S&P Global Ratings believes Russia's housing market will stabilize in the second half of 2021, as the country's subsidized mortgage program expires midyear. The volume of new mortgages in 2021 will likely be about Russian ruble (RUB) 3.5 trillion-3.8 trillion, compared with RUB4.3 trillion in 2020. What's more, we see another decline in 2022 in absence of new state-supported programs to stimulate the market. In the first half of 2021, mortgages will continue fueling retail lending growth, but then slow in the absence of growth drivers but also due to higher housing prices. Strong demand for residential real estate in 2020 has already led to an increase in prices, which is likely to temper demand for new mortgages. We expect a gradual moderation in mortgage lending growth to about 15% in 2021 (from about 22% in 2020), and a further 12%-14% slowdown from 2022.

We saw some frothy market behavior in 2020. Some people started spending savings to purchase residential real estate, though many of them used mortgages, including subsidized programs. However, when the program ends, we don't think housing market will collapse. We anticipate that reduced interest rates on deposits, the still-developing financial market, and limited alternatives for savings and investments will support demand for residential real estate and, therefore, mortgages. Furthermore, the purchase of a newly built property, including mortgage-backed deals, has become easier because the largest developers are selling houses online.

Housing became less affordable in 2020 due to the weaker economy. The Russian economy contracted 3.1% in 2020 on the back of the adverse effects of the COVID-19 pandemic, oil output cuts under the OPEC+ agreement, and lower oil prices. Although the contraction in output has been milder that initially expected, the unemployment rate has increased to about 5.9% as of end-2020 from 4.6% the year before, and real disposable income declined by 3.5%.

State support has counteracted the negative macroeconomic trends. In 2020, the state-orchestrated mortgage program, which pushed the Russian mortgage rate to historic lows, lifted demand for new housing despite the weakened real income of homebuyers. In 2020, Russian banks issued a record RUB4.3 trillion (approximately $60 billion) of mortgages, where about 25% were issued under the state support mechanism (see chart 1). Starting from May 2020, the Russian government announced a special program of mortgages with subsidized interest rates at 6.5%, compared with a weighted average market rate of 8.3% in April 2020. The initiative was supposed to support sales of homebuilders after the lockdown ended and aimed to grant RUB800 billion of mortgages over May-October 2020. Subsequently, the program was prolonged to July 1, 2021, with the additional allocation of RUB1.1 trillion in subsidized mortgages.

Chart 1

State support created better conditions not only for the increased issuance of new mortgages but also for refinancing existing ones. The state-supported mortgage program pushed down market interest rates, which gave a boost to various refinancing programs for previously issued mortgage loans. The share of refinancing increased to 14% of new issues by January 2021 (from 6% a year ago).

Low interest rates in the Russian banking sector have also made mortgages more attractive. The retail funds flowing into the banking system have stagnated, as deposits lost their attractiveness as a savings instrument. We note that, in November 2020, the average interest rate on retail deposits reached a new low of 3.2%, with the inflation-adjusted rate plunging into negative territory and ending the month at -1.2%. We think retail depositors will be less willing to keep their funds in a bank account if banks continue to keep deposit rates low (see "Russian Banks Face A Tougher Path To Profit," published on Jan. 27, 2021).

Despite the double-digit growth in the mortgage market in the past four years, at an average annual 20%, we currently don't see the formation of an asset bubble. Total mortgage debt as a share of Russia's GDP is low at only about 8.5%, on a par with that of Turkey (5%) and Brazil (8%), but much lower than for other middle-income countries like Poland (20%) and South Africa (30%). Indeed, this moderate share and the profile of Russia's mortgage debt indicate potential for further growth in mortgage volumes. The share of mortgages with initial down payments of less than 10% stood at a moderate 3% of the stock at end-2020, according to DOM.RF.

House Price Growth Is Likely To Moderate When The Stimulus Ends

Low interest rates fueled demand in 2020, leading to price growth. We believe that low interest rates, coupled with expectations that the government-subsidized mortgage program would expire soon, pushed forward housing demand and fueled price growth. In Moscow, in particular, prices spiked at the end of 2020, mirroring trends in mortgage issuance. Across Russia, prices of newly built housing jumped more than 20% in 2020 (see chart 3), which far exceeded growth in previous years.

Chart 2

Chart 3

Contributing to price growth, we believe, was about a 6% decline in 2020 in new housing completions (including private homes and blocks of flats). After completions fell to lows in April and May 2020 due to COVID-19 restrictions, the market rebounded in the second half. Completions rose above 2019 levels between August and November, but December, traditionally the best month of the year, was weaker than in 2019 (see chart 4). That said, we believe that the Russian housing market proved to be steadier than some markets in Europe, the Middle East, and Africa, where completions dropped by a double-digit rate after COVID-19 restrictions.

Chart 4

Demand is more than offsetting tighter supply, but we expect the market to come to equilibrium in the next six to 12 months. Some completions and new housing starts spilled over to 2021, but the construction pipeline for homebuilders as of February 2021 was still about 15% lower year on year across the country. As a result, we believe demand will continue to outstrip supply in the first half of 2021, and we expect the state-support mortgage program will remain the engine of demand. As soon as the state-supported program expires, we expect the weighted average market interest rate on mortgages to stabilize to about 7.5% in 2021, and price growth to soften. We understand the subsidized mortgage program is currently expected to be terminated in mid-2021 but might be extended beyond that point. If so, it would likely be more selective and exclude regions and segments where price growth has been the strongest, we assume.

Price And Supply Imbalances Among The Regions Are Likely To Grow

The Russian housing market's structural imbalances are likely to worsen, mainly because of uneven economic performances. The housing market has historically been far from homogenous. For some Russian regions, such as the wealthiest or more favorably located ones (like Moscow and the Moscow region, St. Petersburg, and the Krasnodar region) price rises in 2020 were stronger than for others, and we expect this to continue in 2021 and 2022, mostly due to stronger investment demand.

When it comes to mortgages, we observe a broadly similar bias. Central and northwestern regions, together with the largest cities--Moscow and St. Petersburg--represented about one-half of banking mortgages granted in 2020 (see table 1), heightening regional concentration.

Table 1

We expect that the higher wealth of the best-performing regions would likely support mortgage activity through 2021 and 2022. However, we believe the gap between the regions could widen because poorer regions will be more susceptible to declines in disposable income, which was already negative in 2020 (see chart 5). We also factor in the increasing debt of the working population, especially in the context of recently increased unemployment. We understand that more favorable interest rates have not materially reduced mortgage payments on newly granted loans because of price growth, which has increased the average mortgage payment.

Chart 5

Credit Risk For Mortgages Is Contained, For Now

Credit risk for mortgages at Russian banks is currently contained, with nonperforming loans (NPLs; more than 90 days overdue) standing at about 1.4% at end-2020 and likely to remain steady in 2021, all things being equal. A modest RUB40 billion of mortgages (0.4% of the total mortgage stock) has been restructured because of the pandemic impact's on borrowers' standing, according to Central Bank of Russia data for March to December 2020. Over 2009-2020, nearly 11 million mortgage loans were granted to households. In 2020, there were 5.9 million applications for mortgages, and 3.6 million were fulfilled. By end-2020, the average approval rate stood at about 61% and 65% on subsidized programs, which doesn't signal looser underwriting standards. By the third quarter of 2020, the average loan-to-value ratio exceeding 80% stood at moderate 35% of loans, compared with about 28% a year ago. We currently don't see this as an indicator of looser underwriting standards and anticipate this metric will hover at about 30% in the next few years.

We see sufficient room for healthy mortgage growth in 2021 and 2022 without a marked deterioration in the quality of mortgage loans on banks' balance sheets. Servicing the "average" mortgage requires that the borrower's monthly income should be about RUB40,000-RUB45,000. We calculate that based on the average amount of mortgage loans outstanding of RUB2.5 million, with a 7.4% interest rate on new loans, an average maturity of about 19 years (based on DOM.RF's data at end-2020), and a comfortable payment-to-income (PTI) ratio of 50%. In Russia, about 63.5 million people aged 25-55 are the most bankable, while Rosstat figures show that only 24% of the total population (about 35 million) have an average monthly income exceeding RUB45,000.

One factor that could result in higher credit costs for banks are untested, lower-income borrowers. The share of first-time borrowers who took mortgages in 2020 stood at 24% by third-quarter 2020, according to the Central Bank of Russia. Although lower interest rates temporarily increase the affordability of mortgages, the increase in untested borrowers without a credit history could worsen credit risk in a country where household wealth is unevenly distributed. We believe risks could accumulate related to rapidly increasing indebtedness in lower-income groups. Indeed, about one-quarter of mortgages outstanding were granted to borrowers with PTI ratios exceeding 60% by end-2019. See "Why Russian Banks’ Asset Quality And Credit Costs Remain Key For Investors," published on Dec. 15, 2020.

Credit risks could also rise in case of prolonged strong growth in mortgage lending far and above economic growth. We believe relatively low interest rates and a stabilization in Russia's financial markets cannot outweigh rather weak economic growth that does not provide sustainable ground for a prolonged increase in retail debt. We expect that the regulator, which has given signals that it will keep the fast-growing segment under control, will lead to a tighter regulatory environment and a gradual cooling of the housing market.

Homebuilders' Debt Will Rise, But Cash In Escrow Will Gradually Match That

The escrow accounts mechanism, whereby developers can no longer take payment in advance for uncompleted homes, aims to support the transparency of mortgage transactions, protect borrowers from failures of construction companies, which in turn supports mortgage volumes. The total amount of escrow accounts placed within Russian banks reached RUB1.2 trillion (about 3.6% of total retail funds) by end-2020, up about eightfold over the year (see chart 6). At end-2020, 53% of new projects on the residential real estate market involved escrow accounts, up strongly from about 20% in the beginning of 2020. We believe that effective implementation of the escrow accounts mechanism will boost the confidence of potential homebuyers, thereby stimulating demand for mortgages. This will, in turn, increase demand for longer-term projects with expected finalization in 2023-2025.

Chart 6

We believe that escrow accounts will result in negative cash flow for homebuilders in 2021 and 2022 but add transparency and therefore strengthen the housing market. Given average project duration of three years and the introduction of escrow accounts mid-2019, we expect the operating cash flow of homebuilders will remain negative until 2022-2023. We then see it breaking even as escrow accounts release cash after the completion of projects. As a result, we expect that debt will rise in 2021 and 2022 for Russian housing developers, but cash in escrow accounts will increase to gradually match that (see chart 7). This is what we already observed in the first half of 2020. Total reported debt of the five-largest developers increased about RUB58 billion in first-half 2020 and cash in escrow accounts (which is off real estate developers' balance sheets) increased about RUB46 billion. Cash in escrow accounts covered 19% of the top five developers' total debt at the end of first-half 2020, compared with 9% end-2019 (see chart 7). The increased cash in escrow accounts supports future debt repayment of project finance.

Chart 7

We factored in the strong housing market into the three Russian homebuilders we rate: Setl Group (B+/Stable), Etalon LenSpetsSMU JSC (B-/Stable), and Leader Invest (B-/Stable). However, as a result of new project fiance loans, we expect credit metrics to weaken somewhat through 2022. That said, the rated homebuilders entered 2021 with robust cash balances and strong order books on the back of growth in the housing market, placing these companies comfortably within their ratings ranges. We believe that a potential market softening should not create any material downside for our rated issuers.

Because banks hold the escrow accounts related to the financing of new-build properties, they will be able to step up other mortgage-related activities by offering project finance lending facilities to construction companies, managing household funds, and providing mortgages. At the same time, we believe the banks still hold extremely high concentrations in mortgage market players. Thanks to their long track records as leaders in the mortgage market, Sber Bank, together with VTB Bank, accounted for about 70% of all mortgages granted in 2020.

Mortgages Are Set To Become Banks' Main Retail Product

We expect that mortgages will remain crucial for the housing market, as they currently enable an estimated 70% of residential prime real estate purchases and up to 50% on the secondary market. We expect deeper penetration of mortgages into secondary market purchases if interest rates remain at least stable, as mortgage-financed deals gain in acceptance in the country. Moreover, higher prices on prime properties, together with stagnating income, could shift homebuyer demand to the secondary market.

Due to strong growth, mortgage loans are likely to become Russian banks' main retail product in coming years. What's more, they will remain the most resilient segment in terms of growth and asset quality, helping banks balance credit costs and margins. We believe the share of mortgage loans to total retail loans rising further toward 50%-55% in coming years. As of Jan. 1, 2021, mortgages comprised about 45% of retail loans in the banking sector to reach RUB9.1 trillion (about $120 billion), up from less than 30% in 2012 (see chart 8). Mortgage lending growth of 22% dominated the expansion in retail lending in 2020, dwarfing 9% growth in unsecured loans. The higher share of mortgage loans has enhanced the quality of the sector's retail portfolio, as mortgages in Russia have historically performed better than other retail loans and corporate loans.

Chart 8

Editor: Rose Marie Burke.

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