Irish Mortgage Brokers Blog

We expected a 10% increase in mortgage arrears for the first half of this year, moving the total from 32,321 households to 35,531, however it increased 10.73% and the final figure was  36,438 [statistics for the last four quarters are below].

There is an ongoing inability for banks to deal effectively with people in arrears, both in terms of having the operational capacity or liquidity to offer debt relief in some form, and on the other side we have the Financial Regulator who is incrementally stripping away their power to enforce the mortgage via repossessions.

The arrears of the second half 2010 will go up again, there is no sign of either a slowing growth in arrears, or of a slow down in the rate of growth.

The only growth area in our economy at present seems to be in the deterioration of debt quality . . . but for the second half of the year it will not only be an ‘unemployment’ lead increase, rather it will be with the additional impact of lenders creating the problem via mortgage rate increases that have been independent of any European Central Bank moves (with an general move of c. 1.2% upwards in standard variable rates over the last 12 months).

The quarterly increase in arrears has been near or above 10% for the last three quarters, if this continues we can expect a further 20% by 2011 which would bring the total households in arrears to the region of 43,000 by year end and a likely figure of 50,000 by this time next year.

The solution for more than half of these owners would be repossession, in a functional market economy that is the end result. It is the fair termination of a contract where the borrower is unable to pay and it allows them to put distance between themselves and a financial obligation they can’t afford.

In the last 12 months 387 houses were repossessed, which is about 1% of the distressed stock, but according to the Irish Bankers Federation the rate of repossession by mainstream lenders has gone down in the last quarter to 86 properties, this is the third straight quarter of decline. How is this happening while the general mortgage situation is getting worse? Surely repossessions would go up at a time like this?

Unfortunately, the situation has turned entirely political, and the message that ‘keeping people in homes’ they cannot afford is the preferred solution, this in turn subjects them to endless calls, letters, form filling and stress in dealing with the banks on the basis that it keeps them in the home, but the statistics are showing that it isn’t changing the trend, or giving people the opportunity to get off a one way train. We have no metric of the family deterioration that occurs with financial problems, suffice to say, MABS, FLAC and other representative bodies say it is significant.

The question therefore must ask if a solution that keeps a person holding an asset they can ill afford to pay for is the humane approach, or would it be to release them from debt bondage as early as possible rather than to force them down a path that may have the same end result but with additional arrears interest and stress along the way?

We cannot be seen to encourage people to walk away from their debts, but we would be willing to say that when banks feel a deal may be turning against them in business that they will not continue to fund a project. We know of no reason for households to behave differently.

The rapid growth in mortgage interest supplement and applications for same is turning into a back-door bailout, non-performing loans extended by banks are being serviced by the taxpayer, banks are reluctant to take properties, not simply as a public service – that has never been their remit – rather it is so that the value of those properties do not need to be realised on their balance sheet. Banks assets are based on the value of the loans, not the value of the underlying collateral.

One view is that if you had a business and it didn’t look like it was working out a bank would have no issue in revoking credit lines or offering further support because in their opinion the proposal has soured. For the same reason it is fair to wonder why an individual would be asked to do precisely the same thing when the tables are turned?

A mortgage is ultimately a commercial arrangement and if it doesn’t work out the issue and duties are between the lender and borrower, not the lender, borrower and tax payer, but we are being dragged into the foray through mortgage interest supplement (taxpayer funded), through increased bank charges, through higher taxes which come about as a result of concern about our banking system/sovereign (and the arrears profile with lack of response is part of the issue), and directly by having a property market that is not adjusting in the time that it should.

When property markets reach clearing prices you have better odds of economic recovery (Kevin O’Rourke/ Barry Eichengreen and Agustin Benetrix all recently wrote on this topic), but we are not allowing this to happen, and it means that people who do buy today are paying too much because all of the properties that should be up for sale are not up for sale, it’s a modern ‘beggar thy neighbour’ scenario.

There are answers, but the cheap solution is denial, it has impacted 7bn of loans and only 500m in un-paids, compared to the likes of NAMA  it isn’t expensive, but the resulting reputational risk as a nation is pricey.

With our bonds auctions making news (in the past bond auctions were dreadfully boring affairs) and the recent S&P downgrade on the nation I thought it might be useful to take a look at some charts. What I believe is happening is that nobody truly believes we will default, Greece wasn’t allowed to do it, the ECB is backing auctions where necessary and yield hunters are happy to lend at an appropriate price (thus the over subscription of the issuance).

This is a chart of Credit Default Swap prices, the purple line is Ireland, Spain is white, Italy green and Portugal Orange. Often CDS’s are referred to as being an indicator beyond reproach, but it is important to remember that this financial derivative which is barely over a decade old is actually a barometer in the sense of insurance premiums, and the market is not infinite, so at any given time there may not be a matching number of sellers v.s. buyers and the prices go up, Irish debt likely has some of that playing into it - we already know that perceived risk drives prices up - just making the point that it isn’t the only thing.

Spain has been in terrible shape for some time, and unemployment at almost 20% yet we are trading higher, at the same time, Spain doesn’t have some magical recovery plan, and their banks are suffering (as are the Caja’s) but their debt market is far more liquid and has many more heavy players in it (such as Santander).

So it isn’t to say that default swaps are telling us the wrong thing, but rather that it is a reflection of many factors outside of risk of the underlying reference entity alone. We have also been trending in a loosely correlated pattern for most of the year with the PI(g)S. The end is not yet nigh.

The thing that does concern me however is the fact that the yield is rising on our debt. The thing I am looking at is the price of the bond. The yield (in blue) is the coupon (interest rate of the bond) relative to the price the bond is trading at. With a trading price of c. 93 (ie: it costs €93 to buy €100 of Irish debt) it is a problem because what people are actually doing is getting out of the trade and giving up future capital repayment. Remember: bond buyers are concerned about getting their coupon but above that is the concern that they will get their capital back.

When the price falls the yield rises (although the coupon is staying somewhat static), but again, the price fall is saying that at least some portion of the market are happy to walk away from the yield and even suffer some capital loss in order to get away from the trade.

Why then were recent auctions over subscribed? For a start there was ECB intervention, but that doesn’t explain all of it, it goes a little further. When an auction is held the buyers place bids, and in doing so they have certain prices in them, the bond seller will then sell to the lowest bidders to the extent that a the whole issuance clears.

In plain English: If you are selling €1,000,000 in debt you might get different bidders, one says ‘I’ll buy €200,000 at 3.5%, another says ‘I’ll buy €500,000 at 4%’ and a final one says ‘I’ll buy €400,000 at 3.7%’. What actually happens is that they will sell to the lowest rate bidder first (200k) then the full 400k of the one at 3.7% and then 400k of the one at 4% (the most expensive). And when the bond is cleared they take an average an announce that they cleared the bond at 3.78%.

The over subscription is at least in part due to yield hunters who think that there is money on the table, the bids that do come in are already elevated given the perceived risk, in return this gives the jitters to people already holding debt and they feel at least party obliged to hedge and thus CDS prices trend upwards, or sell their position and move to higher grade paper: hence the capital value drops. It doesn’t always stand that the market can have fear of our debt, yields that imply risk and yet massive over subscription, somebody somewhere is getting the message wrong, the question is who?

In the USA they have a type of shop called a ‘Consignment Store’, and it is a retail premises, like many others, with the exception that it doesn’t ‘buy’ its stock, rather it takes in items that people want to sell and puts them on the shelf, kind of an alternative to eBay, because some things are better sold in person (for instance: musical instruments are impossible to gauge over the web). And to date I don’t know anybody who sold a suite of furniture via eBay. Typically they will stock athletic gear, clothes, books, antiques etc. but unlike an Oxfam which relies upon charitable goods (donated), in a consignment shop the provider of the stock is going in on a profit share basis.

If you had an xBox (for instance) or a t.v. that you wanted to sell, you could put it in a consignment shop, the person there sells it and you do a profit split. With retail space getting cheaper by the day I think it is only a matter of time until somebody opens one. They can specialise, designer clothing (for instance) that was only worn a few times, or what about unused/unwanted presents? Wouldn’t it be nice to have a place to sell them?

Not all of the goods need be given in by people looking to sell something, a shop owner can sell their own product as well, or spend part of the day bidding on the likes of eBay and on the great deals they win they can then sell via the shop. It seems highly inefficient to those of us who are comfortable using the web to buy things, but if the web was where it is all going then it would be there, I’m not trying to say that web sales are not going up [I can't remember the last time I bought software that wasn't delivered over the web - kudos btw: to Steam Games!].

For so much else we still often go to a retail outlet. A consignment shop could occupy some unwanted retail space, create some funky shops in areas that are otherwise going downhill, and help people who are tight on money to both realise income from things they have and want to sell, as well as find deals. It may even be a case that you could trade certain things in or out of a consignment shop.

The main barrier to entry thus far is that thrift took a while to become popular again, and of course commercial rents in the city, which have been prohibitive. There are plenty of shops that might buy something from a person (second hand games for instance), but none that I know of thus far who’s primary stock is that given in by people. In return for selling it the shop owner keeps part of the proceeds and so does the seller. There is an internet based one in Ireland but that doesn’t give the walk in ability nor can you buy a set of weights at it.

Anyway, its an idea that we might see sprout up as the recession continues to bite and people look for bargains, the question is who will do it first!

Working in this business can be tragic at times, the nature of the industry is that we have seen many businesses and individuals financially ruined, but at least they are alive and well, ‘your health is your wealth’ as the saying goes.

Sometimes however, our customers don’t have that either, and people die. We can’t stop that, and we can’t help make it better in any way for the people affected with the exception of the financial implications.

A client of ours passed away earlier in the month, they had two houses and two mortgages. When we were first dealing with them we stressed the importance of protecting your family from the financial impact death brings, it is the greatest wealth destroyer of all (indeed, the greatest destroyer in general).

Our clients took our advice, covering their mortgages in full and in addition to that a further lump sum on the life of the breadwinner. Taking out this cover was a selfless act, the person who has ultimately created the payout has passed away in the process, but they have left the survivors financially secure.

I can’t tell you how many times we’ve had the situation of finding out a client died or became permanently disabled and they didn’t take our advice and because of it they will suffer financially, they are always the ones where we find ourselves saying ‘I should have made sure they took the cover’, although we are obviously not allowed to trade in a strong-arm manner, and rightly so.

Then there are examples like today, where we find out that the person has died, and that tragedy is offset (for our part) by knowing that we did our part in making sure that the family will not also face financial ruin. In our clients case they will be financially secure for the rest of their life and their children will be too. I think that once you have kids you start to appreciate the need for making sure they will be o.k. if something bad happens to you.

It is a dismal business to be in where satisfaction of a job well done sometimes involves the death of another, however, it is the ensured financial survival of those that remain which we are truly proud of, that of seeing advice with ensuing action work as it is supposed to in the case of the worst outcome.

Brian O’Donovan of TV3 covered this story, which relates to a press release by the Financial Regulator.

The Financial Regulator has voiced ‘concerns’ over the manner in which disclosure and transparency are enacted when people move from a tracker rate onto any other rate in a press release yesterday.

There were no firm figures given, and no direct accusations (although the Financial Services Ombudsman has received c. 60 complaints). The release comes on the back of a story in the Sunday Business Post by Emma Kennedy which outlined that PTsb ‘misclassified’ up to 300 mortgages and put them on standard variable rates rather than trackers. The issue was spotted by PTsb and rectified by them, customers have been refunded (on average €5,000) the difference they paid plus interest.

The way in which people ‘come off’ trackers tends to be by their own volition, if they opted for a fixed rate while on a tracker contract they do not need to be re-offered their tracker rate at the end. If they were on a fixed rate and are coming off it they are given a selection of rates and although the tracker was offered in the contract, a lender might put several other rates on the same page and give the client the choice of ticking a box to decide which one they’d like to proceed with.

The guidelines issued yesterday will direct banks to give indicative comparisons of the monthly costs of each rate that may be on offer as well as an outline of the implications of moving away from a tracker rate, as well as details outlining the advantages of a tracker rate.

One lender had given a ‘cooling off period’ to people wishing to change rate from a tracker and the Regulator has determined that this may be put into the updated Consumer Protection Code.

Along with many others, I was confused at the fascination with EBS as a takeover target. You see, EBS’s best year recorded a profit of less than €50 million. Which given the size of its operation and loan book is rather unimpressive. The company is also heavily staffed by union members meaning it would be difficult for present management to wade in and cut the numbers in a meaningful manner.

So what is the obsession with private equity and EBS? And what about PTsb?

For a start, PTsb are not currently my lead favourite as a bidder, there are two reasons, one is that the bank rescue plans are being looked at from a competition aspect in Europe, and if PTsb were to take over EBS it would reduce competitive forces, secondly, PTsb may not be in condition to do a takeover. They have their stress-test due out in September and for now we have no idea of how that will look, EBS would add a large chunk to their loan book but deposits in the society are only c. €1bn and that may not aid in creating the loan/deposit balance that banks are looking for, especially given that PTsb are still firmly over the 200% mark. Lastly is a political consideration, every person working in EBS has a significant other in PTsb, if they were to take over it would make great sense from a costing perspective because you could literally fire almost everybody. However, the government are not likely to be in favour of that given the fall out that would result. If private equity took over EBS might (hypothetically) go from 1,000 workers to 700, but if PTsb took over it would go down to more like 200.

Which leaves private equity in the front line, for two reasons, they will bring some of their own capital (who ever wins the bid will be doing it with implicit state support included), and they will help to maintain competition while not reducing staff numbers as heavily as the first option.

Why would private equity be interested? Most of the distribution in EBS is via an agency network which is basically like having a lot of tied brokers?

The agency network does something brokerage in other institutions fail to do, namely raising funding. EBS have made good headway in that respect, bringing in €750m in 2008, €670m in 2009 and on target to do the same in 2010, but the real attraction is a relatively robust loan book with pricing opportunity.

The big banks have a loan book that roughly looks like this

Fixed Rates 20% (much of which may revert to tracker)
SVR’s           20%
Trackers      60%

EBS on the other hand has the inverse

Fixed Rates 20% (most of which revert to SVR)
SVR’s           60%
Trackers      20%

Which quickly explains the fascination, whoever takes over EBS has the ability to increase rates across the loan book in a manner which will have magnified results, much of the mature loan book will shoulder this quite well and ultimately create a profitable organization.

The three key factors will be to reprice the loan book, to lower deposit rates, and to find operational efficiency via staff numbers. A new owner will find it relatively easy to perform all three and to go on and sell the bank in a few years, that is the reason for the level of interest in EBS, they had low profits in the past because they were a mutual, but take the membership agenda out of the equation and you have a bank that is primed for making profit.

I was having a coffee on Merrion Square yesterday when I saw a lawn mower go by, then I noticed something odd. The grass wasn’t any shorter after he went by, there was no catcher on the back and there was no grass coming out anywhere. Having spent inordinate hours on a similar machine growing up (cutting lawns was one of my pocket money generators) I decided to take a look at the place that had been mowed and found that it hadn’t, so the friend I was with helped me to make this impromptu clip.

The upcoming price increases in electricity are due to a PSO (public service obligation) under which €72 million Euro will be paid to firms who dig up peat bogs to burn (and also to wind farms: which is more acceptable but not nearly as easy to make fun of) for energy. Peat bogs are actually a carbon fixer, they remove carbon from the atmosphere and fix it into the soil.

Richard Tol said it best “Approximately, the amount of carbon released into the atmosphere when burning peat is the same as the amount of carbon captured in the bog. Let’s be generous and assume that we subsidize peat burning at 78 euro/tCO2. The market value of CO2 is 14 euro/tCO2. So, we spend 78 euro to destroy 14 euro, which makes 92 euro/tCO2. Fortunately, we do this for about 1 million tonnes only”.

AIB have announced an increase in their Standard Variable Rates (SVR’s) as well as in their Loan to Value Standard Variables (LTV-SVR’s: which are tiered variables based upon your loan to value), effective from August 10th. Caroline Madden of the Irish Times and Charlie Weston from the Independent both carried the story today, this comes only days after Allied Irish Bank announced that they lost over €2,000,000,000 in the first half of 2010.

Their SVR now stands at 3.25% but where is it headed? For that it is important to look at several different factors, firstly, their cost to income ratio has gone from 48% in 2009 to 63% for 2010. That means that it is costing them €63 to turn over €100 in income, this is a 32% increase on last year in costs which is a bad indication.

There are a multitude of factors playing into this:

1. Guarantee/ELG costs: The bank must pay an insurance premium for the guarantees.
2. Higher deposit rates: Necessary to attract and retain depositors for the lender.
3. Higher wholesale funding costs: Interbank lending is currently only available at higher rates to Irish banks.
4. Returns on investment: Have been low year to date (reflected in the cost/income ratio)

The margin across the bank has dropped (despite rate cuts) from 2.03% to 1.56%, when they increased rates earlier in the year this brought them back by 14 basis points or 0.14%, so mathematically they have about three more such hikes to get back to 2009 levels; if rate hikes are their only action.

However, as likely is that of operational efficiency - namely job losses. AIB need to shed about 25% of its workforce and to take action fast.

They did this with the intermediary channel, in mid 2008 they cut commissions by 50% and later introduced a ‘cap’ so that even if a broker places a loan for €10,000,000 they can never make more than €1,500 from the transaction. This was hard to deal with as an intermediary but we took our medicine, the issue now is that AIB has scores of under-performing and non-performing branches, they should all be shut down, they should cut as deep into their branch distribution as they did on intermediary distribution in order to give the taxpayer value and in order to move away from a reliance on rate cuts as the only solution to their ills.

Where to from here?

Only 20% of the AIB loan book is on a standard variable rate so they are really lashing out at the only part of their residential loan book that they can, the remainder are 20% on fixed rates and a whopping 60% on tracker mortgages, that means they have no repricing capacity for 80% of their loans.

The balance sheet is screaming out ‘rate hike!’, with cost to income too high you have to do one of two things, cut costs or increase income, and ideally both: that signals a rate hike.

With margin across the group falling 25%, and to get it back up from its current 1.56% that signals a rate hike.

With a standard variable that is the cheapest in the market, nearly a full 1% lower than Ptsb it means there is plenty of room and scope for further rate hikes.

They have shown their willingness to address rate hikes and to hammer their customers in order to gain ground, the question now is whether AIB will demonstrate the same courage in dealing with their own staff who it seems are still enjoying gym membership and golf fees on behalf of the bank.

It’s time to make ‘hard decisions’ that might actually impact the people in AIB and not just the customers and shareholders of the bank.