Stiffening competition in the mortgage market to push down bank margins

Russian mortgage lending market 2020 outlook

  • The mortgage market will retain significant growth potential in 3–4 years. On the demand side, we see low housing per capita, a further glide of interest rates, and a robust housing policy pursued by the government (including housing renovation plans in Moscow). The banks are also getting increasingly interested in mortgage lending, as it requires less coverage with capital and boasts a low default and loss level.
  • Mortgage remains one of the most dynamic lending segments. In 2017, the volume of mortgage loans will grow 15–17% (against 26% the year before, with the high base effect of 2016 taking its toll), with the loan portfolio swelling by around 12%. In 2018–2020, we expect the segment to post a slower growth of some 12–13% (disbursement) and 10% (portfolio). By end of 2020, the share of mortgage in GDP will reach 6.5%, but, thanks to lower interest rates, total debt burden of the population will remain at the average level for developed markets (around 9%).
  • Mortgage market growth to be accompanied by price dumping and mortgage margin reduction. Following Sberbank, which has already slashed mortgage interest rates three times this year, other major players with relatively inexpensive funding are forced to join price competition. As a result, mortgage rates are declining today faster than both the key rate and retail deposit interest rates, and growing interest to the segment creates prerequisites for this trend to continue, which may dampen average mortgage margin by 0.5–0.7 pps on the 3-year horizon.
  • Cost of risk in the mortgage segment to rise, with the reason being the expected easing of bank requirements to mortgage borrowers in response to price competition stiffening on the market. At the same time, this should hardly affect mortgage portfolio quality, which is likely to remain much higher than in other segments of consumer lending. Moreover, mortgage risk appetite growth will be controllable, thanks to Bank of Russia’s ability to adjust risk ratios while calculating the capital adequacy ratio.

The forecast has been drawn up in line with General Principles of Socioeconomic Indicators Forecasting.

Table 1. Mortgage lending in Russia till 2020 (key indicators forecast)

Source: ACRA 

Rapid mortgage growth in 2017–2020 will not increase debt burden of the Russians

The mortgage market proved the most dynamic lending segment (even not accounting for currency revaluation) over the last four years. Nevertheless, it still retains considerable potential for further growth in the next four years (2017–2020). Demand should be fueled by low per capita housing in Russia, saving behavior of households (with real estate used for saving purposes), ongoing reduction of interest rates on loans on the backdrop of liquidity surplus and quantitative monetary easing, as well as the proactive housing policy pursued by the government (housing renovation plans in Moscow). Banks are keener on mortgage loans as well, as the latter require less coverage, with an adequate level of margins persisting in the segment thanks to a low default level and very modest loss rates.

Mortgage penetration remains weak: Russia has one of the lowest mortgage portfolio to GDP ratios (only 5%) among the European nations (see Fig. 1), as less than 10% of households used mortgage loans in 15 recent years.

Figure 1. In Russia, mortgage has one of world’s lowest proportions in GDP

Source: Bank of Russia, EMF Hypostat, ACRA calculations

A detailed banking sector forecast is available in the ACRA February 27, 2017 research titled “Weak demand for loans stimulates risk appetite among Russian banks”.

Mortgage looks set to remain one of the most dynamic lending segments. In 2017, the amount of provided mortgage loans should climb 15–17% per year (against 26% the year before, with the high base effect of 2016 taking its toll), while the loan portfolio should swell by some 12–13%. In 2018–2020, we expect slower growth rates in this segment – 12–13% (disbursement) and 10% (portfolio). Among other retail lending segments, only car loans will show relatively high portfolio dynamics (8–10% on average in 2017–2018). Unsecured lending growth will remain weak (less than 7%), as households are likely to further stick to high propensity to save.

As a result, by end 2020, the share of mortgage in GDP will reach 6.5%; but thanks to consistent reduction of rental rates, this growth will not negatively affect borrowers’ debt burden (given the total volume of the retail portfolio), which will remain at the average level for developed markets (around 9%).

The debt burden or the debt service ratio (DSR) is the share of disposable income needed to repay interest and short-term portion of the principal.

Figure 2. High mortgage growth rates will persist in 2017–2020

Source: Bank of Russia, Rosstat, ACRA forecast and calculations

Price competition pushes down margins of mortgage banks

For details, please refer to the ACRA July 5, 2016 research titled “Lowering interest rates to provide modest impetus to consumer lending”.

In 2015–2016, banks grew increasingly interested in the mortgage market, partly due to the government program of subsidizing mortgage interest rates and consistently high quality of ruble loans. On the backdrop of stiffening competition for borrowers, an increasing number of banks started pursuing aggressive pricing policies, in particular by refinancing loans given out by competitors with lower rates or by offering promotional products at rates below the market level. In 2017, a new wave of price competition was initiated by Sberbank (ААА(RU)) that has lowered its mortgage interest rate three times and offered a proprietary refinancing program. As a result, the reduction of mortgage interest rates has been outpacing the dynamics of the key rate and average retail deposit interest rates this year.

By our forecasts, the said trends will bring about an annual reduction of average bank margins on new disbursements by 0.2 pps, which, in the horizon of 3 years, will cause the shrinkage of margins by 0.5–0.7 p.p. on average. During the forecasted period we expect the average interest rate on mortgage loans to drop by 3 p.p. to the level of 8.5–9.0% by end-2020.

Figure 3. In 2017–2020, the average interest rate on mortgage loans will drop 3 pps

Source: Bank of Russia, ACRA forecast and calculations

Mortgage cost of risk to rise

Historically, the mortgage portfolio in Russia has been characterized by the lowest level of overdue debt among all segments of both retail and corporate lending. We expect high quality of the portfolio to persist over the next 3–4 years, with the mortgage segment demonstrating a lower level of bad debt compared to other consumer lending segments (including car loans).

Figure 4. Provision recovery slashed cost of risk in mortgage lending down to zero in 2016

Source: IFRS of the banks accounting for more than 70% of the mortgage portfolio, ACRA calculations

Cost of risk is net provisioning (allowance for possible losses on loans less the provision recovery) for a certain period / average loan portfolio for the period.

The capital adequacy ratio is overall capital / assets weighted by risk profile.

In the meantime, cost of risk (the ratio of created provisions to average portfolio) for the period under review will rise. In 2016, thanks to considerable mortgage provision recovery by Sberbank and VTB24 (which accounted for 60% of all mortgage loans provided last year), cost of risk on the mortgage market was close to zero last year. In 2017, the influence of this factor will be way lower, which will cause an increase in cost of risk. The latter will also be negatively affected by an expected loosening of borrower requirements by a number of banks in response to stiffer price competition and dumping. Much softer mortgage loan accounting requirements used for calculating the capital adequacy ratio enable banks to increase the share of riskier loans without a material increase of burden on their capital. Nevertheless, growth of mortgage risk appetites will be controllable, thanks to the Bank of Russia’s ability to adjust risk ratios in calculating the capital adequacy ratio.

We expect the share of riskier loans in the total mortgage portfolio to grow insignificantly, so the quality of this portfolio is unlikely to deteriorate. We forecast that mortgage cost of risk during the forecast period will be at a comfortable level of 0.6–0.8% of the loan portfolio.

The Analytical Credit Rating Agency (ACRA) conducts in-depth analysis of credit quality of mortgage loans provided by Russian banks. The results of this analysis will be published in one of our forthcoming research reports.

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