Portuguese Banks Convert 36% of the Real Estate Received through Foreclosures to Collateral for Loan Guarantees

8 December 2017

The Bank of Portugal warned that the sale of real estate in the bank’s portfolios might not result in a lessening of their exposure to the property market, but rather a simple exchange of direct for indirect risk.

In December of 2016, the gross value of impaired assets that were received due to the failure to repay outstanding loans on the balance sheet of Portuguese banks amounted to approximately €7.4 billion (about 2% of total assets). These assets were “concentrated in the district of Lisbon and urban real estate (especially housing). Also, half of this amount is related to real estate that entered the banks’ balance sheets between 2012 and 2015,” the Bank of Portugal stated in its Financial Stabilization Report.

At the same time, during 2016, banks recorded significant sales of real estate (€2.1 billion, around 30% of the amount on the banks’ balance sheets), most of which were also associated with real estate received between 2012 and 2015. These sales were partially offset by new real estate that came onto the banks’ balance sheets through additional defaults.

Properties that are in use by the banks are excluded from this tally along with real estate held by subsidiaries based outside of Portugal (3% of the real estate received through foreclosures), assets owned by real estate investment funds outside the bank’s scope of consolidation, and real estate held by corporate restructuring funds. Only sales that resulted in a transfer of the asset to entities outside the bank’s scope of consolidation (including real estate investment funds that, for prudential purposes, are not consolidated with the banks) were considered for the report.

Excessive exposure to the real estate market has been identified as one of the Portuguese banking sector vulnerabilities, the Banco de Portugal stated in its Financial Stabilization Report of December 2017.

This exposure had been mostly indirect, through mortgages that were secured by real estate and loans to companies in the construction and real estate sectors.

However, as a consequence of the financial crisis, there was a significant increase in direct exposure resulting from the foreclosure of properties that had guaranteed many defaulted loans.  Also, the banks received units of real estate investment funds (some of which resulted in the transfer real estate) and corporate restructuring funds tied to the real estate sector.

Currently, the sale of real estate can often merely imply a transfer of the banks’ risk from a direct to an indirect exposure to the real estate market.  The banks have sold many properties that were on their balance sheets while financing the buyers, who use the properties as collateral to guarantee the loans.

In 2016, approximately 36% of the banks’ sales included a loan to the buyer, maintaining the property as collateral, while the remaining sales also included transactions in which properties were transferred to real estate investment funds, where the banks receive units of the funds in exchange.

Some sales have also resulted in additional losses for the banks. Approximately 35% of the sales in 2016 were made at a lower price than the book value of the property on the bank’s balance sheets (net of impairments), which translates into a loss for the banking institution. About 27% of the properties were sold above the book value, and 38% were for an amount that was close to the registered value of the property (again, net of impairments).

The value of real estate that entered the banks’ balance sheets increased significantly between 2010 and 2013, after which it remained relatively stable, close to 2% of the banking sector’s total assets, according to the report. The increase was closely linked to the economic and financial crisis at the time, which was also reflected in high levels of loan defaults and, consequently, the execution of guarantees associated with those loans.

In this context, the execution of credits that counted with property as collateral directly led to a significant increase in the value of real estate that entered the bank’s balance sheets, the Bank of Portugal reported. However, a strengthening of the real estate market in recent years has been reflected in Portuguese real estate prices, creating more favourable conditions for asset sales, thus potentially facilitating a reduction in the banks’ balance sheets.

In December 2016, the value of properties amounted to approximately € 7.4 billion (including impairments), with a geographical concentration in the Lisbon district (approximately 28% of the stock) and, to a lesser extent, in Porto, Faro and Setúbal (accounting for between 12% and 15% of the total). Much of the real estate is essentially urban (housing, non-residential, and land).

The Report showed that the majority of the properties entered the banks’ balance sheets between 2012 and 2015. The real estate originating from executions over five years ago (i.e. before 2012) represents 25% of the total value. In this group, many are non-residential urban properties.

The banks are in the process of selling most the properties on their balance sheets. Comparing the situation at the end of 2016 with that of the end of 2015, the most significant reduction in assets occurred for real estate received during 2015 and, in contrast, there was a proportionally smaller decrease in real estate received before 2012.

Significant sales were observed in 2016, accounting for roughly 30% of the value recorded on the banks’ balance sheets (2.1 billion euros). Most of these sales were concentrated in real estate that was received between 2012 and 2015, the report said. The sales, however, were offset by additional transfers of real estate to the banks during 2016 (which accounted for about 25% of the year-end stock). It is clear that a time lag, which may extend over several years, exists between default and the subsequent execution of guarantees so that most of the new entries in 2016 were related to the increase in non-compliance observed in previous years, according to the BdP.

In 2016, there was a slight change in the typology of properties on the banks’ portfolios. On the one hand, there were more significant sales of urban real estate and, to a lesser extent, in non-residential urban properties. On the other hand, the new properties were skewed towards non-residential urban and land properties, which increased the relative importance of the latter.

The evolution of housing prices in Portugal and its implications for financial stability

After a period of declines, the housing price index in Portugal has recently registered successive increases, and has already returned to the 2009 prices, in real terms, the central bank advised.

“The deviation from the average valuation of residential property was negative from 2008 onwards, decreasing until 2012. From that point on, prices have registered an upward trajectory, and are already very close to equilibrium”, the BdP related.

The analysis shows that housing prices in Portugal are not currently overvalued.

Recent housing price growth is also not synchronised with the credit cycle, the report concluded.

“This analysis does not exclude the possibility of excessive appreciations in certain geographical areas, especially in large urban centres,” the BdP warned.

Original Story: Jornal Econômico – Maria Teixeira Alves

Translation: Richard Turner