Mortgages still fill bank coffers

Greek bankers, at least a few of them, have been happily surprised for a good reason. Demand for loans to build or buy houses remains exceptionally strong, despite the fact that the European Central Bank (ECB) has raised its key interest rate by 1.5 percentage point over the last 15 months or so. This has given more credence to their predictions of double-digit growth in mortgages in Greece this year and next, which is like sounding music to the ears of their shareholders. Investors in Greek banks should be happy. It is not just the three-year business plans that the large banks are unveiling one after another this season, rejuvenating optimism about the resilience of their earnings per share growth. It is also the actual numbers in volume loan growth, especially the most promising category. Evidence suggests that the demand for mortgages, the fastest-growing loan type, appears to be robust so far in the first quarter of 2007, according to top bankers from three of the country’s largest credit institutions. This is happening despite the fact that mortgage growth was very strong in the first quarter of 2006, making a comparison less favorable for the same period this year. We should remember that there was a rush by companies and individuals to get a building permit in the last few months of 2005 before the imposition of value-added tax on new constructions and the increase of the so-called objective property on which taxes are calculated. This resulted in higher disbursements of new mortgage loans in the first three months of 2006. In the meantime, the ECB has raised its key interest rate to 3.5 percent at present from just 2.0 percent at the end of November 2005 but this has done little to dampen demand for mortgages in Greece, according to central bank figures and suggestions by high-ranking bank officials. A 150-basis point interest rate increase in a 15 month period is not small even if the ECB started hiking rates from a very low base. A percentage point equals 100 basis points. Theoretically, this should have led to a substantial rise in interest costs for borrowers and cut into demand for loans, especially variable rate mortgages, but this did not happen. Greek bankers are quick to explain why. «At the same time that the ECB hiked, the spreads on new mortgages were coming down in Greece, lessening the impact on borrowers,» says Yiannis Pehlivanides, the deputy CEO of National Bank, the country’s largest. According to him and other top bankers, the overall interest rate on mortgage loans paid today on new loans is not much different than the interest rates paid before the ECB began its campaign to normalize interest rates by hiking them because of the compression of spreads. Remember that more than 85 percent of total mortgage loans are of the variable type here and most are linked either to the ECB refinancing rate or the three-month Euribor. With average inflation hovering around 3.0 percent, the real cost of money with nominal variable mortgage rates between 4.5 percent and 6.0 percent is not considered unbearable either. However, ECB President Jean Claude Trichet has indicated that another 25 basis point rate hike is likely in March. There is little doubt in the markets that the ECB will set its intervention rate at 3.75 percent next month from 3.5 percent at present and this may not be the end of its campaign to bring euro rates closer to levels which reflect macroeconomic reality and conform to historical norms. The yield on the three-month Euribor futures contract due September 2007 stood at 4.16 percent on Friday, showing the majority of market participants bet there is a good chance the ECB’s official interest rate will be at 4.0 percent at the end of September. We must note that the futures contract settles to the three-month Euribor (the three-month interbank offered rate) which has been 16 basis points higher on average than the ECB’s official rate since the launch of the single European currency in 1999. Bankers recognize that interest rates will bite more if the ECB raises its key rate to 4.0 percent by the end of September but market competition is likely to squeeze spreads on new mortgages to about 100 basis points gradually, which translates into a gross interest rate of 5.0 percent, somewhat mitigating the impact. Although interest rates are an important determinant of demand for mortgages, so are the state of the economy and the demographics of the population. With the Greek economy growing at more than 4.0 percent annually on the back of strong consumer and investment spending, one of the most important factors for sustaining strong mortgage growth is present. With disposable income rising and employment also on the rise, it is not difficult to understand why demand for mortgages remains strong even though Greece’s mortgage-to-GDP ratio is converging fast to the EU-15 average, although still lower at this point. But bankers’ contentions that demand for mortgages remains strong so far this year may not be unrelated to another factor: The desire by a growing number of Greek households to upgrade their dwellings and move to larger flats in the suburbs and the role of immigrants, who are the main buyers of the older, smaller apartments, especially in Athens, sold by the former. In addition, more and more households appear to be interested in buying or building a second resort home, opening up a new market for summer houses. The demographics also partly answer the question of why there is strong demand for mortgages in a country where an estimated 80 percent or more of the population own their own roof. The apparently buoyant mortgage volume growth rates so far this year give more credence to bankers who predict double-digit growth in mortgages in 2007. Assuming this is the case when the actual numbers are published, the shareholders of Greek banks have a good reason to cheer. This is not to say it will be the same story if the Greek economy slows unexpectedly and/or the ECB sees reason to raise its key interest rates to levels way above 4.0 percent, which cannot be offset by narrower spreads.