Baltic Homes That Singed Scandinavia Banks Heating Up: Mortgages

A Visitor Looks Over the Old Town in Tallinn
A visitor looks out over buildings towards St.Olaf's church in the old town area of Tallinn. Apartments, which account for the vast majority of sales, climbed by an annual 12.7 percent in the third quarter, driven by a 14.1 percent gain in Tallinn. Photographer: Simon Dawson/Bloomberg

Home prices are surging in Estonia. The last time that happened in the Baltic region, a property collapse followed in 2008 and 2009, leaving Scandinavia’s major banks saddled with a string of losses.

Apartment values in the Baltic country of 1.3 million people soared by about 20 percent in December from a year earlier, according to indexes produced by local property brokers Ober-Hausi Kinnisvara AS and Pindi Kinnisvara AS. Prices in the capital Tallinn may reach their pre-crash peak this year, said Peep Sooman, chairman of the Association of Real Estate Companies and a board member of Pindi.

“At the end of the day, this rise isn’t sustainable,” Sooman said. “It would be much better if there was a gradual improvement and prices rose in line with inflation, or even twice as fast.”

The Nordic region’s banks are vulnerable to any big price declines and economic fallout even though mortgages play a smaller part in the Baltic market than they did before the crash. Sweden’s Swedbank AB, SEB AB and Nordea Bank AB are the biggest lenders in Estonia, followed by Denmark’s Danske Bank A/S. Nordic banks also are among top lenders in Latvia and Lithuania.

Estonia, which regained independence in 1991 after 50 years of Soviet occupation, has outpaced those neighboring Baltic countries as well as other former Soviet republics. Estonia’s expansion followed state asset sales, while cultural ties to neighboring Finland and Sweden resulted in the highest foreign direct investment per capita in eastern Europe.

Pushing Ahead

After joining the European Union and NATO in 2004, Estonia became the first former Soviet republic to adopt the euro in 2011, followed by southern neighbor Latvia this month. Lithuania, the southernmost Baltic country, plans to switch its litas for the euro next year.

Prices of apartments, which last year accounted for 81 percent of housing transactions in Estonia, climbed by 12.7 percent in the third quarter from a year earlier. The increase was driven by a 14.1 percent gain in the capital, according to the Tallinn-based statistics office. Single-family house values increased by 6.8 percent.

Loan losses at Swedbank and SEB soared in the Baltic region in 2009 as Estonia, Latvia and Lithuania suffered the steepest recessions in the European Union following credit-fueled housing booms. Swedbank posted total credit impairments of 18.1 billion kronor ($2.8 billion) at its Baltic unit in 2009 and the first two quarters of 2010.

Baltic Losses

That resulted in the lender suffering a net loss of 11.3 billion kronor at its Baltic unit between the beginning of 2009 and the third quarter of 2010, when it returned to profit in the region. That loss represented more than 10 percent of its market valuation of 82.2 billion kronor at the end of 2009 and almost half of its market value at the end of 2008.

The bank, whose Baltic loan impairments resulted in a group net loss in all four quarters of 2009 as the regional losses swallowed profits at home, had to ask shareholders for capital twice in less than 12 months and relied on state guarantees for funding.

SEB fared better, posting a second-quarter group loss in 2009 due to loan impairments at its Baltic operations. They reported operating losses from the fourth quarter of 2008 until returning to profit in the third quarter of 2010.

Swedbank controlled 41 percent of the lending market in Estonia as of June, with SEB holding 23 percent, according to the Estonian Financial Supervision Authority. Nordea had 19 percent of the market and Danske Bank’s local unit had 8 percent. The country accounted for 4.2 percent of Swedbank’s total lending to the public and 2.6 percent of SEB’s.

New Fuel

The reasons for the current price increases differ from those prior to the crash, said Tonu Mertsina, a Swedbank economist in Tallinn. The gains aren’t driven “by large amounts of loan money as it was during the bubble.” Last year, 54 percent of purchases were financed by bank loans, down from the peak of 99 percent in 2007, and banks have raised their lending standards, he said.

The apartment market is mainly boosted in Tallinn by low interest rates, consumer confidence and rising incomes, broker Ober-Haus said in a report this month. “As deposit rates remain low, interest in purchasing property for rental revenue has increased significantly in the past year.”

A two-bedroom apartment of 65 square meters (700 square feet) in a nine-story building constructed in 1983 in the Lasnamae suburb about 8 kilometers (5 miles) from Tallinn’s downtown has an asking price of 65,000 euros ($88,381), according to property advertising website A similar apartment in the north-eastern mining town of Kohtla-Jarve, 156 kilometers from Tallinn, has a price of 3,000 euros.

Concentrated Boom

“The real estate price increase is concentrated in single spots in bigger cities and as a real estate market in general, we do not see overheating currently,” Ruta Arumae, an economist at SEB, said in an e-mailed response to questions.

The “rapid increase” in prices in certain cities isn’t driven by bank lending this time as half of all transactions are made without bank loans and lending standards are tighter, with a shortage of property for sale instead being the main driver of the price increase, the economist said.

The number of apartments for sale in Tallinn fell by almost 50 percent in the past three years while transactions nearly doubled, meaning buyers are willing to pay more than they initially planned when they find the right property, said Sooman of Pindi.

Housing Shortfall

While tourists are attracted to the cobblestone streets of Tallinn’s medieval city as well as its shopping centers built over the past decade, a lack of modern housing is one area where Estonia’s gap with western Europe is the most obvious, according to a 2013 report on the economy ministry’s website.

Construction of new homes has fallen short of demand in the past three years and the stock of unsold dwellings from 2009 has dropped. Still, Swedbank doesn’t expect the market to overheat, according to Mertsina.

“Even though the price growth has been fast, the dangers it might pose to the economy are not as great, thanks to the fact that there is no loan bubble,” he said. “Also, some increase in supply is expected in coming years, which should slow down the price growth.”

Though more home purchases are funded from the buyer’s own resources, “it is important that banks don’t relax their mortgage terms, like the interest margin, down payment size and standards of creditworthiness,” Jaak Tors, head of the Estonian central bank’s financial stability department, said by e-mail.

More Supervision

The central bank is due to get added supervisory powers, including the ability to limit loan-to-value ratios, under legislation being discussed in parliament.

“Giving such authority to the regulator is reasonable,” Katrin Taliharm, managing director of the Estonian Banking Association, said in an interview last week. “Even though there’s no need to establish such rules today, having a clear authorization would enable a quick reaction if, for example, the market overheats.”

The average interest rate on mortgages issued in November was 2.7 percent, about the same level for more than a year, according to central bank data published on Dec. 27. New mortgage growth slowed slightly to an annual 10 percent in November compared with the previous two months. Overall mortgage volumes increased 0.5 percent in November from a year earlier as repayments almost equaled new loans.

Lending Growth

SEB’s mortgage lending in Estonia rose 2 percent in the third quarter last year from a year earlier, while it declined 5 percent in Latvia and fell 3 percent in Lithuania. Other lending rose 10 percent in Estonia. At Swedbank, Estonian mortgage lending increased by a net 13 million euros in the two months through August, following an increase of the same amount in the second quarter.

New loans in Estonia in the third quarter of 2013 totaled 28 percent of the level at the peak in the fourth quarter of 2006, according to Mertsina at Swedbank.

The price increases are causing concern. Estonian central bank Governor Ardo Hansson told Bloomberg on Nov. 22 that the country needs to stem climbing property prices and wage growth to protect its economy.

“If it were to continue now for several quarters, several years, you could get into a situation where some of the imbalances start reappearing,” Hansson said.

Sweden’s Risks

Estonia’s prices are rising at a time when the Nordic banks are confronting challenges in their home markets as policymakers try to tame soaring property prices.

In Sweden, low interest rates and a shortage of supply have pushed home prices and household debt levels to record highs in cities such as Stockholm and Gothenburg. A raft of measures taken by the Swedish financial regulator and the government have so far failed to stem housing price increases.

In Estonia’s neighbor, Latvia, the price of Soviet-era housing has barely moved since the credit crunch, though values of new developments close to Riga’s old town are close to pre-crisis peaks, according to real estate company Latio. In the Lithuanian capital, Vilnius, prices are little changed since 2009, according to data compiled by the registry office.

Estonia’s property market would benefit from a greater supervisory role by the central bank, including powers to limit loan-to-value levels, Pindi’s Sooman said. Nordea “actively” increased its market share by about 50 percent from 2002 to 2003 at the expense of its competitors until Hansapank, later taken over by Swedbank, reversed its slide in 2005, according to financial supervisor data.

“All the banks are fighting for market share today,” he said. “It only takes another aggressive bank, like Nordea was in 2002 and 2003. The others would have to follow to keep their market share.”

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