Which Type Of Funding Is Most Appropriate For Hungary

Introduction

This paper is subject to argue which type of funding is most appropriate for Hungary, one of the emerging countries that is under severe macroeconomic pressure and faces challenges regarding its housing and mortgage market.

After analyzing past and future performance of the Hungarian housing and mortgage market as well as macroeconomic development, a funding mix is suggested that intends to solve current and prospective problems on the Hungarian mortgage loan market. Since all three elements, the past and future development of macroeconomic situation, housing market as well as mortgage market are highly interconnected and have a significant impact on the type of mortgage funding in Hungary, the following shall provide an overview.

Overview and forecast

Housing market

First, the past and future performance of the Hungarian housing market can be described by examining house prices as well as house construction. In general, the Hungarian housing market is characterized by the third highest owner occupation rate (92%) in the European Union and is thus way above the EU average of 69% (chart 1). Although the number of housing units built has been dropping since 2005, and are currently stagnating, some promising signs can be seen as housing permits are expected to increase from the end of 2013 onwards (chart 2). According to the FHB Land Credit and Mortgage Bank Company, house prices are expected to rise, since a gentle and slow-paced upward sloping curve will possibly put an end to the "valley shaped" downward trend that started in 2006 (chart 3).

Macroeconomic situation

Second, important macroeconomic indicators such as interest rates, GDP growth, employment rates as well as income expectations have an impact on future housing demand and are thus examined in the following. Compared to other EU countries, the Hungarian economy was significantly hit by the slow-down in 2011 and 2012. While in 2012, Hungarian's GDP growth reached bottom, the macroeconomic prospect seems rosier as the International Monetary Fund (IMF) predicts a recovery-growth of about 1% for 2013 and a stable upswing until 2017 (1.8%) (chart 4). The unemployment rate currently amounts 10.9% and is in line with the European Union's average of 10.7% . In addition, the decreasing GDP goes hand in hand with a continuously shrinking real income in 2012, which is expected to stabilize in 2013. To conclude, the moderate favorable macroeconomic outlook for the upcoming years, signals that Hungary has reached the turning point what could lead to increased future demand in the housing market.

Mortgage market

Beside those forecasts, the Hungarian mortgage market shows a similar picture and has an idiosyncratic structure as depicted in the following. In Hungary, only mortgage banks can provide loans that qualify for a government program of interest rate subsidies, and most of the bonds have been issued by the mortgage banking subsidiaries of OTP and FHB banks. The mortgage market is characterized by a very strong correlation between the net lending of residential mortgage loans and housing unit transactions as it is indicated in chart 5. The market conditions are perfectly described by the fact that, on the one hand, due to the recession, since 2006 the number of housing market transactions has been decreasing significantly, and on the other hand that, parallel with this, the lending of residential mortgage loans declined dramatically.

The current situation on the mortgage market looks as follows. Lending in foreign currencies (EUR and CHF) is prohibited and residential mortgage debt to GDP ratio was 2011 in line with the other Eastern European countries and with 23% far below the EU average of 52% (chart 6). The high interest rates on HUF-denominated mortgages (Representative interest rate on new mortgage loans of 12.54% , 2011, chart 7), the effect of early repayments at non-market rate on sweeping away savings, and the weak housing market in combination with the poor macroeconomic performance resulted in a stagnating mortgage lending activity in 2010 and 2011. Although the average Loan-to-Value (LTV) ratio amounts 50%, the significant decrease in house prices as a result of the crisis resulted in the fact that 36% of the mortgage debtors have an LTV which is above 90% . In fact, Banks can grant mortgage loans with a maximum 75 % LTV ratio.

Funding and banking sector

The three major mortgage banks (OTP, FHB, Unicredit) fund their mortgage loan portfolio by issuing covered bonds which is the common form of mortgage finance in Hungary. In 2011, covered bonds accounted for 25% of the total mortgage loan portfolio, while 75% of the total mortgage loan was financed by deposits. There has been no issuance of MBS (Mortgage-Backed Securities) to date. Although, the loan to deposit ratio of the banking sector in Hungary decreased to around 130 % by the end of 2011, it is still high in international comparison. The rating agency Moody's notes that banks' performance 2012 remained weak and net interest income, which represents a strength of the Hungarian banks, declined by 6.5% in September 2012 year-on-year, mainly reflecting the increase in funding costs and risk spreads.

Summary and conclusion

The following conclusion is based on the effects of all the factors examined so far.

From customers/borrowers' perspective, as regards the determinants of demand, consumer confidence, GDP growth as well as the associated income growth, significantly high interest rates on mortgages loans and especially housing market prospects have shaped the households' decisions on house purchases. On the one hand, Hungarians are currently on a par with Greece and thus one of the lowest in the world in terms of consumer confidence . On the other hand however, the GDP growths slowly but steadily even though below-average with an estimated increase until year 2017, and the Hungarian housing market is on the edge to recoup from losses since 2009 indicating moderate demand over the medium term.

From banks' perspective, previous years of downturn associated with increasing funding costs and higher risk spreads, but a positive outlook for the housing market, high non-performing loan (NPL) ratios as well as monetary policy and new regulation regarding the capital base of the sector such as Basel III, might have a strong impact on lending standards and the mortgage activity in particularly on the type of funding chosen by Hungarian banks.

In accordance with the analyses of FHB Land Credit and Mortgage Bank Company, I belief