan supply by lenders. In Poland, lenders have come up with product innovations such as higher loan-to-value ratios (LTV), often higher than 100%, bullet mortgages, and others. In Croatia, banks typically target their mortgage products to higher income households.
In Russia, more than 170 banks offer mortgage loans. To gain market share, lenders have softened their lending requirements – for example, increasing loan-value ratios to 90%. Thus, the long-term stability of their portfolios may depend on consumer behaviour and house prices.
Move to securitisation
Funding options in the region mainly depend on the progress in transition. In line with chart 1, the following stages can be defined:
- Mainly deposit-based lending. Lenders in Serbia, Albania, Bosnia and Herzegovina, Macedonia and Croatia use deposits to refinance their mortgage loans. An alternative source is credit lines from international financial institutions or credit lines provided from the parent credit institution.
- Establishment of capital markets. In Bulgaria, Slovenia and the Baltics, the covered mortgage bond as a funding instrument has been introduced. In Romania, the legal framework of a secondary mortgage market was implemented in 2006. However, deposits and international credit lines still play an important role in refinance. In Poland, the restrictive design of the Act on Mortgage Bonds and Mortgage Banks has hampered the development of covered mortgage bond systems.
- Transition to market-based lending. Especially in the Czech Republic, Slovakia and Hungary, lenders can stick with various funding options. Russia was the first country to introduce a secondary market institution in 1997. However, its progress was halted by the 1998 financial crisis. Table 3 shows the covered mortgage bond’s importance for funding; in Hungary and the Czech Republic, its importance exceeds even EU-levels.
In most countries, the legislation allows for securitisation, at least as a cross-border transaction (including the transfer of national assets to a special purpose vehicle governed by international law). However, most of the relevant laws require a re-registration of the mortgage which could be time-consuming. Recently, two residential mortgage-backed securities (RMBS) issues have taken place in Russia. Vneshtorgbank sold a mortgage portfolio worth $88.3m; and City Mortgage Bank and the Russian International Bank for Development’s securitisation amounted to $72.56m. One of the main reasons behind this funding strategy is the lack of long-term deposits and without securitisation, banks would be exposed to considerable interest rate risk. In addition, the present surge in mortgage lending means lenders have to either turn to hybrid capital and increase their capital – and their capital adequacy ratios – to fund this growth by using instruments qualifying for Tier 1 and Tier 2 capital, or engage in securitisation.
Unregistered properties
Further transactions are, however, subject to obstacles such as the lack of court precedents. In SEE, in particular, the enabling environment remains weak. For example, in Serbia half of the property is unregistered. The different title systems within the country are a further obstacle. The lack of available data due to the short lending history makes it difficult to define the steady-state default experience. This helps to explain why mortgage default insurance has to date not developed in the region. As a result, the young age of this funding instrument may currently attract investors with a good knowledge of market conditions. They appreciate the opportunities that lie ahead.
Given low market penetration (as indicated in chart 1), the region offers potential for continued growth. Despite this positive outlook, the region must further reform its legislative and institutional framework. However, reform fatigue, in particular in the new member states, does not bode well for progress.
