For the Dutch, holders of the most mortgage debt as a percentage of gross domestic product, tax breaks on house payments are more than a government policy. They’re a tradition under threat.
With debt levels at twice the European average, banks and politicians are applying pressure to change or abolish home-loan deductions, which have existed in the Netherlands since at least 1893. That’s making buyers hesitate, freezing sales in a property market that’s declined for three years, said Boele Staal, chairman of the Dutch Banking Association.
Eliminating or phasing out the deduction will make it harder for homeowners to keep up their payments and may hurt the EUR289 billion ($380 billion) Dutch residential mortgage-backed securities market, Europe’s second-largest and most creditworthy, according to Standard & Poor’s. The proposals come as investor demand for Dutch RMBS is climbing, narrowing spreads against benchmarks to the lowest in Europe.
“In the short term, measures to curb mortgage debt might be credit negative because obviously anything you do which hampers people’s ability to refinance or which reduces credit availability might give them less financial flexibility,” said Andrew South S&P’s London-based head of European structured finance research. “Removing the deductibility of interest payments could obviously make affordability more challenging relative to disposable income.”
So far, investors don’t agree. The extra yield demanded to hold top-rated Dutch mortgage securities over benchmarks has narrowed 10 basis points this year to 155 basis points, or 1.55 percentage points, according to JPMorgan Chase & Co. The spread has contracted from 425 basis points at the start of 2009. That compares to spreads of 610 basis points for Spanish home-loan bonds and 585 for debt tied to Italian borrowers.
Rabobank Groep’s Obvion NV unit priced the first Dutch RMBS deal this year on Jan. 26, a 1.2 billion euros transaction called Storm 2012-I, according to data compiled by Bloomberg. The deal was increased in size with a top-ranked 245 million euros portion paying 110 basis points more than a lending benchmark.
Changing the deduction and recent restrictions on interest- only mortgages “could lead to lower prepayment rates as borrowers are unable to refinance due to the additional monthly cost of a part repayment mortgage,” said Dipesh Mehta, an analyst at Barclays Capital in London.
As Europe’s sovereign debt crisis roils the region, the prospect of rising unemployment and declining spending power is spurring Dutch policy makers to rein in spiraling debt.
Homebuyers can claim tax deductions on mortgage interest for 30 years, making it more affordable for them to stretch out repayment. That’s also driven mortgage debt in the Netherlands to 107.1 percent of gross domestic product in 2010, according to the European Mortgage Federation, compared with more than 76 percent in the U.S.
“The pile of mortgage debt has gotten big, perhaps too big,” said Piet Moerland, Chairman of Rabobank, the Netherland’s biggest provider of home loans. “We need to adjust the course of this tanker and start paying off debt. We think it’s our responsibility to society to alert people.”
President Barack Obama said last year as part of his 2012 budget proposal he favors scaling back mortgage interest deduction in the U.S., while some in Congress want to eliminate a benefit that dates to the creation of the tax code in 1913.
The Netherland’s two biggest mortgage lenders, the national bank, the opposition Labor Party and Christian Union parties and the biggest real-estate brokers group are pressing Prime Minister Mark Rutte’s government to cut or revise the mortgage deductions as part of a broader housing plan.
“No one believes the mortgage-interest deduction will remain untouched and that’s keeping demand down,” Staal said. “Uncertainty about the future and an expectation of further price declines has caused a standstill on the housing market.”
The Dutch Central Bank today said it started a study into the effect of a house price drop and rising delinquencies on Dutch banks’ solvency. The regulator said it may demand that lenders strengthen their capital if it becomes necessary, according to a document outlining its priorities for 2012.
Record-low interest rates from 2003 to 2005, tax breaks and competition between lenders helped fuel a Dutch mortgage boom. Banks typically offered home buyers loans for more than 4.5 times their annual salary and as much as 110 percent of the value of the property, allowing borrowing for renovations.
As many as 15 percent of Dutch homeowners now owe more than the market value of their properties, said Central Bank President Klaas Knot.
“It will become a problem when you see unemployment rising and consumers may get into trouble paying interest,” Knot said in an interview on Dutch television on Jan. 5. “The second problem is that the big mortgage debt distorts our banks’ balance sheets.”
Unemployment in the Netherlands was 4.5 percent in 2011, up from 3.7 percent in 2009 and is expected to rise to 5.25 percent in 2012, the country’s Planning Agency said in December.
Dutch banks rely on external funding as there is a 480 billion-euro gap between savings deposits with banks and loans to households and companies, according to the central bank. The cost of raising funds has increased amid Europe’s debt crisis. Investors demand a spread of 201 basis points to hold Dutch bank debt, from 116 a year ago, according to Bank of America Merrill Lynch index data.
Most Dutch savings go to the country’s pension funds as employers and workers contribute to mandatory retirement plans. The funds had 835 billion euros in assets at the end of the third quarter, according to central bank data. That strengthens the capital of households even though the savings can’t be accessed before retirement.
“An end to mortgage interest deductions is becoming a reality suddenly, whereas some time ago no one wanted to talk about it,” said Benoit Petrarque, an Amsterdam-based analyst at Kepler Capital Markets. “Banks will have to lobby clearly to defend their interests.”
Central Bank President Knot has suggested changing the tax deduction so it gradually declines over the life of the mortgage. ING Groep NV (INGA), the country’s second-biggest mortgage lender, has proposed phasing out mortgage deductions gradually, accompanied by lower income taxes and an end to transaction taxes on home sales.
Dutch house prices have been falling since the third quarter of 2008 after more than doubling in the decade before that. Values, which had risen since 1985, dropped 4.1 percent in 2011 and may fall by another 5 percent this year, according to the Nederlandse Vereniging van Makelaars, a group representing Dutch property brokers. That would be a 15 percent decline from the 2008 peak.
About 227,000 homes were up for sale in the fourth quarter, a 76 percent increase from the third quarter of 2008, the NVM said. About 118,000 homes were sold in all of 2011, it said. Approximately 202,000 homes were sold in 2007, data from the National Statistics Bureau showed.
“We had the wind in our back for 30 years, with rising prices, decreasing interest rates and higher income,” NVM Chairman Ger Hukker said in an interview. “Now we are in the middle of a reset to a new reality that entails lower debts, more repayments and lower disposable income.”
Buyers are steering clear of the housing market because they don’t know what the various proposals to change the tax system will mean for prices and their own loans, Hukker said.
Mortgage applications fell 19 percent in 2011 to 163,500, according to lender data compiled by Hypotheken Data Netwerk. While foreclosure sales rose 35 percent in 2011, they still represent less than 0.1 percent of existing housing stock.
The government has already taken steps to limit risk while stimulating the housing market. Last year, mortgage lenders agreed to limit home loans to 106 percent of the house price, and the interest-only portion of mortgages was limited to 50 percent of the home value. The rules, which came into force as of Aug. 1, apply to new mortgages and existing mortgages that are increased.
In a bid to prevent the market from freezing further, it temporarily reduced the transaction tax on homes to 2 percent from 6 percent and increased the limit for loans covered under the National Mortgage Guarantee to 350,000 euros from 265,000 euros. The guarantee compensated homeowners for 55 million euros of losses due to forced sales in 2011, up from 39 million euros in 2010.
The increasing calls to change the mortgage deduction come after a decade of warnings from organizations and regulators ranging from the Dutch Central Bank to the International Monetary Fund to make debt levels more sustainable.
Prime Minister Rutte’s ruling bloc of Liberals and Christian Democrats relies on an agreement with the anti-Islamic Freedom Party for its majority in parliament. Geert Wilders, the Freedom Party’s leader, has threatened to pull his support if Rutte tries to change tax rebates.
Finance Minister Jan Kees de Jager told parliament on Jan. 17 that the government plans to stick to its coalition agreements. However, he also agreed to requests from lawmakers to present a strategy for the housing market.
“The government offers a false sense of security by promising not to meddle with the mortgage interest tax deduction,” Staal of the banking association said. “People buy a house over 20 years, not just a government term.”
Change Carries Risk
While an overhaul of the Dutch housing market is necessary, tightening mortgage lending rules now carries a risk, according to Peter Boelhouwer, professor of housing systems at the Dutch University of Delft.
“All calls to limit households’ borrowing capacity may have far-reaching consequences for the development of demand and possibilities for new buyers to enter the market,” he said. “Tightening mortgage lending rules in a time of crisis will have big implications.”
Changes to the tax “could erode affordability and the ability to pay as it results in an increase in debt service payments in the near term,” according to a Jan 24 report from Fitch Ratings. It would also lower mortgage debt to gross domestic product and discourage taking out riskier loans, the report said.
While changes to deductions may have short-term consequences for the residential mortgage backed securities market, an economic downturn is unlikely to be an issue for the debt, S&P’s South said.
“Given how well the collateral has performed over the last few years and the bigger downturn in 2008 to 2009 I wouldn’t anticipate the expected economic slump to be an issue for Dutch RMBS,” South said. “We just affirmed the Netherlands’ sovereign rating, so country risk is currently not a significant driver of Dutch RMBS ratings.” The country is one of only 12 in the world with AAA ratings at S&P, Moody’s Investors Service and Fitch.
There are “some specifics about Dutch mortgages” that also make the high loan to value ratios less risky than they appear, South said. It’s “somewhat artificial because there is normally something offsetting that. The borrower has a savings plan or insurance for instance.”
In the longer run, a shortage of houses and a growing population will help underpin house prices in one of Europe’s most densely populated countries, Boelhouwer said.
“At some point that will make the market turn,” Boelhouwer said. “It puts a bottom in prices and will spur a faster recovery.”