In this report, S&P Global Ratings presents a summary of the key developments in the European RMBS markets during the third quarter of 2021, focusing on the Spanish private rental market, in light of the recently announced Spanish Housing Act.

In Focus: Spanish Residential Rental Sector

A seismic shift in rental demand caused by deteriorating house affordability in Spain has been accompanied by increasing rental prices. In response, Spain's minority coalition partners have agreed on a draft housing law that could shake up the Spanish rental market and could create the conditions precedent needed to nurture a buy-to-let mortgage market.

Home ownership rates in Spain are among the highest in Europe, but lending conventions in Spain typically limit loan-to-value ratios for owner-occupation mortgages to around 80%. Because of high youth unemployment and depressed wages, younger households in particular have increasingly turned to renting, rather than home ownership, over the past 20 years, especially since the global financial crisis. Caixa Bank reports that about 52% of people aged 16-29 now rent their homes, up from about 36% in 2008. Nationally, approximately 17.8% of people in Spain rent their property, up from an estimated 10% at the turn of the millennium.

Chart 1

Table 1

The draft law strongly favors smaller landlords over larger, corporate landlords.

For example, landlords that own more than four dwellings will be charged a surcharge of up to 150% on local property tax (IBI) for "vacant properties." At present, no clear definition of vacant properties has been given. We already know that second homes, those listed for rent or sale, houses used for education purposes, and those which are entangled in legal disputes are all excluded. In build-to-rent developments, 30% of the units are to be earmarked for social housing, aimed at renters under certain income thresholds. Rents for "large owners," mostly REITs and institutional investors that own more than 10 units, will also be constrained in areas seen as unaffordable. The draft law also links rents to an inflation index in certain "stressed areas," defined as those where average rent represents more than 30% of household disposable income and has increased by more than 5% above inflation in the past five years.

The law includes changes to the tax deductions allowable that would favor smaller landlords. While deductions for corporate landlords are to be cut to 40% of operating costs from 85%, tax deductions could rise to 90% from 60% for small landlords, if they reduce rents and keep subsequent increases within a specified inflation index.

Rent freezes, combined with tax hikes for larger landlords and tax breaks for smaller landlords, are likely to alter the competitive landscape significantly in favor of smaller landlords.

Direct aid for younger renters with lower incomes

One of the clauses in the law is designed to assist people with their rental payments. It provides 18-35 year olds whose income is no more than €23,725 with direct housing aid of €250 per month to assist with rent payments. Local reports suggest that this will give people an incentive to move out of their parents' homes.

Will the changes reduce barriers to entry for new landlords?

At present, smaller landlords in Spain are not able to access the type of interest-only buy-to-let mortgages common in other markets. Rental properties in Spain are typically funded in one of three ways:

• They are owned outright, without a mortgage;
• They are second homes, owned by borrowers whose income can support mortgage payments on more than one loan; or
• They are funded through a corporate loan to a landlord that has a sizable portfolio.

Underwriting as a second home limits the size of a borrower's property portfolio to their salary, rather than the yield on their portfolio, although interest rates can be keen at 0.89%-2.6%, depending on whether the borrower is a customer. The loans also amortize, whereas corporate landlords can typically access interest-only loans. This gives larger landlords a huge advantage, because rent may not be able to justify the loan on a capital and interest basis. An amortizing loan also reduces the borrower's leverage, and so limits the potential upside.

The increase in rental demand, combined with proposed changes in tax regimes would that appear to favor smaller landlords at the disadvantage of larger landlords begs the question: What are the barriers to the development of a buy-to-let market in Spain?

Fundamental barriers to a buy-to-let market appear limited

Loans to individuals in Spain tend to be repayment loans because of market convention, rather than a regulatory requirement. This means that there is no obvious regulatory reason why a buy-to-let loan could not be underwritten on an interest-only basis. This would appeal to existing and prospective landlords and changes the economics of underwriting a loan significantly, compared with a repayment loan.

Nonbank financial companies can undertake mortgage lending in Spain. They are regulated by the Bank of Spain, but no regulations appear to prevent them from underwriting mortgage loans to individuals based on rental income, rather than earned income. They would likely use warehousing to raise the funds and securitization as an exit strategy.

Certain elements of the Spanish residential regime are favorable to tenants. For instance, tenancy agreements have a minimum five-year period, breakable at the renter's option. Rent increases are also capped at consumer price index (CPI) inflation. However, other fundamentals appear robust and similar to those in other established buy-to-let (BTL) markets. For example, there is a clear process for eviction on nonpayment of rent and landlord rental default insurance is readily available. However, repossession takes longer in Spain than in other established BTL markets, such as the U.K. and the Netherlands.

The effect could be blunted by a lack of regional government support

Because of the relative autonomy which regional governments enjoy in Spain, the country's Autonomous Communities will be able to choose whether to apply these directives, and the degree to which they wish to implement them.

As yet, no enforcement timeline has been stated, but we estimate that the new measures would become enforceable from late 2022 onward. Because of the degree of uncertainty around the details of the final housing law and how it will be applied and enforced, we cannot yet accurately gauge the economic implications for the Spanish residential market.

Conclusion

Rental demand appears to be robust. It may be speculative to suggest that the law could have a significant enough effect on the market to alter the economics of property ownership. We cannot yet tell if, for example, larger landlords will consider divestment of their positions. However, the law is likely to improve the economics of being a landlord for those that have smaller portfolios, especially if interest-only residential investment loans became available. We consider it unlikely that banks would see a specific BTL product as worth promoting, because it would initially be relatively niche. Therefore, the development of any such market would likely need to be initiated by a nonbank lender.

Mortgage Market Updates

United Kingdom

COVID-19 measures update: 

• The U.K.'s furlough scheme concluded at the end of September. As previously communicated, we do not expect adverse performance to be show up in investor reports until early 2022. However, our discussions with U.K. RMBS servicers to date suggest that the end of the furlough scheme has not led to a noteworthy increase in borrowers that have payment problems. Servicers and originators cite various reasons for this, but chiefly that the overlap of borrowers left on the furlough scheme and mortgage borrowers was small. By the end of the scheme, those still on it were often younger people and those who are self-employed in the "gig economy"; these were less likely to be mortgage borrowers. Notwithstanding this positive sentiment, we anticipate that legacy U.K. RMBS borrowers will feel the bite of inflation and potential rate rises in 2022, leading to increases in delinquency.

U.K BTL market is becoming increasingly crowded. 

• Hot on the heels of the trend we identified last quarter, more large corporate landlords are entering the U.K. residential market. Q3 has seen another at least another three BTL landlords launch or announce their intention to launch. Two nonbanks--Market Financial Solutions and Quantum Mortgages--both announced that they intend to pursue borrowers who are underserved by the high street. In addition, Atom Bank has announced that it is partnering with Landbay to originate £500 million of prime BTL assets and both Recognise Bank and Monument Bank have announced that they have launched a BTL range targeting professional landlords. At this stage, it is not possible to say to what degree this additional lending represents new origination capacity for U.K. BTL landlords, as opposed to cannibalizing existing lending. To some degree, it depends on external factors, such as the wider state of the economy and the supply of higher LTV mortgages to first-time buyers.

• For firms regulated by the Prudential Regulatory Authority (PRA) and Financial Conduct Authority (FCA), the PRA underwriting regulations create a backstop that limits underwriting creep. However, if the increased supply of credit to this sector becomes an oversupply, it may become an issue. In such a scenario, even regulated lenders may be forced to compete on other elements of the credit proposition, such as pricing or property type. These aspects are not specifically covered by regulation. For example, we could see more lending on larger and more-complex houses in multiple occupation (HMOs). HMOs are defined as properties rented out by at least three people who are not from the same household; larger properties require a license. We also consider that the recent contraction of rates in BTL lending indicates increased competition and a potential increase in risk in the sector.

Excess spread could be squeezed in 4Q2021 and into 1Q2022. 

• In the first quarter of 2020, U.K. RMBS transactions were enjoying "peak excess spread" because of the prevailing competitive dynamics in the origination space and swap rates. Despite the recent decision not to increase interest rates, we expect to see the opposite trend in transactions executed in 4Q2021/1Q2022. Five-year swap rates are rising and we estimate that competition has forced down asset pricing by 20-50 basis points (bps), depending on the asset. The impact will depend on the exact origination vintage of assets and the swap rates that lenders are able to lock in.

Chart 2

Predicting prepayments in U.K. RMBS transactions is notoriously difficult. 

• Prepayment rates are driven by events both external to the deal, such as prevailing rates and house price movements, and internal factors, such as whether product switches and further advances are retained in the transaction.

• We expect the stabilization in house prices, combined with the expected increase in interest rates, to cause prepayments to fall over the course of 2022. Stabilizing house prices make it harder for borrowers to refinance because their equity in the property will not be sufficient to warrant a further loan. Higher interest rates mean that the delta between the rate a borrower is currently paying and the refinance rate is not sufficiently large to justify paying early repayment penalties. The recent decision to hold rates may lengthen the window of opportunity to refinance, but overall, we expect to see lower prepayments in 2022. That said, prepayment rates on a deal-by-deal basis may vary widely, depending on fixed-rate maturity profiles.

Falling or static house prices may lead to a change in underwriting standards. 

• In our house price outlook for Europe (see "European Housing Market Inflation Is Here To Stay," published Nov. 2, 2021), we predicted generally flat house price growth for the U.K. in 2022. If this proves accurate, this would bring to an end a run of nine years of consecutive price rises in the U.K. Rising house prices can create an illusion of growth for mortgage lenders--as house prices grow, average loan advances increase, meaning that lenders can increase net lending without advancing more loans. Stagnating house prices will present a challenge to mortgage lenders if shareholders continue to expect growth in net lending when the house price environment is not supportive. Especially in the case of BTL, this is happening at a time of increasing competition.
• Lenders tasked with increasing their loan books at a time of flat house prices have several tactics available to them. Some of these will be obvious within standard portfolio metrics--for example, increasing loan to values represents a move down the risk curve. However, they could also adopt other, more subtle tactics, such as changing risk appetite on security properties, extending terms of owner-occupied properties, and increasing the amount of credit given to variable incomes. Although we view stagnating house prices as an issue for all European mortgage lenders, nonbank lenders that only lend mortgages face a unique challenge. These lenders supply the bulk of the U.K.'s securitization supply. Therefore, we will pay particular attention to underwriting changes in the coming year.

Elevated fees in U.K. RMBS:  Over the past 18 months, we have observed an increase in non-servicing-related fees in certain U.K. RMBS transactions. This has been more notable in "orphaned" transactions, where the transaction is no longer part of the initial seller's strategic funding plan. From discussions with servicers, we understand that the increases stem from two separate, exceptional events:

• Issuers have faced additional costs associated with the implementation of IFRS 9; and
• More recently, issuers have faced increased costs related to LIBOR transfer.

Given that most transactions are still generating excess spread and do not have reserve fund draws, we do not see this as an issue in the short term. Increasing fixed fees may become an issue in transactions that have low pool factors, but we would expect fixed fees to fall next year if the reasons given for the increase are accurate. This will be worth monitoring in 2022.

Trend toward more M&A continues: 

• Kensington Mortgages has reportedly been put up for sale by its owners. Public details of the sale remain limited. However, the sale continues the trend first observed at the start of the year, when The Mortgage Lender was sold to Shawbrook. The sale of both Fleet and Paratus were reported last quarter. As we mentioned in last quarter's update, specialist lenders can achieve higher rates, which are attractive to banks and fixed-income funds alike in the current low interest rate environment.

Market is readying itself for more green mortgages. 

• We have not seen any additional green-labelled transactions in the U.K. since Kensington's debut green transaction in Q3. However, the market seems to be readying itself for further green issuance. Some BTL lenders have launched products designed to improve a property's energy certificate, and in the past quarter, more lenders have positioned themselves to launch such products.

Longer-term, fixed-rate loans to return. 

• Rothesay Life has announced it will team up with an unnamed U.K. lender to offer 25-year, fixed-rate mortgages. This extends a trend we have already seen--specialist lenders Habito and Perenna offer similar long-term fixes. Such products may be popular, given that rates are expected to rise. To the extent that they become common in U.K. RMBS transactions, they may alter prepayment dynamics significantly.

A late move to synthetic LIBOR: 

• The FCA has announced that "tough legacy" contracts can transition to "synthetic LIBOR" when LIBOR is discontinued at the end of 2021. The expectation is that synthetic LIBOR would continue for up to 10 years and that each year, the FCA will announce whether it will continue to publish it. The announcement is likely to pave the way for a late flurry of legacy U.K. RMBS transactions to elect to transition to synthetic LIBOR on the asset side. Chart 3 shows the status of LIBOR transition on the liability side of RMBS transactions we rate, as of Oct. 31, 2021.

Chart 3

Netherlands

Regulatory changes could alter local rental markets.  We have already considered the potential impact on the Dutch rental market of the legislation that comes into force on Jan. 1, 2022. The new law is aimed at freeing up housing supply to owner-occupiers. Since then, there have been two noteworthy developments:

• Amsterdam has announced that it intends to prevent investors from purchasing property valued at below €512,000 to rent out. The proposed ban does not apply to existing rental property, so the collateral backing existing Dutch BTL transactions should be excluded. This supports our previous conclusion that a ban would support demand for existing rental property by restricting new rental supply.
• Amsterdam has also introduced a requirement that holiday rental property be registered with the city. This could be more negative for rental yields.

According to Dutch newspaper Volkskrant, the municipality found that the number of rental addresses in Amsterdam dropped to 4,128 on Oct. 4, 2021, from 18,715 on March 28. Airbnb lost three-quarters of its housing supply in Amsterdam once the requirement came into effect. As a result, we anticipate that properties that had been holiday lets could return to the longer-term letting market. At this scale, that could place pressure on rents in the short term.

Where now for BTL lenders? 

• Given the changes to BTL regulation in the Netherlands, Dutch BTL lenders will need to evolve if they are to grow in a market where new production of their core product is being curtailed. The most likely outcome is that lenders will seek to lend on properties outside the scope of the ban. This could include lending on higher-value properties and lending on mixed-use residential properties. Whatever the outcome, we expect the risk dynamics of future Dutch BTL deals could look very different from existing ones.

• The crackdown on the private rental sector seems at odds with rhetoric from the De Nederlandsche Bank (DNB), which has recently advocated for building more homes and stated that the Netherlands needs more affordable private rental property. The politicization of housing supply is covered in more detail below.

Politics and house prices: 

• According to Statistics Netherlands, Dutch house prices grew 14.6% in the year to Sept. 30, 2021. This prompted the DNB to call for the removal of fiscal incentives, not only those for first-time buyers to purchase property, but also the ongoing tax breaks that support owner-occupation in the Netherlands. The DNB argues that the tax breaks given to owner-occupiers have stifled the development of the private rental sector in the Netherlands.
• Although tax subsidies for owner-occupiers have been lowered in recent years, the DNB considers that they still give an advantage. In the DNB's opinion, any schemes designed to allow first-time buyers to access the housing market by allowing them to borrow more will only serve to increase house prices.
• Although we would not expect dramatic policy reversals based on the DNB's stance, it is worth tracking how this debate develops. It may have a wide-reaching impact on the future of the RMBS market in the Netherlands.

Major lenders in the Netherlands have formed The Energy Efficient Mortgages NL Hub (EEM NL Hub). 

• The group hopes to support the promotion of energy-efficient housing in the Netherlands by coordinating the industry response to the EU regulations for sustainable financing and energy-efficient mortgages.
• The EEM NL Hub aims to develop and maintain a Dutch framework for energy-efficient mortgages that facilitates the translation and application of European regulations into the Dutch mortgage and property market. The development cements the status of the Netherlands as the most progressive country on the de-carbonization of its housing supply.

Ireland

COVID-19 measures update: 

• In response to rising infection rates and hospitalizations, the government has recently implemented new measures to curb the spread of the virus. These include introducing midnight curfews for entertainment venues (bars, restaurants, nightclubs, etc.) and updated guidance on working from home, unless it is essential to attend the workplace in person. There are no plans for the Pandemic Unemployment Payment (which ended on Oct. 26) to be extended because only a curfew has been implemented, and not a lockdown mandate. The Employment Wage Subsidy Scheme has been extended until April 2022.

Housing supply: 

• Like other European countries, housing supply and the cost of housing has become an ongoing mainstream news story and, increasingly, a political issue. Ireland is following similar trends to those observed in other European countries such as Spain and the U.K. For example, properties that had previously been earmarked for sale to owner-occupiers are being sold to large corporate landlords, who are attracted by the high yields and stable cash flow. Legislators are increasingly looking for policies that will improve housing supply and affordability. Policymakers are looking at both shorter-term initiatives and longer-term plans to address the issue.

• The October 2021 budget announced that the help-to-buy scheme, which provides tax relief to first-time buyers, has been extended to the end of 2022. In addition, a zoned land tax that will include any parcel of land, irrespective of size, is to be implemented, after a lead time estimated at two years. The intention of the tax is to disincentivize land banking and encourage development.

• As part of its longer-term strategy, the Irish government announced a new housing policy ("Housing for All: A New Housing Plan for Ireland"). The objective is that "every citizen in the state should have access to good quality homes: to purchase or rent at an affordable price; built to a high standard and in the right place; and offering a high quality of life."
• The policy announcement acknowledges current issues in Ireland, such as the high cost of housing, large amounts of unused housing stock, and lack of sufficient homes to buy or rent in the private sector. The government's ambition is to build at least 33,000 new homes per year, of which 6,500 will be for private rental. The policy also advocates the promotion of shared equity schemes.
• In the rental sector, the scheme proposes extending the Rent Pressure Zone Protections to 2024. These were covered in Q2's Market Update. Rents would be linked to the Harmonized Index of Consumer Prices. It also suggests introducing indefinite tenures for rent leases.
• It is not currently clear how these ambitions are to be reconciled with the Macro Prudential Rules on mortgage lending, which limit loan-to-value ratios in both the owner-occupied and BTL spaces. There have been regular calls from lenders to relax some of these rules. Although they are, in part, responsible for the good performance of recently issued Irish RMBS, they have also been criticized for being too restrictive, stifling growth, and preventing people from getting on the housing ladder.

Further agitation for regulatory changes: 

• The main representative body for the banking and financial services sector in Ireland--Banking & Payments Federation Ireland (BPFI)--has been lobbying the government about Ireland's cumbersome repossession process. BPFI claims that the slow process, combined with high capital charges against mortgages, puts the country at a disadvantage. According to BPFI, capital charges are three times higher than the EU average. Irish mortgage rates are the second highest in the EU, behind Greece. The weighted average interest rate on new fixed-rate mortgages was 2.62 per cent in August 2021. This compares with a eurozone average of 1.21%. As in the Netherlands, we monitor pressure to relax the regulatory frameworks that control mortgage lending in case there are consequences for credit risk within RMBS.

Italy

• Italy has extended its Covid assistance scheme to the end of December; previously it was expected to close at the end of September. Companies whose activities have been impacted negatively by COVID-19 can place their employees on temporary leave and get support to pay salaries from the state. Companies that request access to this scheme are not allowed to lay off their employees.

• The Italian government has announced that it will extend the "super bonus scheme" until the end of 2023, making it more likely that we will see green RMBS issuance in Italy. The scheme was scheduled to conclude at the end of 2021 and allows homeowners to offset expenditure of up to €110,000 on home improvements such improving energy use, installing electric car charging points, and installing more-efficient windows against future tax. The scheme was introduced to create stimulus during the pandemic. About €9 billion of the funding has been used in 2021. Even if the scheme does not lead directly to green RMBS in Italy, the modernization of Italian housing stock is likely a positive for RMBS as it will increase the value of the properties and thus the equity borrowers have in a property. It may also limit losses on liquidation in the event of repossession.

Portugal

• In Portugal, the payment holiday application period has ended. Payment holidays ended at the end of September. We anticipate that it may be three months before investor reports reflect the scale of payment difficulties among borrowers.

France

Regulatory tightening of underwriting:  In December 2019, the French regulator (French High Council for Financial Stability, HCSF) introduced lending criteria recommendations for French mortgage loans, to prevent household indebtedness and limit the consequences for financial stability. In January 2021, the HCSF slightly softened its guidelines, advising that borrowers' debt-to-income ratio (DTI) should not exceed 35% (previously 33%) and that loan maturity should not exceed 25 years (or 27 years if the start of amortization has been deferred). However, the HCSF recommendations allow for some flexibility--up to 20% of originations can diverge from the guidelines. The HCSF intends that lenders use this flexibility primarily for owner-occupied properties (at least 80% of exceptions) and especially first-time buyers (at least 30% of exceptions). The 35% DTI rule also applies to BTL investors. In such case, to calculate the DTI ratio, the rental income is added to the income of the borrower, with a typical haircut of 30%, while the debt repayment is taken in full. This limits the development of the multi-property BTL market in France.

Until September 2021, credit institutions were not obliged to follow HCSF's guidelines. On Sept. 29, 2021, the HCSF decided to make its recommendations legally binding. The decision will be effective from Jan. 1, 2022, for all credit institutions. The ACPR (Autorité de Contrôle Prudentiel et de Résolution) is in charge of enforcing the resolution and can impose sanctions if applicable. That said, nearly all banks were already following HCSF's rules before Sept. 29. Since the recommendations were made in 2019, the share of nonconforming loans--those that have high DTI or long maturities--have decreased significantly to 20.9% in July 2021 from 48.3% in the first quarter of 2020. The HCSF confirmed that the constraints did not restrain access to residential mortgage for low-income households, and that loan production remained dynamic.

Related Research

• European RMBS Index Report Q3 2021, Nov. 8, 2021
• European And Japanese Structured Finance Markets Approach LIBOR Cessation While U.S. Markets Prepare For A Major Shift, Nov. 2, 2021
• European Housing Market Inflation Is Here To Stay, Nov. 2, 2021

Social RMBS: Is The Pursuit Of Housing Equality A Risky Business? Sept. 1, 2021

• Why U.K. Buy-To-Let Has Defied Gravity Through COVID-19, Aug, 3, 2021
• How Will European RMBS Respond When COVID-19 Relief Measures Come To An End?, July 12, 2021
• European Structured Finance Market Accelerates Transition From LIBOR, Feb. 9, 2021
• European RMBS Outlook 2021, Jan. 25, 2021
• European Economic Snapshots: Policy Is Keeping The Impact Of The Second COVID Wave At Bay, Dec. 16, 2020