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

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.

Youtube version of the clip is available here

Prime Time did a show on the 15th of July about Negative Equity. Michael McGrath, Fianna Fáil, and Karl Deeter, Irish Mortgage Brokers, discuss the situation facing homeowners in negative equity

15:48 At 16:00 the press release about PTsb increasing rates will be released.

Had the company waited another week the headline ‘third time in a year’ would not have applied. It was this day last year that PTsb first increased rates on their variable clients by 0.5% or 50 basis points, it was a ground-breaking decision at the time, they were the first institution to do this and it opened the floodgates for every other bank to follow suit. PTsb were not in NAMA and they made their case, but it was rapidly criticised (in particular by Gerry Ryan who very decently gave the affected consumers a platform on his show).

The average mortgage balance in Ireland is €230,000 this time last year when the applicable rate was 2.69% the repayments would have been €1,053 per month on a 25 year mortgage. In the three rate hikes (totalling 1.5%, bringing the standard variable to 4.19%) the repayments will rise to €1,238 which will mean a total of €185 per month or €2,220 per year of additional cost to affected households.

If a person with the average mortgage was on the average industrial wage this has the same net effect as taking a €3,000 pay cut, which has arisen due to mortgage servicing costs.

This move will affect 38% of the banks customers which translates into 80,000 households, which represents a loan book of c. €5.3 billion. The 1.5% increase since last year should yield an additional €80,000,000 to the bank.

The EBS increased rates last week, and another has followed suit within days, showing that once again, banks are taking each others lead when it comes to jacking up the prices that consumers must pay. All of this money will disappear into the financial system and put further deflationary pressures upon the economy. We can expect no reaction from our Regulator and zero protection from further increases by other banks. At least Dick Turpin wore a mask.

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.

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.

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]

The EBS distribute through brokers via their subsidiary ‘Haven Mortgages’, the EBS have thoroughly debunked the idea that mutuality means anything by charging their existing clients different rates than new clients. They have also failed to be in the driving seat for a ‘third force’, going it alone has not happened, remaining an independent entity has failed, and the likelihood of private equity getting involved will most likely hinge upon state support being part of the package, thus it seems that institutional buyers will be the only serious suitors.

It is in an environment such as this that costs should be most seriously addressed, they have done this with Haven, slashing commissions and workforce, getting the organisation lean, but thus far EBS have failed to pursue efficiency with the same zeal within their own camp, and this zombie-like bank/mutual/whatever, is now reducing LTV’s for the only efficient part of the operation, Haven will now only offer a maximum of 80% LTV to potential clients, leaving 90% loans with the least effective arm of the organisation, the agent network.

It is important to remember that EBS obtain much of their distribution via their ‘agency network’ which is effectively a network of tied brokers, there are actually very few EBS branches that are owned and operated solely by the parent company, rather it is like branded tied brokers. As non-tied independent brokers we are saddened by the EBS move to force Haven to lower their maximum LTV, the move certainly wasn’t sought by Haven, and it is funnelling resources instead toward the inefficient mother-ship when the sensible thing to do would be to cut costs there and get cheap distribution via intermediaries, but it seems they are opting instead for intermediary distribution but only via tied agents who have different sets of underwriting rules etc. This is typical of Irish banking, punish those who do right and reward those who don’t.

There was a post on Geckko’s World about Negative Equity Loans - and he rightly pointed out that there had been an instant and widespread denouncement of them, then going on to point out that if a person was to try to reduce their debt that it could in fact be a very good concept. My opinion is that the focus will not be as a facility to reduce a persons debt but rather to increase, however, Geckko makes some very interesting and valid points which show that the first reaction was perhaps not totally balanced, as well as giving some smart operational guidelines (it’s worth leaving here for a while to check out the post).

However, there are some distinct advantages for the lender in this process as well which I have not seen any commentary on (if you have please post links in the comment section!).

1: Reduced borrower risk: Surely a higher LTV makes it riskier right? Not necessarily, if you have an existing client who has a perfect track record and you then re-underwrite them with the new ultra-stringent criteria and guidelines then you have something that you don’t get with a new client - a track record on top of ability to service the loan. If new credit is created by taking bets on the people you do know and can count on it is perhaps a safer bet for a bank then extending credit to a different buyer, banks do this all the time on the commercial side, why do you think certain developers had endless lines of credit rather than a bank lending to new developers all the time? Track record counts for a lot in banking, even to the institutions detriment as we saw with certain large developers. If new credit is directed toward existing borrowers in this manner rather than new borrowers it will have very little effect on freeing up credit for first time buyers who are being turned away in their droves.

2: Improved Margins (killing trackers): All new lines of credit will be written (as the person moves property) into the new host of rates available, which doesn’t include trackers. The people in negative equity are also the group with a high concentration of tracker mortgages, as this type of mortgage only came into existence during the boom. Take an example where a person has a 30yr mortgage of €200k and they are in negative equity of €20k and they actually downsize (rather than upsize - which is what the Neg. Equity Mortgage is geared towards), they buy for €170k, now their total debt has decreased from €200,000 to €190,000

Run the amortization calculator on this, they leave their ECB + 0.8% tracker and move onto a standard variable of c. 3.5%. Total cost of credit on the tracker is €259,000 on the lower loan amount on a standard variable it comes out at €307,000 a full €48,000 higher. And that’s where the debt amount has reduced! If it increases that difference is amplified.

3. Better asset holdings: Many people who have used negative equity mortgages in the UK have moved from apartments to houses, the trend here could be similar, if it is then the actual make up of the loan book gets better when you have more houses in it than apartments. The simple reason is that a house owner owns the land beneath the home, they can extend, go into attics and in general houses hold value better than apartments do. If people move out of apartments and into houses then it is better for the bank in terms of the types of property that make up their loan book. I would not be surprised if there are future RMBS’s that specifically exclude apartments.

4. A big PR slap on the back for Banks: One thing any bank who extends this credit will do is look for a high level of positive PR on the back of it, they will stand up and proclaim that they are doing their utmost to help those in negative equity, when in fact, the people in negative equity who do need help are those who have negative equity and arrears at the same time. It may reduce the political back-lash against banking in general and that would be a mistake. We need to keep the pressure on banks from all sides or they will resist necessary change.

Ultimately much of this will not come to pass, because there is only a small likelihood that any bank will ever formally offer a ‘negative equity mortgage’, chances are that it will only ever be done on a case by case basis with nothing available over the counter. No bank wants the moniker of ‘get your negative equity mortgage here!’, so don’t hold your breath. Banks will over this to clients as they see fit, an actual product offering is highly unlikely.

We were delighted at the invitation to join the Marian Finucane show on RTE 1 last Saturday for the second time this year, we were asked to go on alongside Angela Keegan of MyHome.ie to talk about property prices, mortgage lending criteria and property tax.

The RealPlayer version is here

You can check out an MP3 of it here

Or go to RTE and go through the list of shows to find it here

If you were listening to the show and have any questions relating to it please feel free to call us or email your query. We hope you enjoyed the show and if not then listen back to it!

We hope to be on this show again soon and help to raise the debate of Property Tax again.