Irish Mortgage Brokers Blog

Irish banks are caught in a perfect storm of funding costs versus lending costs which spells bad value for consumers. This is clearly seen on the deposit and lending fronts, our banks can’t offer headline rates on deposits, nor can they charge sufficiently on lending. This is creating a multi-billion Euro dilemma which will ultimately be paid for by an already unfairly burdened taxpayer.

On the deposit side foreign banks can afford to pay far more than Irish institutions meaning they can hoover up deposits rapidly and with relative ease, on the lending side, Irish banks are unable to obtain the margin they need in order to compete and remain profitable.

When it comes to leading rates for indigenous lenders you will see that Anglo, despite being nationalised and having the inherent backing of the state on all deposits, is paying the highest rates for an Irish institution on  6 month (it is the best of the Irish institutions) and 1yr deposits (it is the best across the board on 1yr deposits) - this is well above the odds they should have to pay to attract deposits given the state backing, but it is also evidence of how badly regarded the failed bank has become [the nearest rate for a non-nationalised bank on 6mth Ptsb 1.5% and on 1yr Ptsb 3.1%].

The ongoing Banking Guarantee and the ensuing ‘equitable liability guarantee’ is costing the nation via the prices we pay for debt and the embedded cost to our banking system. Banks will pass on charges accordingly, but even with the protection the guarantee brings, the foreign institutions can still outstrip our banks on deposits, while our banks are charging less on mortgages!

This is putting the very banking system into a perfect storm whereby our indigenous players cannot make margin on loans which are increasingly defaulting, and at the same time they are unable to attract deposit business at leading rates because other institutions are out bidding them.

Foreign deposit only banks have several key advantages, they don’t operate branches in the country, this means they don’t have to spend huge money on the payments system the way branches do, they can then lend the deposited funds in any jurisdiction they want, and often they do so by charging rates that relate to the cost of funds, while Irish banks are left with negative margin products and a raft of non-performance. The foreign banks can thus attract capital by raising it here with low overheads and then lending it elsewhere (for instance in the UK or mainland Europe) at higher prices than they would achieve in the Irish market.

This issue is at the very heart of the survival of our banking system, lenders will need to find a way to gain margin by raising prices, drop down deposit rates, and shed staff in order to save money.

The first choice has limited scope as there are so many tracker mortgages out there, the weight of change will fall disproportionately on variable rate mortgage holders, this process has already started. The second choice will be nigh impossible, they can’t drop deposit rates or it compounds the issue they already have of not being able to attract capital (thus the state is going to play a vital role in saving our banks). The third choice of firing staff is unpalatable, but it will come in time as the sector adjusts, the question is - what do they do in the meantime?

The Sunday Times had an interesting article by Niall Brady which was pointing out the arbitrage that the consumer could have between retail institutions, by that we mean you could borrow at one rate which is cheaper than the rate you could earn interest at.

This kind of thing would never happen in a traded market because it would be closed down by practising traders, however, in the retail finance channel it can exist due to consumer inertia and the low level of profit that can be exercised in this manner.

It is however an interesting take on the market and the kind of unusual angle we love to see coming to press, (we should also point out that our firm got a mention in the process!).

The situation that currently exists is one whereby a person can borrow (for instance from AIB on a 2yr fixed rate mortgage) at a price which is below the return on another asset, the thing that wasn’t mentioned in the article was the big win available on a person who borrowed to finance An Post savings bonds.

An Post savings bonds offer a 10% return after 3 years, this is tax free and not subject to dirt, a comparable rate on the bank deposit market would need to be about 4.2% or more.

The state really shouldn’t be paying this kind of money given that risk normally (used to) have a relationship with return, risk free means low to no return, but in the case of An Post Savings Bonds it means above par returns!

There were many innocent parties to the credit fuelled property bubble, they are generally those who didn’t borrow, or who carried no debt, choosing instead to live frugally, and if they used debt they used it wisely. Many of these people are at the polar ends of the age spectrum, very young (who don’t even have access to credit) or much older (who have paid off their mortgages), something we will all need to get used to though is the fact that everybody is going to pay for the mess left behind, this goes farther than NAMA.

The process I am describing is already under way, the very payments system (our financial infrastructure), is going to be used to generate economic rent from the people of Ireland in order to bring in more profit to banks so that they can repair their balance sheets. This price will be paid by the taxpayer outside of the bailout money already being supplied on our behalf. This will be even paid by people who manage to slip through the tax net (often because they earn very low incomes) but who use financial infrastructure.

Financial infrastructure is any electronic payments, our payment system, foreign exchange, ATM’s etc. The fees that banks will start to charge will in essence be like a toll-booth on the financial system for all people who interface with it. Free banking is going to be a thing of the past soon, or it will be heavily restricted to certain terms and conditions such as minimum balances/transactions etc. Two of the bastions of free banking have shut down within the last three weeks (Halifax & Postbank), these offerings were by a newcomer seeking market share (Halifax) and another that had state backing (Postbank which was a JV with Fortis and then BNP Paribas).

The remaining incumbents have no need to extend free banking, there is little reason because as fewer compete based on that premise it doesn’t become the factor that wins business, and as those that had free banking are forced out into the market to choose new banks they will do so for perhaps different reasons than their initial switch to free banks (such as proximity of branches, how good they gauge their online banking to be, availability of credit/overdrafts etc.).

Deposit rates will also come under scrutiny by banks, thus far depositors couldn’t be hit because they were too valuable to the banks as a capital base, this meant Irish banks happily paid over the odds to attract depositors, in fact, two of the best deposit products out there are (oddly) state sponsored, meaning that even our sovereign state is behind the drive to attract deposits with certain providers. However, as competition (in particular international competition that can funnel money out of the country) decreases there will be less of a requirement to satisfy retail depositors [note: institutional depositors have different rates and could be left unaffected], and as NAMA goes through, removing at least some uncertainty from the balance sheet, the decreased loan/deposit ratio will mean the end of the courtship of depositors.

Watch deposit rates drop in relation to their margin relative to the ECB, this trend has begun, it will continue.

Elsewhere margin will increase, on the costing side. In our annual trend forecast we were the first to put a number and time-frame on the line (always a mistake I’m told, either pick a figure or a time-frame but not both!), with an expectation of 100 basis points or 1% being added to the cost of variable rate mortgages in Ireland. While many felt this was ‘impossible’ because we are supporting the banks, today’s news would suggest otherwise. Mortgages will cost more even if the ECB leave rates unchanged in 2010, margins will increase and it is a question of who will move first. My own suspicions are that post NAMA one of the main two will do it, and this will be tightly followed (perhaps lead) by EBS or whatever the new ‘3rd force’ is.

The margin on lending won’t stop at mortgages, in fact, mortgages may be the last bastion to fall (public outcry centres heavily on mortgages), watch for increased margins on overdrafts, personal loans, car loans, credit cards issued by banks etc. This is the second level after infrastructure where rent seeking is easily satisfied.

Regarding credit in general, more forensic underwriting coupled with harsher terms/lower multiples are the order of the day, while there is business out there [this blog would cease if there were NO mortgages!] it is incredibly difficult to place successfully.

It is in the manners mentioned that everybody will pay, at every point in the financial infrastructure a cost will start to occur which is over and above opportunity cost and expense, that ‘rent’ will be one of the primary manners in which banks recoup their profits. There is such a focus on NAMA and not overpaying for the assets that nobody is watching how we will overpay for everything else. Consider yourself warned!

There is concept in finance of a ‘risk free rate’, and normally that is seen as being the rate of return on money by a sovereign entity (in our case it’s Ireland), so in a rational market it should always be the case that anything with an implicit state guarantee should pay far less than those without it, because those without it have to reward investors by offering more in order to attract them.

Oddly, in Ireland the institutions implicitly backed by the state are actually paying over the odds, and in effect that means a transfer is occurring from tax-payer to depositor, in short, we are being ripped off when our sovereign guarantee is not factored into pricing.

For example: Anglo Irish Bank are paying 3.1% for a demand account, this means you can take your money out whenever you want, BOI, AIB, INBS, NIB and many others are paying a mere 0.1% meaning that Anglo are paying a full 300 basis points or 3% more than competitors who are not state owned (albeit they are partially state owned). Rabo are paying 2% so what we are seeing from a deposit account perspective is that Rabo are a better institution in terms reliability than our own state is.

What a joke…. But it’s not so funny really.

Then we have An Post, an implicit state guarantee and you can lodge up to €120,000 with them and earn a TAX FREE rate of 3.23%, normally you’d have DIRT which would take 25% away from any deposit gains, but in this case you don’t, so in order to earn the equivalent elsewhere you would have to be making 4.31%. Again, this is an example of paying way over the odds for funds, the state should in fact be offering well below market rate levels of interest because their return is guaranteed in a way that no other institution can copy.

Are you angry? Don’t be, just make sure that you buy An Post savings bonds and instead make some profit on the errors made from on high, as a financial adviser I can’t believe this continues and nobody is pointing it out, in the USA bond income from Municipal Bonds is tax free, so you always make a ‘tax equivalent yield’ in which you show how much you’d have to make on a taxable bond in order to generate the same income it is as follows:

R(te) = R(tf)/(1- t)

Where: R(te) = taxable equivalent yield for the investor
R(tf) = return on tax-free investment (usually a municipal bond)
t = investor’s marginal tax rate

Bond income is taxed at your own rate of tax, we’ll assume that you had a good year and are on the marginal rate of 41%, and see what kind of yield you would need from any other bond to earn 3.23% after tax.

R(te) = 3.23/(1-.41) = 5.47%

So if you were to go out and buy a corporate or sovereign bond you would need to be earning 5.47% in order to just match the offering by An Post, and you wouldn’t get a return like that which is backed by a sovereign guarantee! (exception is perhaps a Greek bond).

So why are we paying so far over the odds?

That’s a question, I certainly don’t have the answer.

Banks deny that they are cherry-picking applications and brokers say otherwise. What I can say is that we are going through a credit adjustment where there just isn’t the appetite for lending that used to exist. This is natural, it happened (for instance) in Finland in the 90’s, it took a decade for lending to reach bubble levels again. As well as this, when you have a rapid build up of borrowing, it is like people were reaching further and further into the future for greater amounts in order to spend in the present, that is a basic premise of lending, you give up future income streams in order to spend today and that applies to credit cards, personal loans, and mortgages as well. Finally, during a recession in which unemployment is rising, asset prices are dropping and many have taken wage cuts, appetite for high level financial obligations will be naturally surpressed.

So it is no surprise that annual lending for 2009 was only €8.1bn, that is broadly in line with our prediction set out in early January.

The question remains though, are lenders cherry-picking applicants? My opinion is ‘yes that is exactly what they are doing’, they have something with scarcity, mortgage credit, and this leaves them with two choices (remember: they don’t have endless amounts themselves), they either raise prices in order to weed out applications, or they pick only the very best applicants available and offer the line of credit to them.

The price hikes won’t come (yet), once assets are all gone over to NAMA two things will happen, mortgage rates will rise, and deposit rates will drop. So for now you can get good returns on deposit and good prices on mortgages. Anglo just passed €10bn over today, they didn’t operate in retail banking, so rates won’t move, but it means that the show is under-way and when the main street banks start to shift assets to NAMA it will be the starting point for those two trends to commence.

One of my favourite tools is that of the Yield Curve, in the US they look at the Treasury Curve and the TED (Treasury/EuroDollar), in Ireland we use the Euribor, and what the curve tells us is the interbank cost of borrowing money, or I should say that is what it represents because it can actually tell so much more. It is a market mechanism that gives an indication of what the belief is in the market towards inflation, interest rates and cost of funding, this isn’t opinion, it is derived from real money flowing around the world and that is why I like it, the Yield Curve doesn’t lie.

So we’ll take a look at what has been happening in the last month.

We see something interesting here, the short term expectation is that rates will remain low, in fact, with deflation still a fear the short-term working money (banks generally run off the 3 month) is getting cheaper of late. The divergence occurs after the 12 month mark, so essentially in a year the change in expectation in the last month is that rates will start to go up by more than what was expected in December, that is where the blue (jan 2010) line breaks away from the purple (dec 09′) one.

What does that indicate? For a start it means that for the next 12 months nobody is overly concerned about a rate hike, we keep hearing it in the press but in the market there is nothing within the next 12 months that spells that out, if there was (and it’s not to say that things can’t or don’t change - quite rapidly at times) you’d see a much steeper curve arising. The other thing we can take from it is that between the 12 month and 2 year mark a rate hike is expected, part of the increase in price at that point is uncertainty, the longer you look out the more uncertain it gets, but the basics of it are that rates will rise at some point after a year from now.

Month to month trends are not the most telling, we can get a clearer picture if we compare several months - not for a secular image but for a cyclical expectation, so here is a chart showing mid Q3 to Q4 and the start of Q1.

What we can see is that in general, the fear of inflation or costing of it into the market, has dropped since August 2009. There has been some consolidation ever since then,you will see that again, they all have a similar expectation up to the 12 month outlook then the expectation changes. November to December saw expectations drop on prices further out, but since then (with fear of ECB reductions in liquidity provision) it rose higher in January 2010.

Oddly, this curve and the steepening of it is good news for banks, they can borrow very cheap on the short term and get a higher rate of return in Bonds (note: lending is likely to reduce because the risk free rate is better), or they can use that steep end to price out higher fixed rates and then go to the swap market.

One way or another, the big question seems to be pegged (recently) to the one year mark, I think that we may be surprised in 2010 by the ECB not increasing rates or doing so only enough to placate the Germans and French (c. 25 basis points).

On the deposit side it means that you can expect banks to drop the rates they are willing to pay depositors, other than banks which are cash hungry, and what many of them will do is offer out a rate then go to the risk free market (sov. bonds) and place it there, in any case, the short term outlook isn’t one where you can expect a credit multiplier, having said that, if and when that comes it may turn out to be pretty impressive.

I hope you can see now why we watch the yield curve so closely! It is a fairly decent compass when you take the time to look at it and compare it over time, I just hope you haven’t already fallen asleep at this stage!

While we often see opinions about interest rates given by various commentators, I think the most telling indication is often that of the market, the point at which rates are settling at in prices is available at any time by looking at the Euribor Yield Curve, below is the chart for today.

The idea that rates will probably stay c. 1% until well into 2010 is only partially priced in, you can see the yield curve crossing the 1% mark at 6 months (which would be May 2010) - this however, is the Euribor and does have margin factored in, currently the margin over ECB is c. 25 basis points so the 1% base would cross when the graph above is at c. 1.25%. and that is the part that brings us to the latter half of 2010. The yield curve is live and dynamic so it could change at any time, either flattening or inverting. The reasoning behind where interest rates are going is a science in itself, and one that many economists obsess over, I tend to just concentrate on the yield curve, accepting that millions of transactions give as good an indication of what may happen in the future as any other reading may.

What this means for borrowers is that (using the market as a compass) mortgage rates are probably going to stay the same for about 12 months, for those already on fixed rates you’ll notice no change, the same goes for people with tracker mortgages. The people who may see a change though are the people on variable rates - banks are going to increase their margin and this will happen shortly after loans start transferring to NAMA.

One of the issues Irish banks have is that of having higher costing funds, blended rates are exceptionally high given the base rate (blended rates: the average between funds obtained by depositors and the markets) and the only way to regain ground on that is to increase margin where available, contractually the only place this can happen is in the variable rate suite of mortgages. Hence you will notice that the banks are now offering fixed and variable rates only, the variables being determined on LTV’s most commonly.

So if you are on a variable rate it would be worth looking for a one or two year fixed rate for existing business (if you re-mortgage it could be far more costly) because staying on a variable rate leaves you wide open to margin hikes - PTsb has already lead the way, others will follow!

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The lenders offering the best deposit rates are listed below with the highest in each category being the one we have shown.

Best demand account: INBS 3.75% (up to €20,000), Halifax 3.75% (up to €10,000), Anglo Premium Demand 3.1% - no restrictions

Best 7 day notice: Anglo 7 Day Notice 1.6%

Best 1 Month/30 Day: PTsb 30 Day Notice 3.25% (min. €10,000)

Best 3 Month: Ptsb 90 Day Fixed 3.25% & Investec 3 Month Fixed 3.25% (min. €20,000)

Best 6 Month: Investec 3.25%

Best 9 Month: Investec 3.5%

Best 1 Year Fixed : Anglo 3.6%

If you want to consider your deposit options you can contact us on 01 679 0990, we don’t have deposit agencies with every lender listed in the top position, so in some cases we’ll have to send you direct but in any case we can still help you choose the best deal on the market. All rates are up to date as 9th November 09′ and are subject to change.

Rates likely to rise as per AIB’s statement, and PTsbs actions, what we are trying to tell everybody, in clear English is this: ‘If you don’t have a price guarantee on your mortgage via a tracker or fixed rate agreement then you will be paying greater margin over ECB in the near future than you are now’. If you don’t act upon that information then it is your own decision but you can’t say you weren’t forewarned.

Forewarning doesn’t stop disaster, the historical evidence on that is overwhelming, in particular in the military arena, today however, we will look at some of the potential changes we might see in the market.

Floor Rate: This would be a variable agreement whereby the rate will never dip below a certain level. For instance, a bank might say that in a low rate environment it will (in the future) never allow its variable rate to drop below 4%, this would mean that if another crunch in credit/capital arrives that they can easily afford to lure and hold depositors without suffering the margin compression that most of them have in the recent past. While we tend to forget hard learned lessons in finance, it is likely that at least some banks will try to future-proof their operations in this way.

Variable Rate Price Hike: When? Well, for PTsb they have already acted, the other covered institutions will probably do this after NAMA has been set up as to do so beforehand would be far too unpalatable politically and it could jeopardise the creation of NAMA. The UK based lenders have already acted up this but their prices have changed so much that it has actually caused a distortion in the market whereby indigenous banks will be able to profit heavily due to intentionally irrational competition.

The Answer: If you are on a tracker you can sit and hold, ride out the rates, while we still believe 100% that rampant inflation will come, it may pay to have a tracker so that you can over-pay during a time of historically low rates and thereby eat into your capital quicker, many fixed rates don’t allow for any overpayment (for instance AIB’s fixed rates). If you don’t have a price promise the other option is to avail of one via the fixed rate mortgage market, fixed rates on mortgages are not at historic lows buy they are not far off from them, and certainly they are cheaper than the last low rate cycle we saw in 2003 - 2006. Fixing now will protect you from the inevitable rate increases that banks will employ in order to remain profitable.

In a nutshell, those who can afford to pay will be made to do so in order to cover the losses incurred by those who cannot.

Some economists are saying that they expect house prices to rise (in the UK for instance) by 20%, this can only happen if supply and demand rationalise, credit flows more freely and we get some inflation as well, so while inflation is not the hot topic de jour, it will be in the near future.

Negative Equity: If you are in negative equity it will be some time before you get out of it, in some cases it will mean having to repay your loan down to meet the remaining debt rather than finding a cure via market prices over time. In the UK it is felt that it could last 5 years (Oxford Economics report).

If you are in serious negative equity then you can’t move house (by selling up) and for that reason it makes prudent sense to instead (if you are on a standard variable) to make a choice on a fixed rate so that you have set outgoings until such time as either your debt is reduced or the market recovers. Why? Because if SVR’s were to go up rapidly you would be totally caught in the headlights of aggressive rate hikes with no escape option. This means get a fixed rate mortgage now or forever hold your tongue.

What is happening with rates: The deposit environment changing quick, the capital crunch may not be over but the give-away rates on deposits are! To match impairments deposits have to drop right down and mortgage rates have to rise, this week the leading deposit rates crossed below the 4% for 1yr fixed lodgements and that is the first time in over a year that it has happened, the next few steps down will likely come much faster once the psychological Rubicon of 4% has been crossed.