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Fixed-rate mortgage shift to prompt Spanish bank funding rethink

A shift toward fixed-rate mortgages from floating rates is taking hold in Spain and will lead to banks changing their funding models, industry observers say.

Traditionally, nearly all Spanish mortgages have been at floating rates — which tend to track central bank base rates — because they have come with more attractive pricing than fixed-rate loans. In January 2015, just 5.3% of new mortgages were fixed-rate products, according to data from the Spanish Land Registry. But that number had jumped to 36.5% by November 2017.

The prospect of the ECB hiking interest rates is encouraging people to lock in a rate. Furthermore, the gap between pricing for floating rates and fixed rates is narrowing, making fixed-rate mortgages more attractive, according to Juan José Mendez, senior financial analyst at rating agency DBRS. In November 2017, the average fixed-rate interest rate was 3.1% and the average floating rate was 2.54%, compared to an average fixed rate of 5.31% and floating rate of 3.19% at the beginning of 2015.

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Funding models

While borrowers can benefit from lower rates, banks are facing margin pressure. The average all-in spreads over the 30-year ECB benchmark for newly originated fixed-rate loans has compressed to about 200 basis points from 450 basis points over the last two years, according to DBRS. The pricing of floating-rate loans has also tightened.

To deal with the changes, banks will have to adapt their funding models, whether it be through capital markets or deposit composition, Mendez said.

"This is a big change from the historic composition of their pools, so it would all come down to the way they choose to fund it," he said. "It's not just going to be all floating like it was before."

Bankia SA, one of Spain's largest banks, said almost half of its new mortgages in the fourth quarter were fixed-rate. CEO José Sevilla said the bank would use interest rate swaps to hedge the fixed-rate mortgages, depending on the length of the loan.

Javier Bernat, an analyst at GVC Beka Finance, said fixed-rate mortgages were positive for lenders as they offered a guaranteed interest rate and higher net interest margins, and a generally clearer outlook for upcoming risk.

He said some lenders such as Bankinter SA have had to wait up to two years for floating-rate mortgages to become profitable because of current low rates.

Reduces interest rate fluctuations

Many borrowers want to lock in fixed rates, even if they are more expensive, to avoid the uncertainty of an interest rate rise in the future, analysts said.

The average Spanish mortgage has a value of €120,000 and, at a fixed rate, is €60 a month more expensive than at a floating rate, DBRS analysts said.

"If you are at fixed rate, you still pay €60 more just for the privilege," said Vito Natale, head of residential mortgage-backed security and covered bonds at DBRS. "You don't know how things are going to turn out but you expect that rates are going up and then you will be better off later on."

The boom and bust of Spain's property sector in the 2000s has made interest rate changes a sensitive subject in Spain. When Spain's property market collapsed, short-term interest rates rose, leaving borrowers exposed and prompting a sharp rise in the number of foreclosures, said Daniel Lacalle, chief investment officer at fund manager Tressis Gestión.

And hints from public figures that rates could go up before long are also encouraging borrowers to sign up for fixed-rate mortgages, Lacalle said. Spanish Finance Minister Luis de Guindos was quoted in La Información on Jan. 10 as saying people should understand that "this level of interest rates is not going to hold for long."

Mortgage law

The approval of a new mortgage law, based on the EU mortgage credit directive, in the first half of 2018 is also likely to compound the trend toward fixed-rate mortgages, as it will make it easier and cheaper for customers to switch.

The new law will lower early repayment charges and cap them at 0.25% when converting to a fixed-rate mortgage during the first three years of the loan. After that time, there will be no charge. It will also reduce fees for early mortgage repayments.

"It's going to be make it easier to get into a [fixed-rate mortgage] knowing that even if you want to get out later on you can do it for a reasonable cost," said Natale of DBRS.

The move will also increase competition on the market and reduce spreads, Mendez said. Previously, banks could previously charge much higher fees for switching, and now they will respond by competing more aggressively for customers, he said.

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To view the Spanish banking industry on an aggregated basis, click here.

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