Identifying regional differences in the Spanish mortgage market with sheaf methodology.

Author:Aranaz, Magdalena Ferran
Position:Articulo en ingles
  1. Introduction

    Credit to households can have different uses. The Bank of Spain makes a distinction between loans applied to the acquisition or renovation of a house, those used for purchasing durable consumer goods, and the rest, which include the acquisition of land, undeveloped property, securities and non-durable consumer goods. In 1993 61.4% of all household credit was used for home purchases or renovations. Ten years later this percentage had risen to 73.3% (1), and according to the Bank of Spain, in 2011 it had reached 82,2% of total household credit. This means that between 1993 and 2011 it experienced a 33% increase.

    The expansion of credit for the acquisition of housing is closely linked to the growth experienced in the Spanish mortgage market after Law 2/1981 and the later Royal Decree 685/1982, which set the basis for an expansionary mortgage market. Mortgage credit started to grow at a strong pace, especially from 1995 onwards, and this growth continued until 2006. However, the turnaround came in 2007 and the number of new mortgages declined sharply.

    This dynamic behavior of the mortgage market was reflected in the number of new mortgages. 480,713 new mortgages were granted in Spain in 1995, and by 2006 this number had risen to nearly 1,900,000. Economic factors aside, the expansion in credit that started in the mid 90s occurred mainly because of two key elements: a) a fierce competition between financial entities for market share, and b) a favorable evolution in interest rates--the drop in interest rates was bigger in Spain than in other European countries (Mayayo, 2005). For the 1991-1995 period, the average interest rate in mortgage loans with a term of more than three years was 13.3%. For the next five-year period, the average was 6.5, and the next two five-year periods show averages just barely over 4%.

    We should remember that this combination of stiff competition between financial entities and low interest rates was the result of great transformations in the international financial world, which had direct results on European countries. The greater degree of competition between financial entities was related to the financialization (2) process that had been in place since the 1980s, by virtue of which markets and financial logic acquired a growing relevance in determining economic activity. On the other hand, the financial system had experienced a sweeping transformation with the liberalization process (3). In the past, credit had been subject to strict regulation in order to maintain financial stability. However, starting in the 1970s and 80s many developed countries deregulated their financial markets, resulting in increased competition between entities (Volcker, 1986; Blundell-Wiganll and Browne, 1991).

    The gradual reduction in interest rates was a direct consequence of Spain joining the European Union. Interest rates, both long and short term, fell since Spain joined the EU. Short term interest rates were at nearly 20% in 1983, fell to 12% in 1986, and to 8% in 1994. Interest rates rose briefly in 1995, but fell again due to expectations of Spain joining the Monetary Union, and in 1998 and 1999 were even lower than those in the EU. Likewise, long term interest rates also experienced a dramatic reduction from 1990 onwards, converging with Eurozone rates in 1999 at the 4-5% level. Such a reduction brought a significant relief in the financing costs of the Spanish economy. For Spanish citizens the reduction in mortgage rates was probably the most obvious benefit of joining the European Economic and Monetary Union (Piedrafita, Steinberg and Torreblanca, 2006) (4).

    The reduction in interest rates ran parallel to changes in the supply of mortgages by financial entities. Two key elements need to be stressed: a) The financial entities extended mortgages terms and b) the loan-to-value ratio of mortgages grew significantly. Both circumstances are related to the expansion of financial entities after the liberalization process, which had forced to a deep revision of banking strategies. Many entities (particularly "Cajas de Ahorros", savings and loans) followed a clear distinction between their areas of expansion and their traditional markets. The growth in the loan-to-deposits ratio was the result of an outright gamble by financial entities to expand via assets as opposed to gaining market share by collecting more deposits (Delgado, Saurina and Townsend, 2008). In turn, this resulted in looser mortgage qualification requirements, and, most notably, in higher loan-to-value ratios. On the other hand, the extension of mortgage terms allowed financial entities to offer lower monthly installments, attracting more potential clients. The consequence of this process was that a greater number of people qualified for mortgages, and the percentage of homeowners grew.

    Mortgage activity fell significantly from 2006 onwards, with a substantial reduction in the number of new mortgages. Even by 2003 the rate of growth in new mortgages had slowed considerably, and by 2007 it turned negative (5). In 2011 the number of new mortgages was similar to that of 2003, and 66% lower than those granted in 2006, at the height of the real estate boom.

    No single cause can be identified for this trend reversal. On one side financial entities have enacted restrictive policies, leading to a credit crunch and stricter mortgage qualification requirements (6). Real estate prices have been another factor. Between 1995 and 2008 the price of housing in the free market grew by 203%. A significant group of people that would have normally become homeowners for the first time were priced out of the real estate market; the younger segment of the population was particularly sensitive to the rise in housing prices (Marquez, 2008). The recent rise in Value Added Tax for new houses in the free market from 7 to 8% certainly will not help reverse the trend. After a time lag, the fall in demand that started in 2006, along with an adjustment process on the supply side resulted in a reduction of housing prices that started to become apparent in 2009.

    On the other hand, economic conditions since the onset of the crisis have discouraged recovery in mortgage activity. The rise in unemployment that started in 2006 is an obstacle to homeownership for a great number of people, and hinders the capacity of many others to meet their mortgage payments.

    Although the number of new mortgages fell in 2007, the total value of new mortgage loans did not start to decrease until 2008. One reason among others is that the rise in housing prices pushed up the average mortgage size. Although the total value of new mortgages did not begin to fall until 2008 it was already stationary in 2007.

    Once we have described the evolution of Spain's mortgage market we may ask ourselves if such behavior has been homogeneously followed in different Spanish provinces, or if we might find "sub-markets" with distinctive features. This article is based on the hypothesis that all provinces have followed the national pattern of behavior from an expansive cycle to a recessive one, so at least from that angle we can consider there is a certain degree of territorial homogeneity; however we will prove that there are important regional differences in the intensity of both expansion and contraction.

  2. A Review of Current Bibliography

    There are few studies on the evolution of Spain's mortgage market from a regional perspective. A review of current bibliography yields some interesting works that include regional analysis in their assessment of the real estate market, yet few of them focus specifically on mortgage loans, a key element in the demand for housing.

    Some studies employ regional analysis to identify real estate "sub-markets". Variables such as the economy, specialization in specific housing types, geographic expansion and demographic factors are taken into consideration

    (Altuzarra Artola and Esteban Galarza, 2010). Regional analysis is also used in studies that try to explain the behavior of housing prices (Lopez, 2002...

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