Key Takeaways
- We have updated (for all countries other than the U.K.) our under/overvaluation assessment of European residential mortgage markets, which are used to calibrate our loss severity assumptions for European residential mortgage-backed securities (RMBS) and covered bond rating analysis.
- Overall, overvaluations have moderated, compared with our last update. This is driven by exhibited wage growth combined with, in some jurisdictions, house price declines.
- We have updated our approach to determining under/overvaluation for a specific mortgage market. A region or country will now be in one of six categories, ranging from undervalued to severely overvalued. This is detailed below.
- The updated view also incorporates our forward-looking view of factors that are likely to drive income and house prices, such as interest rates and house price forecasts.
We have updated our under- and overvaluation assessments for European residential real estate markets. This update reflects house price and income movements observed since our previous update as well as our forward-looking expectations.
The under/overvaluation assessments differ by country, and we continue to consider most European countries' housing markets to be overvalued relative to the long-term trend in affordability metrics.
The credit impact that house price overvaluation could have on European residential mortgage-backed securities (RMBS) and covered bonds will depend on the geographic distribution of the mortgage pools and the valuation dates of the underlying properties backing the loans in those pools.
Measuring Under- Or Overvaluation
Our view of house prices as being overvalued or undervalued is informed by how much a specified region or country's house price-to-income (PTI) ratio is above or below its long-term average, combined with additional qualitative and forward-looking considerations. We typically use data from the Organisation for Economic Co-operation and Development and, in the U.K., the Office for National Statistics and the Land Registry.
We have updated our approach and now categorize regions or countries into one of six levels of under/overvaluation: Undervalued, Neutral, Slightly Overvalued, Moderately Overvalued, Significantly Overvalued, and Severely Overvalued. Each of these categories aligns with a level of under/overvaluation as detailed in table 1.
When determining the category and absolute level of under/overvaluation for a region or country, we would also consider our forward-looking view of other factors, which are likely to affect house prices and housing affordability. Other factors we may consider include, but are not limited to, house price forecasts, income and inflation expectations, and our view of interest rates.
This new method allows for a more nuanced assessment of housing market conditions through the addition of qualitative overlays and will result in more stability in our estimates of under/overvaluation.
Table 1
| Under/overvaluation | Range | |||
|---|---|---|---|---|
| Undervalued | (-10%)-0% | |||
| Neutral | 0% | |||
| Slightly Overvalued | 0%-10% | |||
| Moderately Overvalued | 10%-20% | |||
| Significantly Overvalued | 20%-30% | |||
| Severely Overvalued | >30% | |||
| Source: S&P Global Ratings. | ||||
Current Estimates Of Under- Or Overvaluation
Current estimates of under- and overvaluation differ by country and are detailed in chart 1.
Chart 1
In the U.K., we distinguish and apply different estimates of under and overvaluation based on region. London and the South-East are together considered to be 50% overvalued, while all other regions are 20% overvalued.
The impact of updated under/overvaluation on rated transactions
In our credit analysis of residential mortgage pools backing RMBS or covered bonds, we establish a broad measure of under/overvaluation for each relevant housing market. This informs the scale of market value declines we assume in our rating stress scenarios which in turn determines rating category specific weighted average loss severity (WALS) calculations.
House price increases following a loan's origination are, in isolation, credit positive. They increase borrower equity, which in our analysis of mortgage pools backing RMBS and covered bond programs means a lower estimated propensity to default, as well as a lower loss severity if the borrower does default.
Changes in our under- or overvaluation assessments can lower or increase assumed loss severities by ratings category. Similarly, the application of indexation can increase or decrease our overall loss severity estimation.
Our over/undervaluation measure provides affordability information in terms of the deviation from a long-term average, which could influence how much property prices decline under some economic scenarios. To account for this in our ratings process, we calculate the loss severity on a loan by applying our over/undervaluation assessment to our market value decline (MVD) assumptions (see our global RMBS criteria in "Related Criteria And Research"). Our over or undervaluation assessment applies to our MVD assumptions when calculating the loss severity for each loan. We add up to 50% of the overvaluation amount to the MVD and subtract 20% of the undervaluation from the MVD.
For example, for a loan in a country with 15% overvaluation, if the standard MVD assumption for a certain rating scenario level is 30% the MVD would be 37.5% (30% + [015%*0.5]), assuming 50% of the overvaluation amount were applied. Conversely, for a country undervalued by 15%, the MVD assumption for that same rating scenario would be 27% (30% – [15%*0.20]).
When indexing property values, we apply 100% of the cumulative upward movements and 100% of the downward movements, based on our criteria. The slightly higher property values that result from this indexation could decrease the probability of defaults and have varying effects on loss severities, depending on loan age and regional over/undervaluation.
Related Criteria And Research
- European Housing Markets: Better Days Ahead, July 17, 2024
- Credit FAQ: How House Price Changes Affect Our EMEA Residential Mortgage Loans Analysis, July 12, 2024
- Asset Price Risks: Overvaluation Persists For Europe's RMBS And Covered Bond Markets, Oct. 4, 2023
- European Housing Markets: Sustained Correction Ahead, July 20, 2023
- Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 25, 2019
This report does not constitute a rating action.
| Primary Credit Analyst: | Alastair Bigley, London + 44 20 7176 3245; Alastair.Bigley@spglobal.com |
| Secondary Contact: | Casper R Andersen, Frankfurt + 49 69 33 999 208; casper.andersen@spglobal.com |
No content (including ratings, credit-related analyses and data, valuations, model, software, or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced, or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor’s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees, or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness, or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an “as is” basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT’S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P’s opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment, and experience of the user, its management, employees, advisors, and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. Rating-related publications may be published for a variety of reasons that are not necessarily dependent on action by rating committees, including, but not limited to, the publication of a periodic update on a credit rating and related analyses.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.spglobal.com/ratings (free of charge), and www.ratingsdirect.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.spglobal.com/usratingsfees.