The European Systemic Risk Board (ESRB) has recently issued its assessment of the vulnerabilities of the residential property sector in Portugal. The main vulnerabilities pointed out to the national market are:
– overvalued house prices, which have been rising since 2016;
– high household indebtedness, although it is falling;
– low demand in new home loans regarding interest rate spreads.
The ESRB considers that the policy applied by the Bank of Portugal to the sector has been adequate and sufficient and that the risk to the financial system is medium. The main vulnerabilities do not stem from credit for housing, despite the fact that mortgage credit in Portugal is one of the largest slices of bank credit portfolios among European countries.
The Bank of Portugal’s 2018 recommendations, which established criteria to be met by banks when granting credit regarding loan-to-collateral ratios and borrower debt, have had an effect, according to the ESRB. However, by the end of 2022, the average maturity of mortgage credit limits will have to be gradually lowered to 30 years.
In this context, the Bank of Portugal has updated its recommendation in this regard, with rules that begin to apply from 1 April.
The ESRB recalls that Portugal had a high number of mortgage loans under the moratorium as part of the prudential and fiscal measures implemented due to the pandemic, so a deterioration in the quality of credit institutions’ assets is likely.
As a substantial part of housing-related operations are carried out outside, without domestic credit, if the economic scenario is less favorable than expected, Portugal may have to change its macroprudential policy, as the measures recommended by the BdP will not be effective here in making the financial system resilient to risk absorption.
Moreover, it is not intended to add additional and unjustified costs to borrowers already facing overvalued house prices, partly due to external demand characterized by high purchasing power.
In 2020 and the first half of 2021, house price growth remained high despite the pandemic. Average price growth was 8.6% in 2020, up from 9.3% in 2019. There are indicators that suggest that the Portuguese property market has remained highly resilient in the face of the COVID-19 shock. The number of transactions decreased by 22% in the second quarter of 2020, but returned to 2019 levels in the third and fourth quarters of 2020.
For the ESRB, the increase in the number of building permits granted from the end of 2020 suggests a growing supply of housing, which could ease demand pressures on house prices.
Mortgage lending has not been the main driver of house price rises lately, but it is becoming so. This credit grew by 2.4% in August 2021.
Only around 40% of housing transactions are funded by domestic credit, a rate that has remained largely unchanged since 2017. Recent growth rates have been positive and in 2020 they increased for the first time since 2015. This may be a sign that the trend is reversing and that the domestic mortgage market is recovering.
Annual rates highest in Europe
The ESRB notes that interest rate spreads have been narrowing and are relatively low (0.8% in August 2021). However, borrowers in Portugal pay one of the highest annual percentage rates in the EU to cover mortgage loan charges; in addition to interest payments, the charges include the costs of maintaining the accounts required to conclude the credit agreement and the cost of the insurance needed to obtain the loan.
Household debt was falling until recently but has started to rise again, driven by mortgage lending. In 2020 credit to households reached 69% of GDP; in the first quarter of 2021, it rose to 93.6% of disposable income.