Something just cracked in the Spanish mortgage market

Spain has already witnessed one of the most spectacular housing bubbles and recessions of this century. As the pressure on the mortgage market begins to build, the government and banks are desperate to avoid a restart.

After weeks of negotiations with banking associations and the Bank of Spain, the Spanish government has authorized a package of measures to help the most vulnerable mortgage holders in the country. On Tuesday, Sanchez’s government approved measures it says will soften the blow of rising mortgage costs to more than 1 million households. These measures are subject to final negotiations with banking associations, which have a month to register before they are scheduled to be implemented next year.

Like F.T. indicated On Tuesday, Spain became one of the first European countries to take emergency measures to cushion the impact of fast-rising interest rates on families already struggling with rising inflation:

Spain is particularly vulnerable to ECB rate hikes because about three-quarters of mortgage holders have floating rate loan agreements linked to its monetary policy, although these are usually only adjusted once a year.

ass the date According to the National Institute of Statistics of Spain, 72% of new mortgage loans in August were issued with a fixed rate, and 28% – with a floating rate. But this is a relatively new trend. In 2020, the ratio was about 50/50. In 2016, 90% of all new mortgages were variable rate, while in 2009 it was a staggering 96%.

In other words, Spanish homeowners made the most of the ECB’s low, zero, and ultimately negative interest rate policies with little regard for the potential risk of a sudden reversal. But it wasn’t just the borrowers who were reckless; it was the same with creditors. As I informed per WOLF STREET in 2017, the biggest beneficiaries of the ECB’s ZIRP and NIRP were Spanish banks, which made sure to include so-called “bottom clauses” in their floating rate mortgage contracts. They set a minimum rate, usually between 3% and 4.5% but in some cases up to 5.5%, for floating rate mortgages even when the Euribor falls below zero.

As a result, most Spanish banks have been able to enjoy all the benefits of virtually free money while avoiding one of the biggest drawbacks: having to offer customers very low interest rates on their floating-rate mortgages.

While this was not strictly illegal, most banks failed to properly inform their customers that there was such a clause in the mortgage agreement. In 2016, the European Court of Justice found the provisions offensive. At one point, it seemed that the European Court of Justice was going to require that all Spanish banks that used the minimum amount provisions be obliged to reimburse customers for all the money they secretly overcharged. In the end, this did not happen, despite the fact that minimum provisions have since been banned.

There are now about 5.5 million mortgage holders in Spain, about four million of which have variable rate mortgages. Of these, just over one million will qualify for the aid package.

The most vulnerable families, defined as families with an annual income of less than 25,200 euros, will be able to reduce their interest rates to Euribor minus 0.1 percentage point, in line with the proposed measures. Many mortgage holders are paying 1 percentage point higher than the Euribor, the interbank rate that anticipates action by the ECB.

The pact also includes a new set of rules for needy middle-class families. The package, which will run for two years, is designed to help families adjust more gradually to the new interest rate environment. To be eligible for the benefit, a household must have an annual income of less than €29,400. Their mortgage burden should also be over 30% of their income and their monthly payments should increase by at least 20% due to the recent ECB rate hike.

These increases led to an increase in the ECB deposit rate from -0.5% in July to 1.5% at the end of October, the highest level since 2011. The Eurozone’s 12-month benchmark, the Euribor, on which many Spanish mortgages are based, was 2.84%. November 22, this is the highest level since January 2009. The ECB is expected to continue raising rates in the coming months.

For holders of variable-rate mortgages in the 19 eurozone member states, this has meant paying significantly more monthly payments as prices for the most basic commodities, including energy and food, are also skyrocketing. in case with an average 25-year Spanish mortgage of €150,000, with a 1% difference compared to Euribor, the monthly payment will rise from around €535 to €750 – an increase of around €215 per month, or €2,580 per year.

The new aid package will mean a family with a €120,000 mortgage and €524 monthly repayment, linked to recent ECB increases, will halve the payment to €246, Spain’s Economy Minister Nadia Calvinho said. Eligible borrowers will also be able to extend the loan term for up to seven years. However, as Spanish consumer protection agency ADICAE warns, this will result in borrowers having to pay more interest overall, even if their monthly payments fall, and in many cases, they will have to pay off their mortgage before retirement.

For Spanish banks, extending the term of the loan while maintaining the amount of monthly repayment for struggling borrowers will have a significant short-term benefit. This means that they will not need to register – and therefore reserve – delinquent loans on their balance sheets.

Another important issue is at stake: an average income of €29,400 could be enough to qualify for a 25 or 30 year mortgage in one of the poorest parts of Spain such as Extremadura, parts of Andalusia, Castilla la La. Mancha, Murcia, Ceuta and Melilla, but that won’t give you mortgages in major centers of economic activity such as Madrid, Barcelona, ​​Bilbao, Valencia, Palma de Mallorca and San Sebastian. Many mortgage holders in these cities are also struggling with rising costs, but they won’t qualify for mortgage relief — unless the relief package is expanded, of course.

Of course, all this defies all logic. The European Central Bank is raising rates rapidly right now in a (probably futile) attempt to tame rising inflation, despite the fact that price increases are largely the result of supply side factors. These include European governments’ continued support for sanctions on their biggest supplier of energy and other vital goods, which has led to a spike in energy prices and general inflation. In other words, European governments are largely to blame for rising spending in Europe.

The ECB’s response was to exacerbate the emerging economic crisis. The more he raises the stakes, the more economic problems he creates. And as that pain mounts, European governments and commercial banks have gone out of their way to insulate borrowers from the consequences of these rising rates. And these effects will only increase as the stakes rise.

The writing is on the wall

Of course, the entry has been on the wall for some time. As in recently warnedfinancial crisis is almost inevitable. The combination of a rising dollar, rapidly rising interest rates and high inflation over the past decades, on top of all the economic problems caused by the pandemic, is putting a huge strain on heavily indebted households, companies and economies around the world.

At the end of September, the European Systemic Risk Board (ESRB), an advisory body set up in the wake of the global financial crisis to monitor macroprudential risks surfacing under the surface of the European economy, issued a “general warning” about Europe’s financial troubles. system. The ESRB speaks with the full authority of two of the EU’s most powerful institutions, the Commission and the European Central Bank.

As I noted at that time, central banks are usually the last to admit that a crisis is around the corner. When they finally sound the alarm, it usually means that the damage has already been done and the crisis they have invariably helped create has already arrived. The first of the ESRB warnings reads:

[T]The deteriorating macroeconomic outlook, coupled with tightening financing conditions, means a new increase in pressure on the balance sheet of non-financial corporations (NFCs) and households, especially in sectors and member states that are most affected by soaring energy prices. These developments affect the ability of the NFC and households to service debt.

This is what is happening now in Spain, which, like the UK a couple of months ago, seems to be playing the role of a canary in a coal mine. A couple of weeks after the ERSB issued its first “general warning”, the European Banking Authority sounded the alarm about a cocktail of risks rising in European housing markets:

The macroeconomic environment has deteriorated sharply and the likelihood of a recession has increased. High inflationary pressures and the consequent rise in interest rates have pushed up the cost of living without a corresponding increase in income. This is a difficult task, especially for low-income, heavily indebted households. Geopolitical uncertainty and the energy crisis are taking a toll on consumer and business confidence. Although the employment rate is still high, these developments could affect the demand in the housing and real estate market.

In October, Spain saw the sharpest drop in mortgage approvals since 2008. And this is just the beginning, according to the Bank of Spain. Per World (my own translation):

The deteriorating economic situation led to the fact that banks began to turn off credit taps. This trend was most pronounced in the mortgage segment, which suffered its biggest drop since 2008 in the third quarter after six consecutive quarters of growth.

This sharp fall in the number of approved mortgages is due, on the one hand, to the fact that banks have become less risky due to the worsening macroeconomic outlook, which has led to their greater rigidity, and, to a lesser extent, to the fact that bank customers are applying for fewer mortgages due to rising interest rates and financing costs.

Another risk, of course, is that a growing number of mortgage holders who are not eligible for debt relief (and other borrowers, including businesses) are starting to default on their debts. Spain has already witnessed one of the most impressive housing booms and busts of this century, which by 2015 over 600,000 claims (and keep in mind that in Spain mortgages are recourse, which means that banks can harass the borrower for all outstanding debt after the home is resold).

It also triggered the collapse of several savings banks and the bailout of the entire system. Perhaps unsurprisingly, the government and banks are desperate to avoid another housing crisis. But as another economic crisis (largely self-induced) looms, which could be even worse than the previous one, this is likely to be a challenge.