Mortgage banks bet on gov’t dodge
Though mortgage lending is booming right now, Jan Sadil, CEO of Hypoteční banka, says growth will taper soon and the extent of the slowdown may be dependent on how well the Czech Republic can bend European Union (EU) regulations
On Feb. 5, while the press was reporting on “record volumes of mortgage loans,” the Ministry of Finance (MF) set its proposed definition of “social housing” for tax purposes and sent it to the European Union (EU). Through this proposal, the Czech Republic plans to bypass an EU decision that would bring the value-added tax (VAT) on residential property up from the country’s current rate of 5 percent to the EU norm of 19 percent by 2008. Sadil, of Hypoteční banka, the mortgage-lending arm of Československá obchodní banka (ČSOB), says that if this proposal is accepted it will keep housing costs low, and set the course of mortgage lending growth after 2008.
Under EU law, social housing is residential property built for lower-income residents and it is thus charged a lower VAT than that charged on other residential and commercial properties. The EU, though, doesn’t specify how one determines whether a building is social housing or not. The MF suggested to the EU that social housing be defined as a flat under 120 sqm or a house under 350 sqm; this, according to Sadil, could encompass some very luxurious “social flats”–a definition that applies to 90 percent of housing in the Czech Republic.
The mortgage market is experiencing record growth. Over the past three years, it has grown 40 percent per year, with Kč 100 billion (€ 3.56 billion) in new mortgages signed in 2006. Česka spořitelna, the leading provider of mortgages in the Czech Republic, posted record-breaking year-on-year loan volumes growth of 88 percent for the period Feb. 1, 2006 to Jan. 31, 2007. For the same 12 months, Hypoteční banka recorded year-on-year growth of 33 percent. Pavel Kühn, deputy director for mortgage banking at Česká Spořitelna, says he expects the market this year to continue at an annual growth rate of 40 percent.
Sadil is more skeptical, saying 20 percent is more likely. Still, he says he believes that despite the expected slowdown the market will continue growing, citing a per capita mortgage debt of only € 589, compared to an EU average of € 11,184, as a sign of untapped potential. He warns, however, that the market will decelerate even more if the Czech Republic’s social housing proposal is rejected, and that a higher VAT rate will put a damper on a market primed for expansion.
Q: It’s been reported that the Czech mortgage market is showing remarkable growth at the moment.
A: The history of the Czech mortgage market is not very old; we started in 1995, but up to 2001 the figures were very low. The increase [since then] is amazing; it’s almost 40 percent year-to-year over the last three years.
Q: You’re quoted as saying that you expect this year’s growth to be 20 percent?
A: [Every year] we’ve had fantastic growth, and I don’t believe it’s possible to keep growing at this speed. If you look at the numbers, [for instance, in 2002] it wasn’t that difficult to increase the volume of loans granted by 50 percent when the previous year [the mortgage market] only provided Kč 14 billion in loans. Last year the base was Kč 100 billion, and to increase it by 50 percent is impossible.
Q: Pavel Kühn of Česka spořitelna has said that he expects 40 percent growth this year. Why is there such a divergence between his and your estimates?
A: Maybe I’m more pessimistic than my colleagues at Česka spořitelna, but 40 percent growth from 100 billion is 140 billion; that’s quite a huge number.
Q: So you see a gradual slowing in the market. Do you think it should stabilize?
A: I expect there will be about 20 percent growth next year, and I think that the growth will continue over the following years, but not at the same speed. But you know, it’s not dramatic because when you are increasing from zero it’s quite easy.
Q: Local media reported that part of the recent growth is due to people preparing for a hike in the VAT on residential housing at the beginning of 2008.
A: The VAT issue is difficult to understand. In the Czech Republic all residential construction work is charged at 5 percent VAT. For other construction work, like for supermarkets or offices, there’s 19 percent VAT. This is an exception from the rest of the EU that’s been approved for until the end of 2007. The Czech Republic wanted to prolong this exception, but the EU said it’s not possible. I think it’s typical for Czech people that if there’s some rule, [they] find a way around it. So I don’t know exactly how it works, but somebody discovered that there’s a legal exception to the agreement in the definition of social housing. If you build a group of flats with some figures that define it as “social housing,” the VAT will be 5 percent.
Q: What numbers are used to define social housing?
A: That’s the issue. Two weeks ago, the Czech government wrote a definition of social housing. They said that social housing is a flat up to 120 sqm, or a house up to 350 sqm. So it’s a very luxurious social flat. This is [the government’s] proposal to the EU, and now we are waiting for [a response]. If the response is yes, the definition will be approved and then almost all new houses built will be social houses or social flats and the VAT will remain at 5 percent. If the EU says no, it will cancel the definition, but it’s not 100 percent clear that they have the right to say ‘no, the definition is wrong, you have to have a different definition.’ If the answer is no, I don’t know what will happen, the government will probably have to make a new definition and I don’t know what that will be. If the EU approves this definition, then I think there will be no impact on the mortgage market after Jan. 1  when there will be new VAT [rules]. The definition is so wide that nothing will change for 90 percent of clients.
Q: So there should be a slight decrease in the market’s growth, if the proposal doesn’t pass?
A: It depends on what decrease means, there’ll still be growth potential, just not quite as fast. People want to live in their own flats.
Q: Could you put a number on the decrease?
A: That’d be very difficult, I don’t think so.
Q: How is rent deregulation affecting the market?
A: It is good for the market. Young people know that it’s better to pay a mortgage than to pay rent and throw your money out the window.
Q: A few weeks ago the Czech National Bank (ČNB) discussed the possibility of a housing bubble on the real estate market, and how people were taking increasingly large loans, creating unnecessary risk for the banking sector. Though the bank board decided that neither of these issues posed a threat at this point, how does one determine when the market faces unnecessary risk?
A: I don’t see a huge risk because of a real estate prices bubble. I agree with a lot of people from real estate that we can expect a gradual increase of real estate prices in the future, and if we forget the VAT for a few minutes, I expect there will be huge growth.
Q: Do you see any signs of increased risk-taking on the mortgage market?
A: The mortgage market in the Czech Republic is very competitive. There are 17 providers of mortgages on the market, so we have to accept higher risk in order to offer more attractive products. One of the riskier products we offer is what we call the “mortgage 100 loan,” which provides up to 100 percent of the real estate value. The typical mortgage is up to 70 percent of the retail value, which in my eyes is a nice mortgage. But three or four years ago we had to introduce this 100 percent mortgage, which creates higher risk for a bank, because there’s no deposit.
Q: What do you mean “had to”?
A: I think it was around 2003 that some banks started to provide mortgages with higher levels of payment, not only 70 percent, but 80, 81 percent. At that time Hypoteční banka realized that it was necessary to attract new clients, so we were the first bank in the Czech Republic to provide a 100 percent mortgage. Of course, a few months later, almost all banks followed our lead. So we had to accept high risk because we wanted to attract more clients.
Q: Why did Hypoteční banka recently increase its capital base by Kč 830 million?
A: We increased our capital in 2006 to Kč 3.4 [billion] for two reasons. The first reason is capital adequacy. We knew that our business is going rather well right now, and we’d have to increase our capital by the end of 2007. It was easier for us to do this at the beginning of the year. Secondly, the main way we raise money to lend to customers is through mortgage bonds which we usually sell within the ČSOB group. There are some limits set by law about the number of bonds that can be sold to one financial group, and these limits are connected to capital. We were almost above the limit [when we raised our capital backing], and we wanted to move the limit up.
Q: What do you think the main reason is for the large growth on the market over the last few years?
A: I think the main reason is low interest rates in general. There is a huge demand for new flats and houses because people are able to have a mortgage. Ten years ago, in 1997, the interest rate was about 15 percent, and there’s a big difference between interest rates of 15 percent and 5 percent. A good economy and especially low interest rates in the Czech Republic are the drivers for the real estate market.
Q: How would a rise in interest rates affect the market?
A: Last year in 2006, the interest rate went up slightly, but you can see the figures were good. The interest rate would have to go up a lot more before there was any effect. There’s not a big difference for a client if the interest rate is between 4.5 percent or 4.7 percent. The ČNB says now that the interest rate should be stable until the end of the first half of 2007. From our perspective, the VAT is more an issue.
Born: Feb. 15, 1969, Prague
Education: 1994, civil engineering degree, Czech Technical University (ČVUT) in Prague; 1997, postgraduate studies in construction and economy, Brno University of Technology; 1999, course in financial economy and banking, University of Economics in Prague (VŠE)
Work history: Since Dec. 2003, CEO and chairman of the board at Hypoteční banka; since 2001, member of board of directors at Hypoteční banka; 1995-2000, various positions in the mortgage credit department, Komerční banka