“Risks in real estate markets were on the rise” in 2020 according to the recently-published annual report by the CSSF financial regulator. A range of indicators point to the increased level of debt across the Luxembourg economy and with it, the risks to local lenders. This has driven the CSSF to act to reduce vulnerabilities.
If it wasn’t obvious from booming housing prices (17% in the first quarter of this year according to Eurostat), there is plenty of other evidence of a tightening residential property market in the CSSF annual report. For example, the loan-to-value ratio compares the average mortgage loan amount with average property values. This has increased by 4.6 percentage points in 18 months, reaching 77.6% in the first half of 2020. Mortgages with a loan-to-value ratio above 90% represented 33% of total new loans in the first semester of 2020. In other words, banks were asking for less than a ten percent deposit for a third of new loans.
More debt, longer repayments
Perhaps even more dramatically, the debt-to-income ratio has increased considerably over this period, from 869% in the second half of 2021 to 993% in the first half of 2020. This is a measure of total debt to total disposable income. It suggests that the average borrower had total debt equivalent to 9.93 of their total income in the middle to last year, compared to 8.69 at the end of 2020.
As well, borrowers are increasing the amount of time they plan to pay back their housing loans. From 21.2 years in the second half of 2018, the average length of maturity of loans has risen to 21.9 years.
Despite these tensions, there is evidence that much of the increased pressure in the housing market is being driven by demand from rising incomes. The debt service ratio measures the share of disposable income dedicated to debt repayment. Although this rose in the first half of last year, this figure was 40% in second quarter of 2018, dropped to 37% a year later before reaching 39% in H1 2020.
Corrective measures
These indicators led Luxembourg’s umbrella regulatory body the Systemic Risk Committee (CdRS) to recommend the introduction of loan-to-value limits on credit. At the start of this year, the CSSF brought in legally binding maximum limits that banks cannot exceed at any time. This requires banks to determine the amounts they lend on the basis of a client’s capacity to repay, within a maximum limit which should not be exceeded.
On-going risks
This appeared to do little to calm the desire to lend. The Luxembourg Central Bank reported in June that local mortgage banks lent €3.69bn in April 2021, an increase of 11% on the same month of the previous year.
Banks are also exposed to the retail property sector. Shop rents fell by between 10 and 15% in 2020, according to real estate agency JLL, with the volume of retail real estate transactions down by 77%. The retail vacancy rate grew to 7.4% last year, and it remains to be seen how this will continue as Covid-related support from the state and loan moratoriums are removed, coupled with potential long-term changes to shopping habits.