Irish Mortgage Brokers Blog

Yesterday the Examiner broke a story about tracker mortgage holders potentially missing out because they are not reading their terms and conditions. This is an issue we have seen first hand in our company, but it wasn’t due to not reading the terms and conditions, it was down to a bank error.

Recently Bank of Ireland had to put 2,000 accounts back on trackers after they mistakenly took them off and onto variable rates. AIB made the same mistake 214 times and PTsb did it 53 times.

In our own brokerages case we saw something similar recently with PTsb, they insisted to a client that no tracker was available. Then, only after the client remortgaged did they admit their error and offer it back. We represented the client in this case and insisted that all costs were also covered in reinstating the mortgage. This means paying solicitor fees, losses on clawbacks, breakage fees for the fixed rate undertaken etc.

Where this happens has tended to be where people come off of fixed rates and in their ‘rate choice letter’ (a letter you get c. 60-90 days before fixed rate expiration) the tracker is not mentioned. Several banks have made this error and thankfully it is becoming more rare as internal audits have identified and remedied the problem in many cases.

Our advice is (as per interview with Newstalk today) to write a short letter if you are coming off a fixed rate to your lender and ask ‘is a tracker available, if not then please point out the clause that indicates this and why’. This should at least ensure that your loan gets a diligent ‘once over’ by the lender who should be able to tell without doubt what the situation is once they go through your paperwork.

There are two sets of statistics floating around; on one hand you have the banks who claim that they are lending and also that the demand for credit simply isn’t there - a belief further expounded by John Trethowan. Then on the other hand you have the likes of PIBA who counter claim that 80% of applications are being refused.

So it is important to break down the vital components. First of all, the debate often centres around Small Medium Enterprise (SME) lending; even if demand for that type of credit isn’t there it doesn’t automatically translate into a reduced demand for mortgages. The point being that we can’t compare SME loans/business loan demand to that for mortgage credit.

Secondly is ‘what constitutes a refusal’, and this is where common sense diverges. Even the bank accept that if you seek €200,000 and are only offered €100,000 that it is a loan not fit for purpose, this even goes for SME loans - imagine trying to borrow 80% of a machine purchase at 200k and then trying to come up with €60,000 you can’t raise? Mortgages are no different, if people don’t have the ability to bridge the difference between the purchase price less their deposit and the loan sanctioned then it is an effective refusal.

If one wanted to be cynical, they would advise the banks to say ‘yes’ to absolutely everybody and only offer them €100 maximum. This ruse would be quickly seen for what it was, and yet when you add in a few zero’s and

Having given the banks support to the point of no return it now seems acceptable for even the Credit Review Office to use the ‘reduced demand’ argument to tacitly approve the strong chance that BOI & AIB will miss their combined lending target of €6,000,000,000 to Irish companies over two years.

If you have no demand in one area then why not funnel those funds which ‘must be lent’ to wherever the willing borrowers are? That our vested interest comes into this is evident - but it is frustrating to see a market down 95% and the issue of loan supply being a strong driver in the lack of transactions.

The vast majority of people who want to purchase a property simply cannot get past the underwriting hounds who have gone from being puppies in the last decade to being dogs at the gates of hell over the last two years. And the blurring of lines between different types of credit and the gathering of statistics give two totally different stories, but much like any cake, you have to look at the ingredients going into it, and in our opinion at least, the way ‘approvals’ are counted and accounted for is wrong, meaning credit is nowhere near as available as we are told it is.

David McWilliams hit an interesting point in today’s piece in the Independent about having ‘too much regulation’, and how it may repel new banks from coming here.

in late 2009 I was picked as part of a team that approached PostBank with a view to turning it into an SME business bank - our proposal never even made it as far as board meetings because they were determined to close down rather than continue, we found the whole process perverse at best.

Instead the same investor group will be setting up in the UK, meaning SME’s in Ireland lose out on funding.

It isn’t that new banks don’t want to come here, it is that they are routinely put off from doing so via the Central Bank and the way in which we grant banking licences in this country.

The other regulatory issue is Basel III.

Asking a bank during a time like this to hold more capital makes sense from a risk perspective, but from every other angle it is a noose.

Banks are being asked to deleverage (have fewer loans versus deposits), market forces are making them pay more for deposits than is healthy, they have huge tracker mortgage books that even when they perform create a loss and at the same time we want them to lend.

Simply put, these are not compatible objectives.

Banks HAVE to become zombies in order to continue because it is only with huge liquidity & capital injections at low prices that they could hope to work normally again - and we have already spent all of the money we have on saving them; so their alternative is to grind along trying to make whatever money they can and in a very very long time they will eventually be breaking even (think Japan)

That is the true tragedy of the crisis, if we had let Anglo close (I argued for this here) and only tried to save a few good banks (even though AIB is a banger it is still the owner of half of the payments system that the likes of EBS sit on top of) then we could have had a chance - it would have also required going right down the order of liabilities as follows:

Sharholders - wiped out
Preference Shares - wiped out
Mezz & SubOrd - wiped out
Senior bonds - turned into new equity
Depositors - saved (in order to maintain confidence)

Then we could have given 25bn in low cost money to the banks to make them healthy. Naturally hindsight is 20:20, we are never so prepared for anythin we are for yesterday!

But the new point is clear - regulation in itself is actually a risk, and a systemic one. Regulatory Risk will be a common word in banking vernacular of the future.

The entire justification of regulation and the bearing of its cost on the financial system (which ultimately gets built into consumer prices) is the avoidance of the systemic risk it is meant to mitigate. It didn’t and it won’t in the future so why is more of it now the solution?

Mainly because it sounds good…

When a bank creates a loan that becomes an asset, the property it is secured upon is the collateral (sorry my teaming millions, I know I repeat this eternally). So if NAMA decide to become a brand of lender this October as we saw from an article in today’s Independent; then how does it work? Where does the money come from?

Take a property that they are putting up for sale (1st picture: pic not related). We’ll say for the sake of this example that it is worth €200,000.

The NAMA position may be that they paid more or less for this particular property but it doesn’t really matter; what does matter is that for the sake of them selling it the property may as well be unencumbered, there is no lien above that held by the NAMA.

This means they can give a title deed to the buyer when they sell it - but don’t forget, when a person takes out a mortgage there are two sales/purchases, the individual buys from the vendor (1st sale/purchase) then they sell it to the bank in exchange for the money [we call the 'mortgage] to complete the transaction (2nd sale/purchase) and the bank then take the ‘1st lien’ or ‘right’ on the property.

Prior to this they put in their deposit (10% or €20,000) which becomes their own, this is their ‘equity’, which is why ‘negative equity’ is described not as value versus the market (that’s called ‘price’), rather value versus the mortgage secured on the property.

What NAMA have indicated is that they will provide a kind of ‘bridging finance’ for buyers, so a certain portion will be made up of Bank borrowing, just a regular mortgage (we’ll speculate that it will be 60%).

This has a key advantage for the bank who will have 1st lien (because NAMA have said that there is some loss sharing mechanism which would indicate that at best they hope for 2nd lien). First of all they have a low loan to value (LTV) mortgage - considered lower risk because before the property gets into negative equity from the banks perspective (60% of 200k is €120,000) the price would have to fall a further €80,000. Secondly it means that they can lend a little more freely because their risk in this instance is reduced, it doesn’t mean ‘lax standards’ but it shouldn’t be as stringent as the lunacy that prevails now where it is so difficult to obtain credit.

So working through the example: The buyer puts in €20,000 (10%), the bank forward €120,000 (60%) leaving €60,000 (30%) to cover.

Thus we have the NAMA input; but where does this money come from?

Quite simply it comes from nowhere.

How? Because the property is unencumbered so what NAMA do is draw up a loan agreement (that then becomes an asset) and they give you the keys, along with an agreement that (speculating) might say that if prices fall then after 5 years there is some kind of loss sharing mechanism.

This means that they go from a situation of having an empty apartment generating nothing into the following:

Buyers input: €20,000
Mortgage: €120,000
Loan written: €60,000

The first two give a cash input of €140,000 which can then be invested (we’ll assume they get 5% p.a.) and they also have a loan of €60,000 which is a future claim on earnings of the buyer (again, we’ll assume 5% interest rate).

If there is ‘loss sharing’ don’t forget, the buyers equity gets wiped out first so it is not a case that if values fall that NAMA are onto a loser, rather it is if they fall greater than 10% over the next 5 years, and that may well be likely but don’t forget, they have money in hand today which will generate profit elsewhere.

That 140k over 5yrs at 5% will give them €178,679 (compound interest being [M=P(1+i)n]), the 60k loan will bring in €16,567 in cash meaning that they have €60,000 at risk but €55,246 in cash-flow, and let us not forget that if prices did fall and fall that the €120,000 bank loan has no loss sharing and would put NAMA in a better position than if they held out and sold at a later date - but I see that as an Armageddon scenario.

If prices fell a further 20% (which could happen and was hinted at in the Central Bank paper ‘Scenarios for Irish House Prices‘) then NAMA only have €20,000 to worry about and depending on the loss sharing scheme put forward all they do is write down the value of their loan on that basis giving the following:

€120,000 underlying bank loan
€20,000 deposit (now wiped out as buyers equity goes first)
€200,000 - 20% = €160,000 so the €60k loan they advanced becomes a €40k loan from that day forward.

Not a bad deal (for them) all said.

The best rates in the market at present are

Variable (<50% LTV): BOI 3%

Variable (any LTV): NIB 3.4%

1yr fixed: AIB 4.15%

2yr fixed: NIB 4.2%

5yr fixed: NIB 4.9%

10yr fixed: NIB 5.5%

We were delighted to be part of TV3’s ‘The Morning Show, with Sybil & Martin‘. We are fans of the show and enjoy the relaxed nature of the conversational commentary style they are so adept at. In this clip we spoke about the costs of finance and the potential removal of fixed rates, while Marian Finnegan (of SherryFitzgerald) covers housing, her background is in urban economics and she lectured at both NUIG and UL before moving to SherryFitzgerald. We hope you enjoy the clip.

Section 23 properties have had their tax treatment changed, in effect the buyer honoured their side of the contract from the outset and after the initiation of this the Government reneged on their side of it. This is contrary to the idea of fairness, the concept of contractual obligations, and it undermines the faith any taxpayer can have in the state.

The state recently cut many people with income tax and reductions in entitlements, but these were never contractual and people certainly didn’t leverage up to obtain them. Landlords may not be a group worthy of sympathy, but at the same time recent changes to taxation on rent (Case V income) mean the amount of financing expense the business can offset has dropped by 25% (mortgage interest you can offset has gone from 100% to 75%), this is contrary to the rules of accounting when you look at any other business.

The only solution is a reversal of this policy, and perhaps the only way to ensure this is to apply the idea of mutual assured destruction. If there were 10,000 section 23 owners who all signed up to a commitment to go into 100% default on the 1st of April if this is not changed then you would see that the state would reverse this policy because it is flawed and because the 60-100m in savings that they would make would be eradicated by the ensuing mess the banks would be left in because of it.

When default becomes discretionary then a solution becomes necessity, and at this point, for many landlords default is becoming an option because they are being hit from all sides. Banks are looking for capital and interest payments at a time when rents are dropping, subsidizing the capital payments is often coming from earned income which is being subjected to more taxation, landlords are making imaginary profits because they can’t offset their expenses fully and now a lasing commitment regarding property taxation has been grabbed because it was easier than making the right decision.

The right thing would be to tax all property rather than just attacking those who hold investment property, they made this move before with the NPPR tax (€200 p.a.), and there was no resistance despite the fact that a flat tax of this nature was grossly unfair and didn’t distinguish between a mansion and a one bed apartment. Now there is an extension of this approach because it’s easy, because landlords don’t fight back, but that forgets the fact that you reach a certain point and people simply roll over or opt out, Atlas can always shrug.

Perhaps it was time that the Government found out that we do have an ace up our collective sleeve, and that it can be used to destroy the system they have fought so hard to save.

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.

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.

I was interested in the front page of today’s Independent in which Charlie Weston broke a really big story about Irish banks being in advanced stages of designing ‘Negative Equity Mortgages’ (this is vastly different than the Negative Equity Loan/Short Sale Loan we have discussed previously). Essentially the bank will allow an individual to carry negative equity out of one property and move that onto another one within certain parameters.

This practice has already existed in the UK and is offered by Nationwide, Coventry and RBS, the schemes have not proved to be very popular, in part because of the stringent underwriting required. It is one thing for a client to fall into negative equity but another to actually facilitate them in compounding that fact and taking a further bet on their ability to repay. What do I mean by that?

First Loan: €200,000
Value: €150,000
Neg/Eq: €50,000

Then the €50,000 shortfall is passed into a second loan of (for example) €200,000 (which by nature will essentially be a 100% mortgage) and now they owe €250,000 with €50,000 negative equity in place the day they close.

In this case the borrower now owes more but they have a different property which they are more happy with and underwriting will ensure that they can still service the loan, but how many people will be willing to take up such a product? And who will the bank be willing to lend to on this basis? Credit is already tight, to trust a person with yet more money and negative equity in advance is a gamble, this beast is the evil love child of 100% mortgages - the very brand of lending that was a factor in the property bubble.

The sole saving grace is that people won’t opt for it, in the UK the uptake has been incredibly low, it is a niche product with little in the way of demand, it will help the people who are happy to use it and will be of little use to the average borrower, having said that, the Regulator recently said that banks have failed to learn their lessons from the crisis and that they don’t lend enough to business and rely to heavily on property, if this is the latest in financial innovation can we truly say they are learning anything at all?