After four months of war in Ukraine and at a time when inflation reaches its highest level in decades, Banco de Portugal (BdP) is raising the tone of its financial stability risk warnings. Among the main risks now is the possibility of a “significant correction in market prices for residential real estate”, a scenario that, if confirmed, could have a direct impact on banks’ balance sheets.
in the very last Financial stability reportdated June 2022 and published this Friday, BdP recognizes among the main vulnerabilities and risks to financial stability “the risk of lower prices in the residential real estate market as a result of changes in financing conditions.”
This risk is indicated when interest rates are rising again, after several years at historically low and even negative levels, making credit more expensive. At the same time by this time House prices continue to rise at a rapid pace, as a result of an increase in demand for housing, especially from non-residents, and a continuing shortage of supply. In the first quarter of 2022, according to the latest data from the National Statistical Institute (INE), house prices in Portugal rose by 12.9% compared to the same period last year.
In this context, BdP believes that “in recent years, domestic bank credit has not been the main driver of house price increases”, but this is a scenario that could change and needs to be monitored. “In the context of the recent higher growth in home credit, it is important to ensure that it does not play a decisive role in the evolution of prices in the real estate market,” the report says.
The regulator also emphasizes that “the adoption of a macroprudential recommendation for new loans has led to an improvement in the risk profile of borrowers and the characteristics of the housing loan portfolio.” Finally, it acknowledges that “loan-to-mortgage portfolio value indicates resilience to a correction in residential real estate.”
However, the risk exists and even deserves more BdP analysis. Based on a statistical model that analyzes the distribution of house price changes in Portugal in 2021, “driven by the prevailing financial and economic situation” this year, the regulator points to “the expectation of deterioration in house prices from 2023”. until 2024 in a central plant.” At the same time, he predicts “an increase in uncertainty” from 2023.
“The current circumstances and this analysis justify the need to continue monitoring risks in the residential real estate sector, in particular in the context of the normalization of monetary policy and the continuation of the dynamics of house price growth,” concludes BdP.
The financial situation of the family may worsen
Added to the risk of real estate price adjustments is a deterioration in the financial situation of families as a result of higher interest rates and inflation, which, in turn, can lead to an increase in loan defaults.
“In the current macroeconomic and geopolitical environment, along with the expected rise in market interest rates, the financial situation of individuals may worsen, which will increase the risk of default,” acknowledges BdP. “In Portugal, the share of floating rate housing loans is around 90%, which leads to an increase in market interest rates, which leads to an increase in debt servicing. The most common index is the 12-month Euribor. Added to this effect is a reduction in real disposable income and the impact of the pandemic crisis on the financial situation of some families,” he adds.
However, the regulator emphasizes that “there are factors that reduce the risk of default by individuals”, highlighting the decline in debt that was observed in the period before the pandemic and affected families with different income levels. At the same time, there was an “improvement in the risk profile of new borrowers as a result of the macroprudential recommendation.”