The quality of residential mortgage loans included in Dutch covered bond collateral pools has improved throughout the past decade. This gives some comfort that these assets will be able to withstand challenges arising from any notable increase in interest rates.
The combination of declining interest rates, rising house prices and amended mortgage market rules has fundamentally changed the characteristics of the residential mortgage loan books of Dutch banks over the past few years. Dutch covered bond collateral pools are a good reflection of this.
These changes arguably give some comfort that Dutch residential mortgage assets will be able to withstand challenges that could potentially arise if a) interest rate levels were to rise notably, and/or b) a correction in the Dutch housing market were to take place, due to a rise in interest rates. In this article, we discuss four important trends.
We also note that, as of 1 January, De Nederlandsche Bank (DNB) will start to apply a floor to the risk weighting of mortgage loans of Dutch banks using internal models for the calculation of their capital requirements. This will further strengthen the resilience of the Dutch banking system against a potential housing market correction.
The Share Of Interest Only Loans Has Declined Significantly
Since 2013, only new amortising loans that will be repaid in full within 30 years can benefit from interest rate tax deductibility in the Netherlands. As a consequence, the share of amortising mortgage loans (mainly annuity) in Dutch covered bond collateral pools has risen substantially at the expense of interest only mortgage loans or other types of mortgage loans, such as (bank) saving, investment or hybrid mortgage loans, with full repayment at the end of the term of the mortgage loan. The latter types of loans also provided mortgage borrowers with the full tax deductibility advantages, but unlike interest only loans, these loans are linked to separate savings and/or investment accounts dedicated to the repayment of the mortgage loan at the end of their term.
The increased amortising nature of mortgage loans in the Netherlands reduces the repayment risks related to these loans in the event of a negative housing market correction. That said, we do note that in some covered bond collateral pools the declining share of interest only loans has started to reverse and is modestly trending higher again. The yearly declining tax deductibility of mortgages may have made tax deductibility less of a decisive factor for some borrowers. This is especially true at lower mortgage interest rate levels, which result in lower tax deductibility advantages.
The Share Of Amortising Mortgage Loans In Dutch Covered Bond Collateral Pools Rises
Image Source: Issuer covered bond investor reports (average of three active Dutch covered bond issuers), ING
Loan-to-value Ratios Are At Their Lowest Levels Of The Past Decade
Since the end of 2013, indexed loan-to-market values for residential mortgage loans have declined substantially. The major reason for the improvement in these loan-to-value (LTV) ratios have been the strong house price rises in the Netherlands in the past number of years, leading to an increase in the value of the properties securing Dutch mortgage loans. However, also on a non-indexed basis LTV ratios have improved somewhat, reflecting a) the increased amortising nature of Dutch residential mortgage loans, and b) the gradual lowering, since 2013, of the loan-to-market-value (LTMV) cap for new mortgage loans from 106% to 100% (including transfer tax) by 2018.
That said, we do note that the house price rises and related mortgage market lending growth in the Netherlands in the past years has coincided with an increased market share of non-bank mortgage loan providers, including insurance companies. As we showed in our ING research report Insurer's-Triple Trouble, insurance companies tend to have more favourable capital charges than banks for mortgage loans, in particular in the lower LTV buckets, giving them an advantage over banks in this segment.
Loan-to-value Ratios Are At Their Lowest Levels Of The Past Decade
Image Source: Issuer covered bond investor reports (largest Dutch issuer), ING *WA CLTOMV = weighted average current loan to original market value, WA CLTIMV = weighted average current loan to indexed market value
Mortgage Interest Rates Are Low And Mortgage Rate Reset Periods Are Longer
The European Central Bank's interest rate cuts and accommodative monetary policy stance during the past decade have spilled over into lower mortgage interest rate levels. The lower yield environment also coincided with a flattening of yield curves, which has generally contributed to a narrowing of the interest rate differential between floating rate and fixed rate mortgage loans in the past few years. In addition, the flatter yield curves have seen mortgage interest rate terms being fixed for longer periods of time in the Netherlands. This is illustrated by the rise in the average remaining time to interest resets of Dutch covered bond collateral pools. The lower mortgage interest rate levels have improved the affordability of existing mortgage loans, even though for new mortgage loans, this positive effect has in part been cancelled out by the parallel rise in house prices.
Lower Mortgage Interest Rate Levels And Longer Reset Periods
Image Source: Issuer covered bond investor reports (average of three active Dutch covered bond issuers), ING
Residential Mortgage Loans Are Currently Predominately Fixed Rate
The Dutch mortgage market has always mostly been characterised by fixed rate mortgage loans. However, the combination of declining interest rate levels and a flattening of yield curves has even further marginalised the share of floating rate mortgage loans in Dutch covered bond collateral pools. The substantial share of fixed rate mortgage loans in combination with the longer interest rate reset terms do make Dutch mortgage loans less vulnerable to the immediate affordability impacts of a rise in interest rates. At the same time, this also reduces the flexibility of banks to protect the net interest rate margins on their mortgage lending books in the event that rising yield levels start to affect the funding costs of banks.
The Share Of Floating Rate Mortgage Loans Declines
Image Source: Issuer covered bond investor reports (average of three active Dutch covered bond issuers), ING
Hence, the combination of low mortgage interest rate levels, the increased fixed rate nature of Dutch mortgage loans and the longer interest rate reset periods may cause further pressure on net interest rate margins in the event that yield levels and funding costs start to rise. This is precisely why we expect Dutch banks to remain active in the covered bond market next year, particularly in the longer maturity buckets, to lock in longer term funding at still relatively low yield levels.
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