Irish Mortgage Brokers Blog

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?

In the first quarter of 2010 there were c. 62 business days, and from this time frame we have gotten the most recent lending figures from the Irish Bankers Federation on mortgages in Ireland. Those figures stated that there were 6,954 mortgages drawn down in the first quarter of 2010 equating to €1.22bn in lending.

Those are the hard facts.

Then come the contradictions. AIB claim to have about 40% of the mortgage market - that headline is from last November but we can assume it should still remain at above 30%, an institutional contraction of 25% would be known because it would definitely make headlines (the 40% of the market AIB has is 100% to them so if it fell to 30% that would be a 25% reduction on their single institution figures). Back on topic - if we accept that AIB is holding at least 30% of the market then that means they were responsible for 2,086 mortgages.

EBS are saying they have about 28% of the market, up from 21% last year. The bit I like best is where they say that one in two people who go direct to a bank for a mortgage went to EBS. Sadly, this doesn’t factor in the reality on the ground - every broker in town has a back door with the EBS via one of their agent branches and clients are regularly sent to them for loans when their more conservative broker wing won’t do the mortgage [EBS are loose on policy when you go direct].  A 28% market share would mean EBS were responsible for 1,947 mortgages.

We didn’t find statements of market share from the other banks, but I think it would be fair to say that between PTsb, Ulsterbank, NIB, INBS and KBC that they were jointly responsible for perhaps 15% of the market? (1,043 mortgages).

So we are now looking at a picture like this: AIB 2086 mortgages + EBS 1947 mortgages + everybody except BOI 1,043 mortgages = 5,076 mortgages

Nothing spectacular there until you get back to the fact that we had about 62 banking days in the first quarter of 2010, because during that time Bank of Ireland were claiming they were doing 100 mortgages a day. That would equate to 6,200 mortgages.

BOI figures 6,200 + everybody else’s figures of 5,076 = 11,276 mortgages

Reality = 6,954 mortgages.

Difference between the two? About 4,322 mortgages or in the region of €870,000,000 in lending.

In a nutshell, somebody somewhere is telling porkies. Who even cares any more.

Trading conditions in the year to date remain challenging, particularly in Ireland. Conditions have improved in Great Britain and our Capital Markets and Polish businesses are performing well. In the US, M&T reported strong results in the first quarter of 2010.

OPERATING PROFIT
Please note that all trends in this update are in constant currency terms.

A combination of factors is placing downward pressure on our net interest margin and / or operating profit before provisions this year. These factors include:
•    Highly competitive and uneconomic market repricing of customer deposits
•    The elevated cost of wholesale funding and the higher cost of the Government Guarantee
•    Reduced income on capital and increased interest payments on higher yielding bonds following the two capital exchanges successfully completed in the past year
•    NAMA administration costs and reduced income from NAMA loans
•    Targeted loan volume reductions outside Ireland to reduce our loan to deposit ratio

Positive factors, including loan repricing across all portfolios and a reduced impact or non recurrence of   some of the above factors, are expected to have a much more significant effect in the medium term future than in 2010.

At the end of April, overall loan and deposit volumes were both broadly unchanged compared to December 2009. Loan volumes exclude the effect of loans transferred to NAMA

Customer demand for credit is weak in Ireland where we have increased lending capacity to the business and mortgage sectors. We are deleveraging our balance sheet by taking some opportunities to reduce lending in our other businesses.

Costs continue to be closely managed and reduced. We are developing a cost reduction programme that will reset the base to a lower level, reflecting a more streamlined structure more aligned with the bank’s reduced size following completion of the business disposals now underway.

ASSET QUALITY

NAMA
In concluding that AIB is required to raise €7.4bn of additional equity capital, the Financial Regulator has assumed a 45% discount to AIB’s NAMA eligible loans of c. €23bn. The actual discount will be determined when all the loans are valued and may differ from the aforementioned 45%. When further valuation is sufficiently advanced we will advise the market of any material changes in expectation of the amount of loans that will transfer to NAMA or the overall discount rate. Loans will continue to transfer to NAMA in tranches and there may be wide variations in the discount rate for individual tranches. Variations could occur due to factors such as location and the proportion in each tranche of land and development relative to investment and other associated loans.

Pending transfer of loans to NAMA we continue to assess their quality. Credit downgrades are continuing and where there is evidence of impairment, we are incurring bad debt charges. These charges are increasing the stock of provisions we hold for NAMA eligible loans which will partly offset the effect of the discounts applied to the loans on transfer.

Non-NAMA

Republic of Ireland Division
Bad debt charges in the first quarter were at a rate similar to that incurred in the full year of 2009. The stock of provisions held for loans reflects their current risk profile and the provision requirement for the remainder of the year will be determined predominantly by economic conditions.

Our residential mortgage book of almost €27bn continues to perform better than the sector average. The bad debt provision rate requirement in the first quarter of 2010 remains modest and not materially above the rate for the full year 2009. As expected, arrears continue to increase and future loss levels will largely be determined by unemployment in Ireland.

The credit grading profile of property & construction loans continues to weaken, reflecting low levels of activity and demand. Following the NAMA transfer process, this portfolio will reduce to c. €12bn of which c. €9bn is investment property and c. €3bn is land and development.

Our other portfolios are performing in line with our expectations.

International (Capital Markets, CEE and UK divisions)
There are clear signs of stability in the credit profiles of our Capital Markets and Polish businesses. In the UK, there are also signs of stability in our Great Britain portfolios though conditions remain challenging in Northern Ireland. First quarter provision charges in each of these divisions – Capital Markets, CEE and UK – were less than the rate for the full year 2009.

CAPITAL
Our capital ratios at the end of March were broadly unchanged from the position at December 2009. These ratios reflected ongoing bad debt provisions on NAMA eligible loans, which further discount the value of the loans prior to transfer, and the c. €445m gain from the capital exchange completed in March.

In our announcement of 30th March 2010 we set out a series of capital actions we intend to take in response to the increased regulatory capital requirement announced on the same day and to be achieved by the end of 2010. These actions include asset / business disposals, equity raising and we will also consider further liability management opportunities. We will advise the market of progress in relation to our capital actions as it occurs over the coming months.

A recapitalisation plan has been submitted in response to the Financial Regulator’s request of 30th March.

FUNDING
Customer deposits remain our principal source of funding at 51% of overall funding. Our loan to deposit ratio at the end of March was broadly stable compared to the 146% ratio at the end of 2009 and significantly lower than at the end of March 2009. We expect to continue deleveraging the bank’s balance sheet and the effect of transferring loans to NAMA is material in that respect. On a proforma basis, the loan to deposit ratio at the end of March 2010, excluding NAMA eligible loans, was c. 124%. The NAMA bonds will significantly improve our liquidity profile, further enhancing our contingent liquidity resources.

Term funding activity has been successful in the year to date, well supported by the ELG (Government Guarantee) scheme. We have completed over €6bn of greater than 1 year term funding in a combination of public benchmark transactions and private placements. This €6bn is well ahead of our target and represents c. 60% of maturing term funding (net of covered bonds) in 2010. Of our overall wholesale funding c. 41% now has duration greater than 1 year, compared to c. 30% at the end of 2009. We have little maturity of term funding in 2011.

Overall funding market conditions and pricing have improved during the first quarter of 2010. However, recent negative sentiment in the sovereign credit markets demonstrates that markets remain volatile and vulnerable to changes in sentiment. Duration remains short and pricing elevated compared to historic norms.

ISSUE OF ORDINARY SHARES TO NATIONAL PENSIONS RESERVE FUND COMMISSION (NPRFC)
Discussions on our restructuring plan with the European Commission (EC) are ongoing and are being conducted in conjunction with the Department of Finance. At the request of the EC, AIB has agreed not to make discretionary coupon or dividend payments on certain of its securities. As a result, the annual dividend on the NPRFC’s €3.5bn preference shares, amounting to €280m, due today 13th May, will not be paid in cash. Under AIB’s articles of association, it is required to issue ordinary shares to the NPRFC equal in value to the amount of the dividend that would otherwise have been payable. As a consequence of this, AIB will issue 198,089,847 ordinary shares to the NPRFC by way of bonus issue. This number of shares is equal to the aggregate cash amount of the annual dividend of €280m on the NPRFC’s holding of preference shares, divided by the average price per share in the 30 trading days prior to today’s date. Application will be made in due course for the listing of these new shares. This issue of shares increases the ordinary shares of AIB in issue to 1,080,845,303, of which the 198,089,847 shares to be issued to the NPRFC represents 18.33%, bringing the NPRFC total ownership of AIB ordinary shares to 18.61% (excluding any shares which the NPRFC would be allotted if it were to exercise its warrants over ordinary shares granted to it when it subscribed for the preference shares in 2009).

Further details of our performance and outlook will be provided in our 2010 Interim Results announcement scheduled for 28th July 2010.

-ENDS-

For further information please contact:
Alan Kelly    Catherine Burke
General Manager, Corporate Services    Head of Corporate Relations and Communications
AIB Group    AIB Group
Dublin     Dublin
Tel: +353-1-6412162    Tel: +353-1-6413894
email: alan.j.kelly@aib.ie    email: catherine.e.burke@aib.ie

Forward-looking statements
This document contains certain “forward-looking statements” within the meaning of Section 27A of the US Securities Act of 1933, as amended, and Section 21E of the US Exchange Act of 1934, as amended, regarding the belief or current expectations of the Group, AIB’s Directors and other members of its senior management about the Group’s financial condition, results of operations and business of the Group and certain of the plans and objectives of the Group, including statements relating to possible future write-downs or impairments. In particular, certain statements with regard to management objectives, trends in results of operations, margins, risk management, competition and the impact of changes in Financial Reporting Standards are forward-looking in nature. These forward-looking statements can be identified by the fact that they do not relate only to historical or current facts. Forward looking statements sometimes use words such as ‘may’, ‘could’, ‘would, ‘will, ‘aim’, ‘anticipate’, ‘target’, ‘expect’, ‘estimate’, ‘intend’, ‘plan’, ‘goal’, ‘believe’, or other words of similar meaning. Examples of forward-looking statements include, among others, statements regarding the Group’s future financial position, income growth, business strategy, projected costs, capital position, estimates of capital expenditures, and plans and objectives for future operations. Because such statements are inherently subject to risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking information.
These forward-looking statements are not guarantees of future performance. Rather, they are based on current views and assumptions and involve known and unknown risks, uncertainties and other factors, many of which are outside the control of AIB and are difficult to predict, that may cause actual results to differ materially from any future results of developments expressed or implied from the forward-looking statements. Factors that could cause actual results to differ materially from those expressed or implied include, but are not limited to, changes in economic conditions globally and in the regions in which the Group conducts its business, changes in fiscal or other policies adopted by various governments and regulatory authorities, the effects of competition in the geographic and business areas in which the Group conducts its operations, the ability to increase market share and control expenses, the effects of changes in taxation or accounting standards and practices, acquisitions, future exchange and interest rates, the risk that the Group may not participate in NAMA or that the NAMA Scheme may turn out to be unsuccessful in achieving its goals, the lack of control over the nature, number and valuation of the assets to be transferred to NAMA and the success of the Group in managing these events.
The Group cautions that the foregoing list of important factors is not exhaustive. Investors and others should carefully consider the foregoing factors and other uncertainties and events when making an investment decision based on any forward-looking statement. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this Report may not occur.
The forward-looking statements speak only as of the date of this document. Except as required by the Irish Financial Regulator, the Irish Stock Exchange, the UK Financial Services Authority, the London Stock Exchange or applicable law, AIB does not have any obligation to update or revise publicly any forward-looking statement, whether as a result of new information, further events or otherwise. AIB expressly disclaims any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained in this document or incorporated by reference to reflect any change in AIB’s expectations with regard thereto or any change in events, conditions or circumstances on which any such statement is based.

We were really pleased to be featured on TV3’s news with Brian Daly on how AIB rate changes would affect consumers, the clip above was aired on the 30th of March 2010

Yesterday AIB increased interest rates for both existing and new borrowers. This comes as a huge blow to consumers, in particular given that the consumer is the same taxpayer who has done so much to bail out the bank. Do people have the right to be angry? Hell yeah they do!

The move has been coming for quite some time, we have been harping on about this for over a year, the most recent prediction was to put a time-frame and figure on the hikes, stating that it would start in Q1 of 2010 and in the course of the year we’d see c. 100 basis points or 1% of an increase across the board with a further 50 basis points or 0.5% in 2011. Today’s Independent has stated that we can actually expect all of it in 2010.

Why is this happening?

Simply put, the banks are not charging enough to cover the costs of loans that are not performing. In a way you could think of it as the people who are able to pay are paying for those who can’t, the banks need margin to absorb impairment, a situation that was brought about by reckless lending and borrowing.

This isn’t linked to NAMA, which is there specifically for commercial loans, this has to do with the residential loan books of banks, currently there are about 30,000 mortgages in serious arrears, nearly 7,000 have not made a payment in a year (greater than 12 months in arrears) and many more are crossing the delinquency Rubicon of 3 months in arrears in a daily basis. What is stopping this from being a bigger problem? Mortgage Interest Supplement, savings, family support, and forbearance by the banks.

Reckless lending deserves a comment, banks lent money to people who probably should never have qualified in a conservative traditional banking environment, that is a given, we all know that. The truly reckless decision though, was where banks gave up any cost control in the future…. Imagine owning a newsagent and agreeing that come hell or high water that you would never charge more than €1 for a litre of milk? Sounds stupid? Well, that’s exactly what our banks did in the widespread distribution of tracker mortgages, they effectively gave away their ability to control their margins in the future, in banking that is a HUGE error.

The cost of funding has increased for banks, the rates they have to pay in order to compete are historically high when compared to lending rates, they are caught in a perfect funding storm, harried on one side by foreign competition who don’t have a payments system and branch network to operate, on another by a public and political pressure-cooker which threatens to blow if they price risk appropriately, and lastly by a bond market which doesn’t trust them and is charging higher prices for the use of their money unless there is a sovereign backing to the security (LT2 AIB bond has a 10.75% coupon).

In this mess you have bankers who are afraid of causing further scorn - don’t forget, most of them live here and are not planning to emigrate once they retire - and a perception that in bailing out the banks that in return we can expect a price promise, or that they will give the public preferential rates, sadly this couldn’t be further from the truth.

if you have problems viewing the video you can watch it directly on youtube.

I should state from the outset that I am against a banking enquiry if it is the ‘9/11 style public enquiry‘ it was originally billed by Patrick Honohan as (pic related). I also believe the primary failure in Ireland was one firstly of regulation and governance over and above what went on within the banking system, it is after all, the responsibility of regulators to exert their control over the systemic aspects of banking rather than vice versa, however, it seems to be the popular choice to have an enquiry and thus I have outlined how a relatively cheap investigation might be set up.

The people of Ireland are calling for blood and it is no surprise that various powers now want to deliver on it, they join other leaders from antiquity such as Titus, Nero and Caesar in wanting to please the masses with blood-letting, sadly, we have a history of making any investigation extremely expensive (it would actually be cheaper to have a real life gladiator tournament than a tribunal) often with little result - the tribunals are largely testament to this, in particular when they involve white-collar issues and not criminal ones. The fact is that in Ireland after an investigation find you guilty, that if you are rich enough you tend not to go to jail, and the only hardship might be having to cover your own legal bills.

So in advance we have several aims.

1. clearly define what it is that we are trying to ‘investigate’, much of the activity in banking is well documented and there is a large and clearly defined audit trail, for this a knowledgeable auditor can do
the job if there are specific issues known in advance that need to be considered. So if the issue is that ‘bad loans were intentionally placed’ or that ‘underwriting requirements were avoided’ or ‘legal requirements circumvented’ then it is all right there in the audit trail, oddly though, the feeling I get is that people want a general ‘explanation’ with a motive attached, I don’t know that we will ever get one, even if we stopped the entire nation to focus only on this enquiry.

2. define the parameters of relevance, is this about breach of regulation, irregular practice or outright illegal activity, depending on what you opt for (or indeed if we opt for all of them) it may be a case that we don’t need to do much research at all. This ties in with point 1, because banking is such a paper-trail intensive industry there is very little that cannot be uncovered with relative ease, if however it has more to do with conversations in board-rooms and the like then we get into a softer brand of evidence.

3. set a time frame and make the results public, something the Government fails to do, and when they do they don’t stick to it, not even when its a fairly set infrastructure project (think LUAS, Port Tunnel etc.).

Process: The first thing to do would be to remove the onus of discovery from the regulators alone, they don’t have the resources and it would take far too long, instead we should have a two phase initial inquiry which encourages people to rat out the wrongdoers.

I know (only anecdotally) that there is a huge amount of rage within the rank and file banking staff, they would all be only too happy to make sure that any people at the top that they can expose are given what they see as their comeuppance. There is a precedent there too, most of the public don’t know that former BOI chief Michael Soden was vigorously paring down BOI’s IT department just prior to the precarious information being found on his PC, odd that… You go to chop the IT department then suddenly the IT department brings you down?

There might be a ‘cosy cartel’ or ‘golden circle’, we see that kind of language used to describe many things if you look at some of the books out this year, or the tv/paper headlines, but in these ‘circles’ their strength lies only between themselves, every other rank and file member of financial institutions are likely more than happy to see these people brought down, and they want vindication for the regular Joe’s, this is one course where they might achieve it.

Phase 1: (60 days) anybody who worked in finance within the last decade can send an affidavit into the regulator, they can turn whistle-blower on any activity they know about within any field they have worked within, giving names, rough dates etc. equally, anybody can write in a confession in advance, stating their version of events upon any activity that may have been done with bent rules or contrary to regulation/law. This will provide a large body of evidence for the regulator to read through, they can then tie together the various affidavits to the organisations they relate to and that will be the foundation of further investigation. The obvious flaw is that perhaps nobody will whistle-blow, but this could easily be worked around by ensuring that professional bodies will get involved if any wrongdoing is uncovered

Phase 2: (30 days) The Regulator reads through the statements and filters them into criminal, very serious, serious, breach without serious implication and non-serious strata’s, then they set to work on the biggest ones first.

phase 3: (40 days) there would need to be some precedent set so that people implicated in the affidavits from phase one are placed with a burden of proof in phase 3, all the people implicated from phase 1 will have to defend their position from any implication placed against them in phase 1, rightly or wrongly, the people who come clean in the first instance should be given a precedence of ‘truth’ so that there is no reverse investigation based solely upon their affidavit, so they can’t ’self incriminate’, however, they can eventually be investigated if they failed out outline their own role, if they do confess and help then you do the standard treatment of greater leniency for them.

Finance isn’t like the Mafia, people won’t protect each other, perhaps if there is guaranteed anonymity for the people who make statements in phase 1 (not anonymous submission, but within the investigative process if their identification is protected) then it will encourage a full disclosure from within industry. The fact is that getting people to dob each other in from within is far more effective than trying to get in and pry answers from without. It works in breaking drug rings, criminal gangs, it is cornerstone of the RICO act and history tells us that people have an innate desire to not live in prison, so even the biggest criminals rat others out, they might be competitors or former bosses, it doesn’t matter, its effective.

phase 4: 6 months: All of the information is studied and investigated, the most pertinent being dealt with first and the less important either going into later investigations or thrown out altogether depending on the gravity of same - but with a formal warning issued as a precaution.

The regulator must then have a set level of fines which is relative to the size of the firm and or individual in breach, and professional bodies must also be involved - to the degree that any criminal breach or high level regulation breach results in the removal of professional recognition (eg: Institute of Bankers/ LIA would strip people of QFA, ACCA, ACA, CFA etc.) would all endeavour to do the same, and the regulator would create a ‘black list’ of people from the investigation so that it is known publicly, a further move would be that these individuals cannot be directors of financial firms, or become regulated personally, effectively we need to ‘clean out’ the system, in one fell swoop, not via the slow grinding attrition that we have seen thus far where the culpable are creating their own terms of termination.

The end result is that criminals would graduate to jail, and serious offenders are dealt with in a variety of different punitive manners, but if it must be done, then it must be done quick, with a set agenda. We shouldn’t put the uncovering of some ‘higher truth’ that we won’t ever really obtain above that of running a cost effective investigation in a timely manner.

When making a mortgage application this is a question that many first time buyers want to know, how much money do I must I have for a deposit? Well, that kind of depends on which bank provides the mortgage finance!

Lending criteria is different for every bank/building society/lender, this goes for rates, the general underwriting criteria as well as the ‘loan to value‘, the deposit you need is 100% minus the Maximum LTV and that will give you the deposit amount you require.
For instance, ICS have a maximum LTV of 92% so the deposit you need - if you are obtaining finance through them - is 100% - 92% = 8%.

What is interesting in that example is that when you go ’sale agreed’ on a property the estate agent will ask for a security deposit and the balance of 10% at the signing of contracts, this is an example of industry lingo being so embedded that it becomes separate to reality. The fact is that if you obtain 92% finance that you don’t need to give a security deposit plus the balance of 10% at the signing of contracts, it would be the balance of 8% - your solicitor will talk to the other side and organise this.

The mortgage criteria on deposits required by each bank is listed below. We have put them in the order of the banks that are actually lending.

Banks Lending Normally:
AIB, ICS, BOI all require at least an 8% deposit.

Banks Drip Feeding Lending:
EBS 8%
Haven & KBC 20%

Banks That are essentially Not Lending:
INBS 10%
NIB 20%
BOS 20%
PTsb 10%
First Active (Not doing any new mortgages)
Ulsterbank 10%

The banks that are currently lending in a regular fashion all provide 92% finance, it will be no surprise that they are headed for the maximum market share on lending in 2009, obviously the €1,000,000,000 that we gave each of them earmarked for first time buyers helps a lot too! In any case, there are plenty of banks and lenders to choose from, the issue is currently more about ‘who’ is lending as opposed to what prices or options are available, if you can’t get approved with one of the current primary lenders then you may have to wait up to 3 weeks for an initial response or find yourself with the option of a variable rate which is 400 basis points above ECB.

Yesterday the National Asset Management Agency (NAMA) legislation was brought out in the Dail (that’s the Irish Government buildings for our international readers) . We have put some of the developments into simple graphs to give an idea of the way NAMA will work and what the prices are as well as what they mean (for the pedants out there- they were drawn by hand to demonstrate the point).

So the total value of the loans is €68 billion, adding on €9 billion in rolled up interest - development accounts often had this factored into the end sale price, generally showing c. 15% profits (as a minimum) with the roll up included.

The €77 billion in loans will receive a 30% haircut (across the board) meaning the price paid will be €54 billion. It is important to note that different institutions will see larger haircuts than others, so it might be that BOI gets 20%, AIB 25% and Anglo 37% / INBS 42%, the 30% represents a varied pot in which individual loan sizes and haircuts will vary, having said that we know already that the biggest discounts will need to be applied to INBS and Anglo.

Brian Lenihan stated that the original value of these assets was €88 billion, of which the loans were €68 billion (before rolling interest was added on), an average LTV of 77% applied (which is over standard commercial lending levels so some more digging may be needed to see if there were cross-security/cross collateral considerations or cash flow producing securities for additional lending involved). These loans will being bought for €54 billion imply a 40% drop in the values of the assets on an economic basis (not today’s market price basis).

Each loan going to NAMA will have 185 queries/questions required on the property itself, and a further 300 on the loan, that means the diligence will be c. 500 questions that must be answered for each property. The staff of NAMA (c. 50) can’t cope and thus the banks are taking people out of credit and having them go to work for NAMA but on the bank payroll, so in essence NAMA has outsourced the work at no additional personnel cost which was a smart move (one of few).

The actual value of the assets in today’s market is (we are told) €47 billion, this means that there is an upfront shortfall of €7 billion, so no matter what happens there has been a potential tax payer cost of €7 billion at a minimum, obviously that is the market value though and not a long term value which assumes that prices will eventually rebound (the estimate is 10% in 10yrs), that point can be argued for and against, the issue will be (in my opinion) the ongoing cash flow to ensure loans are serviced. There isn’t any information put forward about expected default rates and that could easily skew the numbers.

The debt is also predicated on Euribor and while Liam Carroll’s case was tossed out of court because it relied on low interest rates, we have pegged the NAMA on the same hopes! It tells me that this plan probably wouldn’t stack up if it was provided judicial oversight, then again, fairness was never part of the plan.

Having said that, of the assets going across c. 40% of them are cash flow producing assets - in some cases this is blocks of apartments that were retained by developers and let out or other commercial rents. The banks will have a big job ahead of them in the near future: they will have to raise some capital quickly to avoid dilution of their shares/potential nationalisation (or at least majority state ownership which is effectively the same thing), if today’s share price performance is anything to go by the appetite is back so this seems likely to be a working solution. NAMA isn’t about fairness, and in that respect it is a massive failure, it is about a plan with a chance and in that respect it has a better chance of success than the alternatives put forward.

We have been saying for some time that interest rates on mortgages must rise, you can look at supply and demand, or you can look at the types of products that have ceased to exist such as tracker mortgages (removing fixed margin loan products) and then there is the proliferation of variable LTV products which set the stage for the ability to manipulate margin on more loans. The question is ‘what all of this means’, and the purpose of this post is to explain how deposits, business lending and mortgages are all interconnected parts of the banking system and how margins are set based upon them.

Last week PTsb finally came out and said that they were considering an increase in margins on variable rates. This came partly as a relief, not because we relish the idea of people having to pay more for their loans but because it means that Irish banks are slowly going to start taking the necessary steps towards recovery. These steps are (in a nutshell) higher margins, more prudent lending, and deleveraging. Irish mortgages have had some of the lowest margins in Europe, this is in part due to the propensity for Irish borrowers to easily research what is a small market and their willingness to show no loyalty in lending - although we are extremely loyal when it comes to day to day banking. The IMF even commented on this in their report on Ireland.

While foreign owned banks get into nationality based credit retrenchment it will set the stage for lending to return to higher margins, Bank of Scotland who shook the market up in 1999 with low rates and trackers is now charging the highest rates on the market for variable rates. Thus, there is no meaningful competition on the rate front and with only two or three banks open for business it gives two vital ingredients, firstly is scarcity value and secondly is decreased competition.

If we want to have strong banks then they have to charge higher margins, margins in Ireland are so low that if a single lender defaults it can literally have an effect of (not actually but in terms of damage to the lending book) taking down two performing loans with it.

Rates must rise in order to allow businesses to access credit, that might sound crazy but in fact it is due to margin compression linked with banking rules such as ‘revenue neutral’ balancing when rates change. The blog on margin compression tells you all you need to know as to why banks have to pay more for deposits and not earn more on mortgages when rates drop. However, the side effect is that the balance of income when you get margin compression must come from somewhere else, and the revenue neutral rule [basically when rates drop a bank can't make a sudden increased profit because of it] means that companies cannot access credit except at high costs -because they are in essence paying the margin that deposits are eating and borrowers are not paying- illogically we are saving consumers but not saving the firms they work for!

To understand this consider all the elements of a bank, deposit rates are unnaturally high in an effort to attract and retain capital, you can’t drop deposit rates when a rate cut comes through or depositors flee, and political pressure and contractual obligations (eg: trackers) mean you have to pass the rate cut to borrowers, thus you create a losing position and the only customers left to take up the slack are commercial borrowers - but they often have euribor trackers, and businesses who are now paying much higher margins and being denied access to credit.

Unless we want to live in a society where banks are constantly bailed out then they need to be able to make enough money to offset losses and unfortunately they are unable to do that at present, raising margins and curtailing lending is key to them doing this, it makes life miserable for many (mortgage brokers in particular!) but in a market where competitors are charging ECB+5% it doesn’t make any sense to sell scarce capital for less than half of that amount!

Imagine a sale on gold for half the price the physical gold is worth and you start to get the picture, its just not good business practice. The solution is screaming ‘increase rates!’ but banks are slow to do that in the current climate because it is so distasteful to the Irish taxpayer who bailed them out, obviously foreign owned banks have no issue (their loyalties lie with other sovereignty tax bases) but they are still part of the market so Irish banks shouldn’t try to tow a ‘low cost’ line when it doesn’t make sense, isn’t reflective of the value of credit and when it may lead to more financial assistance being necessary.

We want cheap loans but we don’t want to bail out banks, take your pick.

If there is one useful piece of information you can take from this post it is this: if you are on a variable rate then switch to a low cost fixed rate, fixed rates are dirt cheap at the moment and you don’t have to switch lenders, you can do it with your existing borrower if you want, the reality is that variables have no price promise or protection, and if lenders are going to start to raise variable rates then it would be best to get the protection that a fixed rate offers now rather than after the rate increases occur becuase it will happen in fixed rates at the same time meaning you won’t get a chance to jump ship in time.