Austrian lending limits will not ensure financial stability if interest rate-risk is excluded
“Headline political risk, rising living costs and the looming monetary policy turnaround have all failed to stop Austria’s house-price boom. House-price growth is outpacing economic fundamentals yet shows little signs of weakening,” said Reber Acar, associate director in Scope’s covered bonds team.
In the first quarter of 2022, Austrian house prices appreciated by 12.4% on an annualised basis. Since 2010, they have more than doubled whereas house prices have increased by ‘only’ around 45% in the EU.
Annual growth in Austrian house prices
“What is worrying is that the current boom is heavily debt-fuelled and underwriting standards have loosened in recent years,” cautioned Mathias Pleissner, Scope’s deputy head of covered bonds. “More than half of new mortgages have an LTV of more than 90% and for every fifth mortgage, payments eat up more than 40% of household income.”
Because the banks have only paid lip service to the Financial Market Stability Board’s (FMSB) recommendations for sustainable lending, the regulator is now introducing legally-binding lending limits. The Financial Market Authority’s proposal translates the FMSB’s recommendation and includes a loan-to-value (LTV) limit of 90%, maximum debt servicing capacity (DSTI) of 40% and loan terms that should not exceed 35 years.
“Austrian regulators also decided to grant a very generous 20% flexibility quota, already weakening the well-intended and necessary measures. Other countries facing elevated house prices, like Norway, only allow up to 10% for exemptions,” said Acar.
Regulators have averted their gaze from the emerging risk of higher interest rates although they are aware of the different risk profiles of fixed and floating-rate mortgages. They are recommending a general DSTI limit of 30%, while a DSTI of up to 40% should only be considered for fixed-rate mortgages where the fixed-rate period covers at least half of the loan term.
“The problem of this approach is twofold: recent experience has shown that banks will be reluctant to follow such recommendations, and consumer-friendly rules on prepayment penalties today make fixed-rate mortgages expensive. If the regulator wants to reduce financial stability risk by promoting fixed-rate mortgages, it will need additional aid from the legislator,” said Pleissner.
The share of fixed-rate mortgages in Austria has seen a substantial rise in recent years thanks to the ultra-low interest-rate environment and the subsequent compression between fixed and floating-rate mortgages. As banks’ refinancing costs have substantially increased in recent months, it is only a question of time as to when interest rates will follow. Similarly, the spread between fixed and floating mortgages will likely rise again as this is a function of the absolute level of interest rates.
“High inflation reduces available income and will incentivise borrowers to go with the cheapest available option. Higher shares of floating-rate mortgages will expose borrowers to interest-rate risk – especially those that have maxed out LTV and DSTI limits even beyond the banks’ generous 20% flexibility quota. From a financial stability perspective, we call on the regulator to address this risk when implementing the final version of the enhanced macroprudential toolkit,” said Acar.
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