The change in monetary policy finally occurred in July 2022, after six years of zero or negative rates. The rise in interest rates marked by the European Central Bank (ECB) is a boost for the financial sector, which sees its recurring income increase, mainly thanks to variable rate mortgages (referenced to the Euribor, which are regularly updated once a year). But what happens with those ultra-low mortgages that the sector granted in the last five years? Do you earn or lose money with them? The sexy answer is that the bank always wins. But the most certain is that they are profitable, although with nuances.
Risk management is key in these cases. Entities have a tool to protect themselves from the risk of these fixed loans: swaps. This is a coverage that, in practice, eliminates the risk of fixed-rate credit and converts it into a variable one. “There is a high stocks of cheap fixed mortgages, which right now is a problem because banks have become more expensive in their liabilities, which will affect those who have not been covered,” explains Joaquín Maudos, deputy director of the IVIE and professor at the University of Valencia.
The supervisor, already in the last years prior to the rate increases, conveyed to the banks his concern about very aggressive fixed rate mortgage offers. The sale of these loans around 1% became widespread, even lowering that threshold in many cases. It is true that, in exchange, they linked these users to very profitable products that partially compensated for that low interest (home insurance, life insurance, alarms…). Despite this, the Bank of Spain conveyed its doubts to them.
“There was concern that the ECB’s rate increases would put mortgage portfolios with lower rates into losses. In this sense, the answer must be negative because the banks have covered themselves,” says Francisco Uría, partner responsible for global banking and the financial sector at KPMG Spain.
The supervisor’s alert came during the years of zero rates, when it was more complex to foresee future risks. In many entities, the urgent was then prioritized over the important: they had to maintain their income level in some way to compensate for the loss of recurring business due to an anemic monetary policy. On the cost side, they had already tightened their belts to maximize the efficiency of their operations through structural cuts and layoffs. There wasn’t much more room left.
Resurgence of the fixed rate
In this context, banks took fixed-rate mortgages out of the drawer. These loans were reviled in Spain, where those signed at a variable rate had taken precedence. Instead, they opted for the change to at least ensure a minimum margin in a few years in which the Euribor was even negative (between February 2016 and March 2022).
In this way, while the entities financed themselves almost free in the interbank market, they lent for the purchase of housing with a rate of around 1% in the cheapest offers. An assured profitability, even if it were minimal, until monetary policy has turned around.
“If the bank covered all the fixed mortgages it made between 2019 and 2021, when the swap At 15 years it was at zero or even a little negative, even if the loans were at 1%, that portfolio would be as profitable as another variable,” argues Ignasi Viladesau, investment director of MyInvestor. That is, if banks fully protected themselves from risk, rate increases are not a threat.
Despite this, as is often the case in a sector as complex and regulated as the financial sector, there are many aspects. The first thing to keep in mind is that not the entire fixed rate loan portfolio is covered. According to ECB figures, in aggregate, only around a third of the Old Continent is protected. “If they don’t cover themselves, they usually earn more, although they have more risks,” adds Viladesau. And right now we are in a moment of risk in which the coin comes up tails.
There is a recent example of excess risk on the balance sheet that has ended with the collapse of an entity. “Rapid and intense rate increases also generate losses, as demonstrated with the Silicon Valley Bank,” recalls Maudos. The Californian entity suffered a latent fall in the value of an asset (sovereign debt) that materialized in losses as it needed liquidity.
Financial groups, however, can be protected in other ways. “Hedging against rate increases can be, above all, via swaps to make the mortgage portfolio more variable, but they can also use current account funds, a liability that is almost insensitive to rising rates,” adds Leopoldo Torralba, economist at Arcano Economic Research.
Spanish banking has an advantage in this aspect, being eminently retail. In fact, according to data from the Bank of Spain, more than 90% of household deposits in July were in sight. That is, almost unpaid (the profitability of these checking accounts was then only 0.12%, according to the supervisor). And these are very stable funds.
In addition, entities can complete their protection with other balance sheet tools. For example, with very liquid assets such as Treasury bills. They will also be able to offset the uncovered portion with excess liquidity (the spread between deposits and credit), although this would be less profitable than depositing it directly with the ECB.
Misalignment: risk or opportunity
The price of the swaps It varies over time and is set by the market based on future expectations. For example, 15-year coverage is now around 3%, while in the years before the interest rate increases they were at 0%. Hence, the moment when purchasing insurance is much more important today than in the past, when its price was more stable.
In practice, banks do not hire a swap for each fixed mortgage, but the coverage is for a specific amount that protects the portfolio in aggregate. “The risk models work much better than if coverage were done individually, something that would be unviable due to cost,” explains Viladesau.
In this way, there may be cases of banks that have room for more fixed-rate mortgages to enter and others in which there is excess and even have an uncovered portion. Therefore, when entities are overhedged, it is an opportunity (they would have room to offer better conditions to their clients). “There were several banks that broke the market like this,” criticizes a senior leader of the sector in Spain. Otherwise, if it does not have everything covered, the entity must adjust its accounts, assume part of the risk or cover it in other ways. And, above all, closely monitor advance prepayments and new production to try to get it back on track.
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