Irish Mortgage Brokers Blog

We were talking about Debt Forgiveness on The Morning Show with Sybil & Martin yesterday. The two guest were Angela Keegan of MyHome.ie and Karl Deeter of Irish Mortgage Brokers.

TV3’s Midweek carried an interesting piece on Debt Forgiveness, the clip above had some commentary from our company on the matter.

There has been some coverage of people saying that the PTsb offer of a discount for overpayment is not good value, that the bonus should instead be in the region of 25%.

I don’t know where that figure has been taken from, having tried to work it out several times we just can’t make it stack up.

The form that you need in order to opt for this over payment is here.

Is the idea of an overpayment any good?

In the PTsb scheme you have to consider ‘net interest’ rather than just stating that it isn’t a great idea. The figures I have done are based on the clients position rather than what the bank may or may not make - in the same way that I don’t query the margin a shopkeeper gets on a Mars bar - which is where some focus has been on this.

Rules of scheme: you can’t pay more than 50% of your mortgage, every 5k gets a 10% bonus, so take an example as follows €200,000 mortgage on a 2.25% tracker over 25yrs, €100,000 on deposit at 4%
[one flaw in any current demonstration is that deposit rates are not likely to remain high but interest rates will go up] We’ll just look at the interest portion to strip out the capital repayment portion

Mortgage: 200k x 2.25% = €4,500 p.a
Deposit: 100k x 4% =    €4,000 then apply DIRT = 4000-27% = €2,920
Net position = -1,580

Now, put 100k against mortgage = 200,000 - 110,000 (100k + 10k bonus)
Mortgage: 90k  x 2.25% = 2025 p.a. interest cost [because you are keeping the same monthly repayment, effectively reducing the term
Deposit: zero

So it looks like you are €445 less well off per year but your capital position is better by 10,000 upon which you are also not paying interest so there is an interest savings there of €225 and to get the €10,000 up front v.s. earning the €445 p.a. means it would take almost 20 years to catch up by earning interest and offsetting it against interest payable (10k/445).

The person now also has only 10yrs left on their mortgage instead of 25 and if they decided to pay it down and then use their old mortgage payment in a savings plan they do better by it. Getting rid of debt is a good idea, and the PTsb bonus scheme just puts a sweetener on it.

Obviously, if you don’t have a rainy day fund then this is not for you, if you have a cash bias or debt elsewhere that is at a higher rate then it is a bad idea, otherwise I think it gives the consumer an advantage as well as the bank, nothing wrong with a win-win situation.

IRELAND is in payback mode at the moment. As a country we’re experiencing “deleveraging”, which means that many people are using most of their money to pay back excessive borrowing. However, that practice only puts cash into the banking system and not the real economy.

This is because banks aren’t lending — they’re too busy using the cash to put out fires within their own institutions. There are 786,000 Irish households with a mortgage, and six per cent of them are in trouble. The vast majority of that six per cent haven’t paid the bank a single cent in more than six months.

SOLUTION

Our Government-led solution is to encourage that to continue. They’ve made it almost impossible for banks to repossess homes — Labour’s solution of a two-year moratorium on repossessions reeks of “delay and pray”. A further 24,000 mortgages have been restructured and are still not performing, while 35,000 are only staying afloat due to a change in their conditions — mainly by not paying back the loan, only servicing the
interest.

That’s before you consider the 110,000 households in arrears on their gas and electricity. Money problems
are everywhere. This is at a time when European Central Bank President Jean Claude Trichet is talking about possible ECB rate hikes. When Ireland’s debt deluge comes along, things are going to get messy.

DEPOSITS

At the same time, households are sitting on more than €93billion worth of deposits in liquid cash, according to the Central Bank. This means that we’re perhaps looking at an Ireland divided. We already know that every second house has no mortgage on it. So it would be a strange assumption to believe that the group in debt are sitting on huge deposits at the same time and not choosing to pay off their loans.

That means the younger people are carrying debt and the older people are carrying the wealth and our children are going to have to pay for it all. The time to act is now. Part of the IMF bailout was an insistence on an overhaul to our bankruptcy laws by the first quarter of next year.

This overhaul could be as little as a draft outline or proposal — or it could be something more concrete that would make a difference. The new Programme For Government hasn’t mentioned full implementation of
a great report produced by the Law Reform Commission of Ireland. Its look into Personal Debt Management and Debt Enforcement provides wide-ranging workable solutions to the problem.

The report is the most comprehensive document on debt that this State has seen in generations. It also outlines solutions that have been tried and tested in other countries and which have been shown to work. So it’s time for us to tell the Government that we want the report enacted.

LAWS

Be sure to let them know loud and clear that we require sensible laws in this country so they can’t plead
ignorance when it’s too late. We need laws that allow people to fail in a reasonable fashion. If we’ve sold future generations down the Swanee, then the least they deserve is a mechanism to allow people to fail and then get back up

Internationally mortgage rescue schemes have been an abject failure from the perspective of using the success of their mission statement and intended scope as a gauge.

In researching this blog I spoke to representatives from The Association of Mortgage Intermediaries in the UK, the Mortgage Bankers Association of America, and Loan Value Group, they all had similar sentiments on rescue schemes to date.

The ‘Homeowner Mortgage Scheme in the UK planned to help 42,000 borrowers when it was set up in early 2009, to date it has helped 34. That is less than 1:1000 of the intended group.

Mortgage Rescue Help was another plan in the UK, that was meant to assist about 6000 in the short term, the actual figure as of Q3 2010 was 629 or about 1:10 of the intended target group.

In the USA the ‘Home Affordable Mortgage Programme’  (HAMP) was aimed at helping 5m borrowers, in fact, 5.5m have entered foreclosure, 1.7m repossessions, and only 467,000 have restructured - that is less than half of the 1.3m who have applied for modification because people and lenders are cancelling the arrangement and more than 1 in 10 who do get a modification are going on into outright default.

Moral hazard is oft used, that if you don’t pay your loan I won’t either. However that is not true, I spoke to Frank Pallotta of Loan Value Group in the US, their firm is a specialist finance house that creates programmes used by large banks to prevent people from defaulting. And he said that people who are in negative equity are the group that will be at risk of moral hazard, so that creates a far smaller pool of loans.

That makes sense, why would a person with equity in their home willingly sacrifice it for a write-down? One  which to obtain would mean destroying that which they worked hard for and sacrificing their credit history in the process? It doesn’t add up so simply.

Half of the properties in Ireland have no mortgage on them, and of the 790,000 mortgages about 250,000 of them are in negative equity, but that negative equity is of varying degrees and a person who is €5,000 in negative equity has a far different view of their situation than a person in €150,000+, on top of that, you have to accept that like any scheme, there would be a implementation date and an underwriting process.

So if you said on a Monday, we are taking all arrears cases today and we will look at the loans individually and decide what level we are writing them down to (bearing in mind from an operational standpoint that banks already have the SFS [standard financial statement which is standardized document across all lenders under the interim report from the Expert Group] which would make the task relatively simple given the uniformity of the information available), then you do a level of underwriting which is the inverse to the that which was done at the time of the loan sanction. If a person can get their loan to a point where they feel they have a shot at getting on the right side of it again they’ll do it.

Moral hazard is also a false pretense given that we set out in law an inability for banks to start legal proceedings in less than a year, that is actually moral hazard central, live for a year mortgage free if you want! How many people are intentionally going into arrears to obtain that €10,000 after tax bonus?

The Deferred Interest Scheme has a strong likelihood of becoming another souvenir in the annals of failed policy. To say otherwise is effectively taking a view that the best minds in the USA and UK are not up to scratch compared to our own policy makers - who borrowed elements of the idea from the UK and USA. Charlie Weston recently reported that the savings to the average entrant would be about €750 of a savings over the course of 5 years.

Already the scheme is failing and it hasn’t even been formalised, because KBC (12.5% market share), NIB, Ulsterbank, Start, Nua, Leeds Building Society, Halifax, Bank of Scotland Ireland, Fresh, GE Money, Springboard and Stepstone have not signed up.

Who has: EBS, Bank of Ireland, AIB and PTsb, in other words - the covered institutions, the banks that will agree to anything and sign up to all state requests in order to maintain their government support. If you want a clear example of moral hazard, look to the incentives in those relationships to get a true understanding of it.

RTE 6 O’Clock News - 17th November 2010 from Irish Mortgage Brokers on Vimeo.

The Expert Group on Mortgage Arrears reported today with their final set of recommendations. Irish Mortgage Brokers featured in the piece by RTE who’s reporters Samantha Libreri and David Murphy covered the story.

Below is a comment made by the Regulator at UCC while talking to a group of compliance officers.

“Reform of the bankruptcy regime could allow borrowers to earn a fresh start by discharging their debt over a reasonable period of time, Mr Elderfield said. However, he cautioned against debt forgiveness for the thousands of mortgage holders currently behind with payments on their loans.

Addressing compliance officers in Cork, he said it was understandable that some people wanted to go beyond rescheduling debt to consider some form of debt forgiveness.

“However, the cost of any support will need to be borne by the taxpayers or by the banks and therefore, in many cases, effectively the taxpayer as well, and this raises questions of fairness for taxpayers who are not in debt and, at a time of immense budgetary pressure, affordability for government finances.

“There is also the risk that any scheme would create perverse incentives and in fact make the arrears problem worse by encouraging some borrowers to stop making payments”

The unusual thing about this is that both scenarios are ultimately the same, this is a circular argument.

If you create a situation where people can walk away from debt they cannot service - and then in turn somebody else takes up the balance (we are in favour of this), then the net result doesn’t change. You have a mark to market valuation and somebody somewhere buys the asset.

The differences with debt forgiveness is that there is no mark to market - it is normally a certain amount but not a percentage based upon prices drops or valuation- and that the person occupying the asset doesn’t change.

From a banking system perspective it is disingenuous to say that on one hand ‘debt forgiveness’ will be a cost imposed on other people who are paying their loans, when writedowns on unpaid loans does precisely the same thing. They are one in the same, the costs become embedded in the financial system.

It doesn’t matter what method you use to clear the weight of debt, the fact remains that somebody’s balance sheet has to record the loss and then take a writedown, will it be the individual, the bank, the state or the taxpayer? ‘Take your pick’ is the answer.

Currently about 25% of the mortgages in Florida are delinquent, there is a huge amount of foreclosed property on the market, short sellers can’t offload fast enough, property prices are falling, and it is also a judicial foreclosure market meaning people have similar issues to the problems we have here when a home in negative equity is repossessed, they owe the difference.

A possible solution being tried there is that of mortgage mediation. This is vastly different than the scheme in place in Ireland, and perhaps active mediation with a set point of contact and a set representative would be a good idea, chances are we’ll never know because it is not likely to be rolled out in Ireland.

Nassim Taleb says in this interview that the debt problems of 2010 are worse than those of 2008, he has re-released his now famous book ‘Black Swan’, and his core belief presently is that recession is not the issue, debt is the issue. Fragility is exacerbated by high levels of debt - we can see that from an Irish context on Sovereign Debt/Bank Debt (whether the problem is real or perceived).

One of the most poignant things Taleb talks about is the failure of stimulus, and he rightly points out that Greece is not being asked to ’stimulate’ their way out of their debt issues, they are being asked to look for austerity solutions, perhaps Keynesian beliefs might be shunted once again into history?

The point holds true in our opinion, high levels of debt are a wealth destroyer and inhibitor to prosperity, the drag on economies, in particular our own, will be evident for many years to come.

I was on the panel on Frontline recently and during it I mentioned a thing called ‘Negative Equity Financing’, we were asked by a few journalists and some clients about it, so hopefully this post will help to clear up what it is, and how it may work.

For a start, I’m anti-bailouts, in general and in particular, so debt forgiveness is not really something you’ll  see supported here, but we are big believers in facilitation, and any means that can help to oil the cogs is likely better than one that tries to create a new machine - albeit in time that is what we need; changes to our property and debt laws. However, in the here and now facilitation is quicker and easier to implement and has a better chance of reaching those it is intended for.

Negative Equity Financing is the idea we have put forward, but it isn’t just a case of doing a short sale because that doesn’t work in Ireland.

A short sale is where a person sells a house for less than the mortgage owed on it, in the USA you may or may not be able to do this, it depends on secondary lenders (if you have a 2nd lien on the property) and whether you are in a judicial or non-judicial foreclosure state, in Ireland it’s all the equivalent of ‘judicial’, to get your house taken you need a court ruling. Thus we need to find a way around that issue.

To do this we could have a facility that advances cheap credit to cover the shortfall, it allows the sale to take place but the individual carries out the difference as a low cost loan that can be paid back over time at a very low interest rate.

In the picture to the left we see a current property value (in green) v.s. the mortgage secured on the property (in yellow) and the negative equity element of it (in pink), generally mortgagees has paid a deposit so all said they may be down over €50k but it is really v.s. the mortgage that the issue arises if one wants to move or sell - because it is greater than the price you could achieve on the open market, meaning the person is stuck.

Ideally the banks would let this happen but it has twin issues of using available liquidity and on a secondary basis, unsecured debt is highly risky - you don’t want to put risk like that back on the balance sheet after we have paid so dearly to remove it. It also reduces the asset value of the bank/building society and the remaining loan has virtually no recourse. All said, banks would rather take the property (in normal circumstances), except for recently where they would rather not take it because it means realising market prices and that is why they are not complaining about forced forbearance.

That is where the ‘facilitation’ comes in. The state could issue bonds in return for the debt, this would be a similar type of bailout to what they did in NAMA, except this would be for regular borrowers as opposed to dealing with development loans. In this case the loan would be backed by the person and secured against their tax credits (more on this later).

The actual funds for this could come from the same source that the likes of HomeChoiceLoan obtain funding from (loan finance from the Housing Finance Agency). Indeed, HomeChoiceLoan could be the very lending vehicle to do this as it is an existing operation that is not lending in the manner it was intended to.

The state would need to pay the bank a certain amount of money (coupon) for this facility [3 month euribor perhaps] and in return it would be able to charge the borrower a near cost interest rate - lower than a bank could ever secure thus ensuring the person isn’t affected by the trend in lending margin increases, but at the same time greater than the token interest paid to banks which allows the process to occur. In doing this the bank maintain asset quality and a small cash flow, while the state incurs a small profit on the exchange and can obtain reasonable security (via the tax system).

This would allow people in varying degrees of negative equity to sell and move on or perhaps just sell, the main thing is to get people out of debt they can’t service, the general reaction of ‘keeping people in the family home’ is missing the point if the family home is a sinking ship, when that’s the case it is generally the last place you’ll want to be.

So let people get out from under debt they’ll never be able to service, especially with the margin hikes and eventual ECB rate increases that are coming down the line. They can then services a much smaller debt at secured margins (as it is state backed and funded) and the security will be against their tax credits. How does that work? For a start, it has never been tried so this is supposition.

However, the idea would be that if you start to default on your loan that Revenue take away your PAYE allowance, or any other state benefits you would normally be in receipt of - not to the point of pushing people into poverty - but to the point of ensuring that in the majority of cases that eventually the debt will be repaid at the artificially low rate of interest, this solution is not pain free, and it isn’t meant to be.

The obvious flaw is that a person could leave the country, but if they are willing to do that then they might do it anyway and even an old fashioned bailout might not work, a borrower could easily abandon their property despite any plan. So if a person is willing to leave at any cost then you have to accept that it’ll happen in some cases.

Negative Equity Financing would instead make sure that people keep manageable debt and in many cases they could even stay put, renting the house back from an investor and the warehoused loan could have a delayed start time, in any case, the state would be able to collect in all cases except where the person flees the country.

This could also have some positive impacts for retail credit, by reducing traditional impairment (which has so many knock on effects).

This isn’t a ‘bailout’, rather it is a means of letting people pay their debts in a manageable manner, the current structure of debt is such that there are people who will never get out from under it (as it stands today), but if there are market or semi-market propositions that facilitate them in doing this they are perhaps worth trying. The current approach is actually increasing the indebted persons problem, forbearance measures don’t wipe the slate, rather they continue to add interest to the capital sum owed making the situation worse.

An idea like this would allow people who want out to do so, but to pay a price, which will hopefully help to avoid the obvious moral hazard issues that arise with straight out debt forgiveness. This is a ‘NAMA for the little person’ that won’t leave a sour taste in your mouth.