The Dutch RMBS market is specific, and resilient
The property market is a bellwether for the performance of the economy, and the market for the securitisation of residential mortgages follows suit. The Dutch market is a case in point. Yuval Toledano, EMEA Structured Finance analyst at credit rating agency Moody’s, views the performance of Dutch RMBS in 2023 with guarded optimism during a conversation ahead of the Securitisation Event in Amsterdam.
What does the European RMBS issuance landscape look like from where you are sitting?
European structured finance issuance more broadly was relatively subdued at the beginning of this year, mainly due to uncertainty regarding the impact and extent of monetary policy tightening by central banks. However, issuance has picked up recently. Activity has also picked up in The Netherlands, mainly in Prime and buy-to-let RMBS. Overall, we expect that issuance volumes in 2023 will be similar to 2022 in most European consumer and SME ABS markets, driven by large retained prime transactions. However, we expect that transaction activity will slow in some sectors, such as NPL
How does the Dutch housing market fare today?
After several years of exceptionally high house price growth, the sentiment on the Dutch housing market has clearly turned and house prices have started to decline. So far, however, the pace of the decline has been moderate, and we expect house price levels to be supported in the coming years by a deep and persistent housing undersupply.
There is broad agreement in The Netherlands that the pace of construction of residential properties will need to accelerate over the coming years in order to address this imbalance and ensure adequate housing for the Dutch population. However, the construction sector is facing strong headwinds throughout Europe and in The Netherlands – increasing energy and raw materials costs, decreasing house prices, and slowing economic growth. In addition, environmental regulations – for example relating to nitrogen emissions – are slowing down and sometimes even preventing new construction projects. These factors will limit the degree to which house prices will decrease.
Nevertheless, the current macroeconomic climate, which features high inflation and rising interest rates, may lower households’ borrowing capacity by pushing up mortgage interest rates, thereby temporarily reducing demand for house purchases. Similarly, although the labour market is likely to remain tight, weak economic activity and the impact of inflation on households’ purchasing power could also temporarily lower demand for house purchases.
How does the price of housing affect the mortgage market in the Netherlands?
To understand today’s Dutch mortgage underwriting standards, it’s important to look at the historical context. Between 2008 and 2014, in the wake of the global financial and European sovereign debt crises, Dutch house prices decreased by around 25% peak-to-trough in real terms. Because loan-to-value ratios for Dutch mortgages were very high, the result was that around one-third of Dutch mortgages slipped into negative equity. In order to improve the resilience of the mortgage market and increase the stability of house prices, the Dutch government decided to overhaul the underwriting requirements for Dutch mortgages. It’s partially as a result of these efforts that the Dutch mortgage market is now in a better position to weather an economic downturn.
What specific type of changes?
The three most important changes were, in chronological order: (1) a much stricter application of the mortgage underwriting code of conduct, which was later even superseded by specific mortgage underwriting legislation; (2) the limiting of tax deductibility of mortgage interest payments on newly originated mortgages to loans which fully amortise within 30 years on at least an annuity schedule; and (3) the gradual reduction of the maximum loan-to-value ratio to 100%, with a limited exception up to 106% to allow for investments in energy-savings measures. Taken together, these changes have completely altered the types of mortgages originated in The Netherlands – something we can clearly observe in our loan-level data. The stock of pure interest-only mortgages, and especially of more complicated interest-only products with associated deferred principal repayment vehicles such as savings accounts and insurance products, is gradually being phased out of the Dutch mortgage market.
How does the Dutch market compare to other European countries?
On the surface, some of the characteristics of Dutch mortgages still compare unfavourably against those in many other European countries. Despite the gradual reduction, a maximum loan-to-value ratio of 100% is still exceptionally high in an international context. However, given the tax deductibility of mortgage interest payments, Dutch households are to a certain extent incentivised to maximize their mortgage debt, so the high loan-to-value ratios are not necessarily indicative of underlying weak borrower credit profiles. And, in fact, Dutch RMBS has consistently been among the strongest-performing RMBS markets in Europe. Dutch RMBS pools tend to have low arrears and very low defaults and losses.
What is the evidence?
During the steep house price correction between 2008 and 2014, our 90+ days arrears trend for Dutch RMBS increased, but remained at very low levels, peaking at only 0.75% of outstanding pool balance in June 2014. During this period, Dutch RMBS outperformed other major European RMBS markets, such as UK Prime RMBS, reflecting the strong credit fundamentals in The Netherlands. Arrears levels have since sharply declined, and currently our 90+ days arrears stands at a historic low of 0.08% of outstanding pool balance. This robust performance is driven by a number of different factors, including full personal recourse to the borrowers, a creditor-friendly personal insolvency regime, the availability of a public mortgage loan insurance scheme (NHG) for many lower-income borrowers and first-time buyers, strict affordability testing, and a generous social welfare system.
Is the strong performance through the financial crisis reflected in your analysis?
Moody’s is proposing several changes to our methodology for rating RMBS backed by residential mortgage loan portfolios originated in countries other than the US. On March 6th, we published two Request for Comments (RFCs) that describe the updated general framework, as well as several changes to five country-specific settings including the UK and Ireland. We expect to publish on a rolling basis separate RFCs to address country-specific settings for the countries where we rate RMBS using the MILAN framework, including The Netherlands.
The proposed changes to our MILAN Stressed Loss analysis (MILAN analysis) include updates to several components of our analytical and modeling framework. We expect the proposed changes to allow the MILAN analysis to better discriminate between residential mortgage loan portfolios with different loan and portfolio characteristics and associated credit risk and to better reflect the strong performance that prime RMBS pools have exhibited during multiple crises.
For additional transparency, we have also published an external version of the MILAN model that reflects the proposed new approach and a loan-level data template. These materials will remain available during the RFC period and can be used to model residential mortgage loan portfolios using the proposed updates. We have also released an external RFC version of the ABSROM model that can be used to evaluate cash flows derived from portfolios of assets and their associated liability structures under the proposed approach.
Are you seeing new innovations in the RMBS market?
One interesting trend which began to pick up steam around 2019 is the growth of the private rental market in the Netherlands and the subsequent issuance of Dutch buy-to-let RMBS. Since the first transaction by Domivest in 2019, the issuance of Dutch buy-to-let RMBS has increased significantly. For a while, as house price were increasing at a rapid pace, the Dutch rental market was growing, especially in the large cities within the Randstad. There was a backlash, however, in the form of a growing public sentiment that private investors with deep pockets are pushing up house prices and crowding out first-time buyers. As a result, over the past two years, the Dutch government has enacted various measures intended to curb the growth the private buy-to-let market.
What has changed?
Among other measures, the government introduced a rental permit system called opkoopbescherming, under which Dutch municipalities are permitted to require the issuance permits for the purchase of properties for rental purposes. Almost all large municipalities have now implemented a version of this permit system.
The transfer tax for buy-to-let purchases has been increased, while at the same time being decreased for the purchase of owner-occupied properties, especially for younger buyers of lower- and mid-priced homes. And various other measures have been implemented which have increased the tax burden on private landlords. This climate makes investing in buy-to-let properties in the Netherlands less attractive, and it limits the potential for growth in the sector. And that is also what the Dutch government intended.
Does this change your outlook?
It does – in terms of the issuance volumes of Dutch buy-to-let RMBS. In the past we forecasted an increase in the issuance of Dutch buy-to-let RMBS. However, given the adverse impact of these measures the economics of the BTL business, we now expect the issuance of Dutch buy-to-let RMBS to decline. It’s important to note, however, that the performance of outstanding Dutch buy-to-let RMBS has been excellent to date, and we have a stable collateral performance forecast for this sector for 2023.
Have you seen any other trends?
Some Dutch mortgage lenders have begun offering green mortgages. These come with interest rate discounts for highly energy-efficient properties, as well as properties which improve their energy efficiency by at least one EPC category. This is a trend which we expect to continue developing over time. We expect mortgage lenders to increasingly offer better terms for loans on energy efficient properties, which includes lower interest rates, as the growth of the green mortgage volume continues.
Does this impact RMBS?
The Dutch market has been somewhat ahead of the curve regarding green RMBS. Europe’s first green RMBS deal was Obvion’s Green STORM 2016. Since then, Obvion in particular has been very active in green RMBS issuance, having built up the Green STORM program with multiple subsequent issuances of large volumes. The main challenge for such securitisations is the availability of green collateral: loans backed by energy efficient properties. That is the main limiting factor for green RMBS. But that will likely improve as data availability improves and the coverage of EPC ratings for properties improves over time. There is a lot of investor appetite for green RMBS but currently the stock of loans is limited.
Is there anything else which you will personally be looking out for during the event?
I’m very curious to hear how the other market participants believe the Dutch economy and housing market will fare in the new environment of high interest rates, high inflation, and declining house prices. I’m looking forward to an interesting exchange of ideas.
For more information or tickets, visit the eventpage of the Securitisation Event 2023.