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Housing loans collateral shortfall

Using publically available data from the Central Bank of Cyprus, Pavlos Loizou MRICS considers the size of the shortfall between the value of housing loans granted by the banks and the market value of their underlying collateral.

HOW big is the shortfall between housing loans and their collateral?

The short answer is that no one can be certain. We have chosen to use data from the Cyprus Central Bank (CCB) to make a calculated guess as to what this could be. The data covers the period 2008 Q1 – 2012 Q2 and is publically available.

Loans granted over the past few years had varying requirements in relation to property values [the maximum allowable Loan-to-Value (LTV) ratio was 80% for primary residence and 70% for a second home] and there was/is some confusion as to what the definition of the Market Value (MV) of a property was/is, e.g. with or without VAT.

We do not know the actual value of the properties that banks used as collateral to grant the various housing loans, but the CCB provides a breakdown of the amount of housing loans outstanding per quarter. Whilst we cannot be certain as to the ratio between property value and loan amount, it would be reasonable to assume that most loans would be at the limit of the allowable ratio, i.e. the loan would be 80% of the value of the property. Thus, if we assume that these loans are 80% of the properties’ values, we can work our way back to calculate the hypothetical MV of the collateral.

Having calculated the value of the collateral, we then need to adjust these property values according to the movement of house prices over the period (the ratio between loan and value may have been 80% at the time of granting the loan, but as property values have decreased, ceteris paribus, this ratio must have increased). In order to be consistent, we have used the CCB’s residential price index to make these adjustments. We then recalculated the ratio between loan amount and property value in order to see how this has changed. As shown in the tables the LTV ratio for loans granted in 2008 is above 90% and almost all other loans are circa 85-90% of property values.

It is now time to “play” with our model. A reduction in house prices by a further 5% from 2012 Q2 prices, increases the LTV ratio, but leaves property values still higher than the total loan amount.

Reducing prices by 10%, leads to a shortfall in the value of the collateral relative to the loans of €69 million (1.0% of all housing loans granted over the period 2008 Q1 to 2012 Q2). Reducing prices by 15% leads to a shortfall of €353 million (4.9% of all housing loans), by 20% to a shortfall of €803 million (11.2% of all housing loans), and by 25% to a shortfall of €1.334 billion (18.6% of all housing loans). Remember that this only relates to housing loans granted from 2008 onwards. Commercial loans, consumer loans, etc. are not part of this assessment.

Before we move on to address the implications of the above, it is important to comment why we have not reduced the balance of the loans during this period. Notwithstanding that most housing loans have an interest only/”teaser rate” at the beginning of the loan term, in the early part of a loan’s term the majority of the payment relates mainly to the interest and not to the loan. Only as time passes and the loan is slowly repaid, does the interest payment result in a decrease in the outstanding loan amount.

As noted, a decrease of more than 5% in property values will begin to result in a number of borrowers going into negative equity. This has significant implications both to them, as they will be paying off a loan that is bigger than the value of their house, and to the bank, as its exposure to potential loses will increase. Furthermore, it reduces the bank’s options if loan default does occur, as the potential income from the asset will not be enough to repay the outstanding loan. Thus, banks will be forced to crystallise their losses on the sale of the collateral, increasing their need for capital, and then to choose whether pursue the borrower or his guarantors for the balance.

In our calculations we have not accounted for a number of other costs that would be related to any sale, and for which there would be a further shortfall from the bank. These would include: rolled up interest, unpaid common charges, immovable property tax, estate agent fee, transaction fee (transfer duty), legal fees, etc. Thus, even if property prices do not fall further (highly unlikely) the shortfall amount will increase simply by accounting for these added costs to the bank. Loan recovery data from the USA put these costs at 30-40% of a property’s value at the time of loan default, i.e. a further decrease in the property’s value by 30-40% in addition to any decrease in house prices.

There are another three unanswered questions. How long will it take for the bank to take possession of the property? If the bank does take possession and tries to sell it, who will buy? And more importantly, who will finance the buyer?

It would appear that we have entered “limbo”, where, as the economy deteriorates, debtors default on their housing loans, increasing banks’ loses, causing banks to require more capital to account for these loses, constraining lending and causing the economy to deteriorate further. This becomes a self-fulfilling and self-fuelling negative feedback loop, which will require a jolt in peoples’ psychology, the economy and the property market in order for all to break out of it.

If you think that this scenario is far-fetched, have a look at Ireland. House prices in Dublin are 56% lower than at 2007 and in secondary cities the drop is between 70-80%. The percentage of mortgages in arrears of 90 days or more is 10.9%. As shown in the attached tables, if a 56% decrease in house prices was to occur in Cyprus, then the shortfall between housing loans and their collateral for the period 2008 Q1 – 2012 Q2 would be circa €2.445 billion. Assuming a rate of default of 10.9%, the expected loses to banks would be €267 million. Sláinte!

Pavlos Loizou MRICS

Lead Consultant, Leaf Research

 

Readers' comments

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  • John Swift says:

    Mike I pointed out on certain Cyprus forums that property prices in Paphos especially had reached ridiculous levels, this was greeted with howls of bile from many members.

    The fact is that prices had vastly overtaken UK prices which in fact was unsustainable.

    Our friend’s property in Tala was valued at €393K in 2006, she had to settle for €250K in 2010, another friend took a drop from €150K to €90K for a town house in 2011 as these two ladies could no longer afford to live in Cyprus.

  • @Jim – the level of nonperforming loans attributable to property developers is not available.

    A paper published by the European Commission in July states:

    The share of non-performing loans to non-financial corporations has been increasing significantly. Loans to non-financial corporations represent around 47% of total loans to the private sector. At the same time, nonperforming loans, as a percentage of total loans, increased significantly from 7.4% in March 2010 to 9.1% in March 2011 and 10.1% in September 2011. The high incidence of non-performing loans is an additional burden on the profitability of Cypriot banks, thereby affecting bank deleveraging. The challenge is to ensure that banks remain solvent in the face of rising non-performing loans from the corporate sector.”

    and

    Asset quality in terms of nonperforming loans is rapidly deteriorating. Nonperforming loans (NPLs) have been increasing since 2008 and a significant deterioration took place in the second half of 2011, with the result that NPLs reached 10.2% of total loans for Bank of Cyprus and 13.9% for Cyprus Popular (Laiki) Bank by the end of 2011.”

    and

    “Non-performing loans, as a percentage of the total loans of Cypriot households seem to be low. Despite the adverse economic conditions, household non-performing loans did not increase significantly. The management of the biggest Cypriot banks does not anticipate any significant increase in their number, since Cypriot household debt is much covered by deposits.”

  • Maxwell Hannah says:

    Has anyone told the Cyprus Government of this ??
    Blimey

  • Clive says:

    The Cyprus banks will eventually be forced sell their property debt portfolio’s to the highest bidder at say 30/40% of their value to a foreign organisation that will then ruthlessly, repeat ruthlessly, repossess and sell the properties.

    You only have to look to the USA to see this in action right now.

  • Mike says:

    What I find perplexing is the fact that some in positions of authority were seemingly unaware of this problem (or chose to ignore it) when I would venture to suggest that most Cypriots of a certain age knew full well that property was vastly overpriced from around 2005/6 onward and continued in an unsustainable upward spiral at ever increasing speed. I had a devil of a job trying to convince friends and colleagues that this was so and in the end I don’t think I succeeded as people, for reasons only known to themselves, wish to believe their investment is appreciating at a vast rate of knots.

    I can only assume most property was not bought as a home but as an investment and as long as there was a supply of people with more money than sense willing to pay inflated asking prices then the bubble was being inflated further and further until at some stage it had to burst.

    I guess I am not to unlike most people and when buying property, the house or apartment itself is only a small part of the overall consideration. Environment, infrastructure, utilities, crime rate, economy, local and central government, language, peoples demeanour & mindset, education, Healthcare and financial provisions must all be taken into account amongst many other things. Accepted that some developers were a little economical with the truth and that some were in cahoots with lawyers and advocates of dubious ethics which left unsuspecting and trusting buyers at risk there was still a lot of evidence available to warn of the pitfalls. Spending ones life savings on a property of dubious construction surrounded by unmade roads, with no connection to utilities and amongst mountains of fly tipped builders rubble and plastic bags only to realise in time that the unit is only worth 30% of what you paid, assuming a buyer can be found,is a harsh lesson to learn. Therefore is it any surprise to learn that there is a chasm between housing loans and value of collateral held by banks.

    Well done to Mr Loizou for his analysis but citizens must be protected from the archaic and immoral legal process of standing to lose their properties due to circumstances beyond their control and in some cases as a result of, what in most countries would be considered, fraud. Lets hope a solution is found to protect buyers and at the same time not endanger the economy.

  • John Rose says:

    The figures don’t add up
    Loan taken out in 2006 LTV 80% £80
    Property value(100%) £100 in 2006

    Property prices have halved by 2012 so the loan will be £80 which is £30 greater than the value of the property now which is £50
    ie negative equity

  • Jim says:

    Pavlos, would you make a similar model based on non performing developer loans?

  • Geo says:

    The banks will not repossess property, despite their threats to do so, because they do not want valueless “assets” when they can come after property with value in the UK. Despite these Cyprus properties being written into their Cyprus mortgage agreement as “security”.

    Those who bought in 06/07/08 have seen their title less properties plunge in value by 60/70%. Negative equity? you bet and then some!!!

  • Costas Apacket says:

    This is an interesting report, but it seesm to ignore the fact that a large number of property assets will have double loans secured against them.

    One loan for the purchaser, and another one for the Developer.

    What would be the shortfall if the actual LTV was nearer to 180% of the original sale price Pavlos?

  • Steve says:

    Notwithstanding any questions on the assumptions made (for example, what proportion of mortgagees actually borrow less than 80% of MV?), this article prompts the raising of some important secondary issues.

    Most of the developers’ sole means of income is from selling houses and this must fund all overheads, including borrowings. Assuming they used to make 40% profit on house and apartment sales, their net profit now could be negative or single figures on the few properties they manage to sell. If they go bankrupt, then they will not be fixing the building issues that are currently preventing the issuing of many title deeds and they will not be around to fix the future construction problems (for which they are liable if caused by flawed design or construction) as and when they occur, like walls falling down, subsidence, collapsed drains, etc. Nor will they be providing the tax records to enable their clients to claim back immovable property tax that may have to be paid.

  • andyp says:

    On our development of 10 houses, of fairly standard construction, we had 640,000 Cyp. I would therefore suspect that the total figure would be mind boggling.

  • andyp says:

    I wonder how much “collateral” has been secured against property without the knowledge or authority of the rightful owners?

  • Gavin Jones says:

    Pavlos Loizou.

    Thank you for taking the time and trouble in providing us with the information.

    Unless I’ve misread the above, I understand that the above only refers to private individuals who’ve purchased properties on a mortgage.

    Are the figures readily available relating to the indebtedness of Cypriot developers to the banks or will we possibly have to rely on the troika before these are made public?

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