Irish Mortgage Brokers Blog

Trinity Economist Kevin O’Rourke received a lot of attention recently which centred around a paper he wrote with Agustin Benetrix and Barry Eichengreen that featured on VOX.

The Sunday Tribune picked up on it with the headline ‘House price fall could be worst in history‘. Fairly powerful statement that! Kevin O’Rourke is a man who I personally have a lot of respect for (an example of his work is in a talk he gave to the CFA last year here) so we were delighted when he kindly took a call today while on a working holiday in France.

My questions are in bold, the main thrust of his answers follow them.

You say a rapid adjustment would be best, what can be done to facilitate that?
“You have to start by wondering ‘do we think the Irish adjustment is rapid or not?’. In general one thing that comes out of international experience is that property prices are quite sticky downwards, vendors take property off the market and new properties stop being built as well. Can policy speed price falls up? I’m not sure, but you don’t want to have policy that slows them down, that much is for sure”.

Should we therefore get rid of TRS? That is just a Government/fiscal incentive toward home ownership right?
“First it might be better to at least get rid of the asymmetric policy of subsidizing home ownership but without property taxes”.

Does restrictive credit therefore help as opposed to hinder the adjustment? If a rapid journey towards a bottom is a good thing?
“Statistically – the more credit is available the more likely it is that the market bottoms out, and the more prices fall the more likely it is to bottom out. We didn’t think about the possibility of restricted credit speeding up price decline, which may get us to the bottom faster. Increasing rates will have a downward effect on prices, reduced credit availability the same. On the other hand they may be helping by allowing the bottom to be reached faster”.

How much further is required (from the index of average prices) to hit bottom?
His opinion – “I agree with Morgan Kelly. In particular there is a total disconnect between rent and prices. There is one property I saw in Dublin recently that had a renting price of €4,000 per month but an asking price of €3.8 million!” (that’s a 1.3% yield if you are wondering).

If our GDP issues are affected structurally (in terms of decreased government spending) and not just by the business cyclical then how will that affect housing?
“One thing that would help for house prices is a resumption of growth, but I think that the ESRI projections of last week were optimistic. Their low growth scenario is perhaps somewhat of a high growth rate when you look at Ireland, I don’t forecast on that topic but if you want to look at different scenarios you could be more pessimistic, there are worrying indicators coming out of the States, the Baltic Dry Index is lower”.

“Austerity across Europe hasn’t kicked in yet. We are committed to taking more out of the economy every year for the next 2-3 years. The British housing market is also back into decline”. The main reason he thought the ESRI was too optimistic was their growth figures of c. 3% over 2011-15. Per capita growth in the USA over the last 100 years has been a little more than 2% per annum. There were ups and downs but on a smoothed basis 2% per annum is about right. You can grow faster when catching up, as we did in the 1990s, but once you’ve caught up on the technological frontier 2% is about as good as it gets per capita.”

Do you think that if we cut deep and hard enough that we could make anaemic growth look good? That it would perhaps represent 2+%?
“That is quite cynical… Something like that might occur if you cut very very deep, output collapses even more, and once that stops you get a bigger rubber band effect. I’m not sure why you’d want to do that. Furthermore, other issues also suggest low growth in the future, for example unemployment – if it lasts too long it can make it difficult for people to get back into work”.

How will rate increases by lenders affect the market? Given that the value is not being passed or maintained, and that banks are actually capturing the value in the market?
Higher rates would have a downward effect on prices, and our results show that low rates affect the probability of bottoming out positively. It’s a crude correlation, the lower the real interest rate the more likely it is that the market bottoms out. Interest rates are going up meaning we can expect an acceleration in housing price deflation.

Any plans to stop renting?
No.

What parameters did you use in the calculations? Where are the weaknesses in your calculations
“Perhaps we haven’t adequately accounted for the five core variables interacting with each other to the degree that they might have, they were actually viewed as being somewhat independent”. The calculations were based on a group of countries including Ireland and then the average results were applied to Ireland, as opposed to being based on Irish experience alone.

“We took conditions in other countries: the regressions looked at what correlated in those countries with the end of housing slumps, and what we found was that the higher was GDP growth and credit growth, and the lower were rates, the more likely it was that the slump stopped. Smaller prior bubbles and larger price declines during the slump had the same effect. Our approach was a binary yes or no one: did the slump end in a given quarter? Monetary policy is factored in (via real rates and credit availability).
Why do different countries bottom out?

“Different countries bottomed out for different reasons. In the States there’s a 1 in 8 chance of a bottom, and there is a 16% chance in Japan and  in Germany. In Germany this is based on the bubble not being too big to begin with, in the US and Japan it’s due to the very large price decline to date, low rates and signs of higher growth . But remember: one in eight is less than one”.
ENDS

Youtube version of the clip available here

A recent report by Moody’s pointed out that increased negative equity will cause a rise in arrears. The commentary surrounding this (in Ireland) takes the view that correlation is not necessarily causation. That people in negative equity won’t automatically go into arrears unless they cannot pay, that negative equity of itself is only an issue if you lose your job or have to sell. This is a valid opinion but it ignores the operational aspect of a household in respect of the way that they react when financial difficulty occurs.

There are several hundred thousand households in negative equity, and about 35,000 in serious arrears, how many of those people would not be in arrears if they were not in negative equity? The answer is: how ever many would have sold their house as a solution.

The first thing many people do if they know they are going to be headed for a situation where they stand no chance of paying their mortgage is to put their home up for sale, in the past this simple act disqualified you from receiving mortgage interest supplement (MIS), and that has thankfully changed, but you can’t put your house up for sale when you are in negative equity because the sale will not clear the mortgage and in many cases the bank will prevent this from happening. They will instead push for full repayment of the debt, an application for mortgage interest supplement and while this happens the individual goes further and further into arrears.

In the past the majority of people had some equity in their home, and that meant that arrears might eat into the equity, and if they decided to sell then they would be out from under the debt and the arrears. However, this is no longer happening, which is why 21,000 households are more than 6 months behind in payments and a further 7,000 have not made a payment in a year. They are stuck where they stand and little can be done about it.

And that is the way in which negative equity and arrears are perhaps more closely tied to one another than we often hear about, where one actually can cause the other.

Sometimes talking about present values, par and yield to maturity will catch even a well versed practitioner off guard, but to see a pricing model in action helps and that is precisely what this video does - in this clip an assumed future rate is discounted into present values and we arrive at the bond price. Well worth watching (twice!).

EBS have announced a rate hike of 0.6% which is a follow on from their last 0.6% hike that was levied against variable rate mortgage holders on the 1st of May, this brings their margin increases to a total of 1.2% for the year to date.

Today’s Indo lead with this story (by Charlie Weston) and rightly pointed out that by the time this is over, a person with a €300,000 mortgage over 30 years could expect to pay just over €3,000 a year (after tax) in increased mortgage payments. For a person on the average industrial wage this is like a full months wages before tax being sucked away by the financial system. Tax hikes and wage cuts aside, this will ultimately reduce the money that is being spent in the economy and it will disappear into the financial system where banks will use it to de-lever further.

The contention for many people is that they are being punished, not for what they have done wrong, but for what they have done right, the people who will see their loan payments increase are those who have performing variable rate mortgages. The increases are threefold, firstly is to cover the cost of funding that EBS and other banks are facing, a large part of this is down to the institutional decisions that they made. Secondly you have the people in arrears who’s impairment costs are affecting the cost of funding to the institution as well as decreasing the operational income the bank can obtain. Lastly is to subsidize the tracker mortgage holders whom the banks mistakenly lent to at rates that are (as it turns out) not commercially viable.

What can people do? Very little, personally, if I was an EBS member I would withdraw all of my savings from them immediately, banks have two sides to the balance sheet, one is lending (assets) the other is deposits/funding (liabilities), and while reducing liability might be a good thing for most companies, in banking it doesn’t work that way, they need those deposits in order to fund loans. Removing deposits from a bank when they make a decision that adversely affects you is really the only thing a small person can do in response to the institution.

Economically we have a concern that rate hikes will ultimately prove to be a deflationary force on the Irish economy, and there is little that can be done to stop this, the Financial Regulator has made it clear from the past that they will not intervene on prices, the Department of Finance is taking the same approach. However, these rate hikes are taking away the same income that the state needs to survive on and will push many people into financial difficulty and out of the effective tax net. For the average worker €3,000 a year is almost 10% of their income, if there was a 10% of income addition to income taxes there would be a revolt, but not so when banks hit their customers, people are acting irrationally and we don’t understand why.

The banks set to follow (according to the article) are AIB, BOI, PTsb and INBS. We had predicted a 100 basis point increase in 2010 starting in Q1 by 50bps followed by a further 50bps later in the year with a final 50bps in 2011, this has proved to be quite a prescient prediction (and one we wish we could have been wrong about!), but it isn’t one that people have to be powerless about, do your talking by changing your mortgage to a different institution or moving your deposit, change your credit card provider (if it is via your bank) and switch your life and home insurance (where appropriate). Consumers are only able to be victimized to the extent that we allow banks to get away with it.

Battersea power station was bought for £400m in 2006, REO took a loan for £226m other £134 was cash/other equity, the purchase was split 50/50 between BOI and BoS in London. only exposure for Bank of Ireland was that loan and now it is in NAMA, people are making a big deal about this and it is important to look at the facts rather than what it represents.

The BOI loan has gone to NAMA and BOS was taken by LLoyds, that is the current state of play. Lloyds and NAMA agreed to extend the loan facility to august 2011 - so they (REO) can get through the planning process, which happens to be the single largest planning application in the history of the UK, literally a truck load of paperwork went into the council in connection with the station.

Exposure on the loan is now at £100m, it has been a performing capital and interest loan. While the value of Battersea fell as all properties have, it also rose in the last year, the current value is estimated to be in the region of £338m and the NAMA portion is £100m which is about 34% of what is currently owed on a property that is levered in the region of 60%, in lending terms this is good collateral and if the payments are being made then there should be no issue.

The loan was only there to purchase, and value is minus planning, post planning the value of the site would rise considerably, because planning is really what this property hinged on all along.

The figure of €6bn we hear is not the ‘cost’, and certainly not the cost to NAMA, rather it is the completed value over all phases over ten years, and this figure is dependent on planning occurring.

Generally what happens is that a developer will finance the 1st phase, then start the 2nd, sell the first and roll it along. It’s across the road from Chelsea and the house of parliament, in the 9 Elms area, there is a 9 Elms regeneration taking place, all the signs are that there will be planning. the only way to preserve the building now is probably to develop it and not let it rot away. The post code of SW8 is one of the best in London, so the development actually has a lot going for it.

The main thing to get to grips with is that the BOI/Lloyds loans were never intended to get the property over the final line, rather they were there to get the ball rolling and it will likely remain as such.

The idea to spin this away from REO to a new listing on its own, or possibly unlisted with new JV partner is to the taxpayers benefit, let the project continue and get out of NAMA thus reducing any potential liability to the Irish tax payer. This is also the type of asset that proves that NAMA has some great collateral, it isn’t all fields in Leitrim.

As far as REO goes, half of the portfolio of the company is investment, last year their rent roll increased from €46.8m to €48.3m and 2/3 of the top ten clients are Vodafone, NTMA, KPMG and M&S.

The history of REO was as a listed property fund, Treasury bought into it, it is a jersey listed company with a listing in London, its main asset presently is Battersea.

Treasury is a 66% shareholder and investment manager in the company, hopefully this is helping to paint a picture of what is actually going on rather than what one may only ’suppose may be going on’. The development isn’t a banger as it has been painted out, rather it is likely one of the most exciting projects on British soil in a long time and has a good chance of success, if it falters then it falters, but it shouldn’t and won’t be at the Irish tax payers expense.

What we are not saying is that people should try this, this post is merely pointing out that this kind of thing could happen and that a failure of enacting sensible policy soon enough could encourage people to look for solutions such as what we describe here as a means to solving their personal debt issues.

We don’t endorse handing back the keys, we are not suggesting that people do it or consider it, but merely looking at the pro’s and cons of doing so and demonstrating a method whereby a person could potentially try to fool the system while doing so.

The Cons are basically that you lose your home, and assuming that in this case the person is in €100,000 of negative equity then they are also hit with a judgement for the shortfall plus expenses, for the following twelve years that debt can come back to haunt you. Your actual credit may be restored in year seven but that doesn’t mean you are off the hook.

Consider the position of Joe Bloggs, he is deeply in debt, he has lost his job, his girlfriend who lives with him is still working and paying the mortgage, but things are not working out financially so Joe decides to hand back the keys to the bank, the €1,500 mortgage is now replaced by a property they rent for almost half that price. The €100,000 of negative equity that Joe was in would have cost almost €200,000 to pay off over the life of the loan, that is now a thing of the past.

Joe now decides to change his name by deed poll, he becomes Timmy Topper, Timmy has the same date of birth as Joe, but the ICB (Irish Credit Bureau) doesn’t track name changes. Timmy doesn’t like getting calls from collections agencies, the land-line ceased with the tenancy of the house, and he changes his mobile phone, getting a ready to go, now the letters are going to an old address to a person who doesn’t live there and nobody at the bank knows how to reach him.

Timmy then gets all of his papers in order, obtains a library card, an electricity bill and goes to a branch of Ulsterbank and opens an account, at this point it is necessary to lie, and say that he was abroad and didn’t have an account here before, or that he never used a bank account and his past job paid cash or he used a credit union, or he opens a savings account and later converts over to a current account. In any case, he is now back into the financial system minus any firm link to his defaulter past.

His girlfriend has remained squeeky clean all this time, he now gets added to her credit card, car insurance and they then open a joint account. Now Timmy is fully within the financial system and showing up as an upstanding citizen. The judgement is still in the sytem, and it is still tied to Joe Bloggs but Timmy has essentially an entirely new identity as far as all of the financial databases are concerned, there is nothing to connect him with his former self.

In fact, his PPNS number is the only thing, but ICB and other searches are not dependent on this, only revenue could patch it all together and their concern isn’t about whether he didn’t pay a bank back money he owed them, they are worried about tax liabilities only and they won’t actively work with any other companies.

Timmy has a new life, he can perhaps get a mortgage, and in a short amount of time reinvent himself and almost nobody will know the difference, and the people who know him may not even know that he did this because he doesn’t go around forcing them to refer to him as ‘Joe’, and in any case, he could make his new name ‘Timmy Joe Topper’ in which case it is easily explained away by saying ‘people call me by my middle name’.

This might seem like a lot of effort to go to for a person just to gain €700 a month in cash flow and avoid paying out €200,000 from future cash flow, but for a person who earns the average industrial wage there is definitely an incentive structure there.

There are flaws to this plan, and there are downsides, but it won’t stop a certain percentage from perhaps doing something like this, it won’t stop many from walking away from debts they believe they have no chance of paying in the future, and sadly, the argument against doing so is relatively weak versus what can be gained by the individual in this process. Renting is generally cheaper than buying in every market except for a constantly rising one. So even if a person doesn’t change their name and reinvent themselves, they could just rent and then in 12 years when it all dies down have considerable cash savings that they use to buy a property.

In the initial years putting your savings into a pension means that no creditor can get at it, and in the latter years spreading it across several institutions, in particular using foreign deposit takers could keep your savings off the radar of the bank you owe the debt to. Alongside of this there is the high probability that our debt laws will be changed and that the 12 year rule will cease to apply. For some people doing this would actually be the most rational decision if self preservation was their ultimate ideal, but perhaps Maslow’s hierarchy changes when it comes to debt?

We were thinking of changing the way that brokers operate, by saying to our clients ‘our service comes at a price, we’ll advise you on any lender in the market and be totally independent, if we place your loan with one that pays commission you can set that against your fee, and if not then pay the fee’, doing so in the belief that totally transparent and independent advice is a good thing, and something that everybody wants, the broker, the consumer and the Regulator.

Sadly this is not the case, instead the Regulator (soon due another name change to ‘Central Bank Financial Services Authority of Ireland’) is relying on the letter of the law in the Consumer Credit Act of 1995 to ensure that brokers can’t give best advice. This is an example of total regulatory failure.

The actual portion of the code is S. 116.1.b which states ‘A person shall not engage in the business of being a mortgage intermediary unless— ( a ) he is the holder of an authorisation (”a mortgage intermediaries authorisation”) granted for that purpose by the Director, and ( b ) he holds an appointment in writing from each undertaking for which he is an intermediary.

The guidance given by the Regulator is that this is to be interpreted as meaning ‘you cannot advise a client on any mortgage unless you hold an agency with the bank/lender which you are advising about’. In other words, you can only offer advice based upon the agencies you hold, it seems many of have been breaking the rules by being honest with our clients and letting them know about mortgages that we cannot broker, and in the current climate that honesty is wrong and deemed to be outside of the remit of an independent broker.

So why bother forcing the industry participants to have certain qualifications, minimum standards, and undergo continuous professional development (CPD) if they are not going to be able to give the advice they are trained to give? This makes a donkey of common sense, and the CBFSAI (Central Bank Financial Services Authority Ireland)  would do well to remedy the situation sooner rather than later.

How do you explain such an anomaly? What is wrong with advising a person to go where ever the best deal is available? This is yet another example of regulatory failure, and sadly, the state are forcing advisers to be tied into the banking system by not allowing them to advise a client on any mortgage product outside of those for whom they hold an agency.

You can’t become a mortgage adviser unless you hold a letter of appointment with a bank, surely this is a mistake? How are we ever going to move financial advice away from commissions if you have to be in the commissions system to offer any advice? To do so without the full authorisation is illegal.

We can only live in hope that many of the irregularities in how regulation works in practice can be ironed out because the primary loser at this point in time is the Irish consumer, the very people for whom the Regulator was established to protect.

We have been talking about the idea that the Chinese ‘miracle’ could not last indefinitely, in this clip from Bloomberg, Harvard Economist Kenneth Rogoff (co-author of ‘This time it’s different’) talks about China having a real estate bubble in the making, the bursting of this bubble is not about ‘if’ but when… Watch this space! [If the clip doesn't play for you then follow this link ]

Today we were delighted to do the first of what will hopefully be a regular slot on the Business section of the Breakfast Show on Newstalk 106 with Conor Brophy. The topic today was that of Site Value Taxation (we had an article in the Sunday Times about it this week), property prices and then a mention of our Investment Property Profile which was done in association with PropertyWeek.ie and ODKM Architects in Terenure.

We looked at some properties in the Dublin market that might obtain a 7% yield, they require some work (sweat equity!) and although they all didn’t come out at 7% some were above 6%. This is helping to reinforce the believe that the market in general has not rationalised but that in particular you can find good value if you look for it.

Aidan McLoughlin of of the Independent Trustee Company was also there with some fascinating insight into non-bank lending that is occurring whereby pension funds are lending to businesses who cannot obtain credit via the banks, this is some compelling evidence that credit is not forthcoming to SME’s in the way that we are being told that it is.

[To see the Investment Property Profiler report click on the image]