Irish Mortgage Brokers Blog

Caroline Madden wrote an article in today’s Irish Times ‘Just who is getting the mortgages?‘. It is a question that begs answers, at first it seemed to me like asking ‘Who is John Galt?’ (Rand readers will understand). The stories we hear constantly is that banks are hoarding credit, they will not extend credit to particular groups and when they do the underwriting is so strict that even credit-worthy applications are being turned down.

This article features our feelings on the matter, we believe that some of the banking statistics being thrown around make fore ‘good copy’ (good PR) and very little else, as we are not seeing applications turn from approvals in principle into closed loans, and in many cases, approvals are coming in far below what the applicant is actually looking for.

One element of this is natural, after a credit fuelled boom you often have a collapsing demand, credit after all, is like reaching into the future to realise income from that point and transporting it into the hear and now to spend, so when many people use credit and it goes toward a speculative bubble, a normal result is a fear of credit and an avoidance of borrowing as well as a reduction in the appetite in general for credit.

What is not normal however, is the refusal of banks to play their part in the intermediation process, whereby they take money from savers and give it to others in the form of loans, and that is symptomatic of the credit crisis, banks would rather sit on liabilities than make any effort toward the creation of new assets.

A highly debated element of the recapitalisations to date and the NAMA debate have to do with credit flow, that if banks are given money that they will start to lend it out, the problem being that we currently have a rapid credit contraction.

The new Financial Regulator Matthew Elderfield made his first public appearance since arriving nearly three months ago, and he said “A robust recapitalisation exercise will ensure that Ireland’s banks start this process in a stronger position and with a better funding outlook”. He is alluding to the thing that many people are forgetting, that when a bank has as high loan to deposit ratio they naturally hoard credit during times of widespread credit deterioration in order to ensure they have sufficient capital to face the impairments.

NAMA won’t ‘force lending out’, this is the aspect of fiscal policy not being able to ‘push on a string’, fiscal and monetary policy can pull a string and reign credit in but the force doesn’t work in the opposite direction, what it will do however, is get the banks to a point where they don’t fear impairment will undo their prospects in asset acquisition via loans. A bank is a little different you see, their assets are loans, but those loans can also act like a liability, whereas their deposits are liabilities, but these provide capital and therefore act kind of like an asset, banks are somewhat unique in this respect.

When a bank is in the region of 120% they are operating at very normal levels, NAMA will allow this to happen, and the recapitalisation will enforce this further, meaning the banks will be in a position to start lending again. It won’t force it, but any bank is generally keen to engage in the business they are destined for which is lending, there is no reason for banks to remain frozen once the cogs are in a position to start turning.

The one by-product of this will be repricing risk, this means (for you and me) paying more for financial services, in the UK after their property crash the margins on lending rose sharply, so bank will start to lend but they will do so charging handsomely for the privilege. It is a natural progression from a credit fuelled bubble, decompression of competitive forces won’t be good for the consumer, or for growth, but it will be good for banks, and necessary too, if banks had kept their margins the current dilemma would be better met by operational profit, and the bubble would have had some credit restraint (as stress testing based off higher mortgage rates would reduce accessibility to credit). It wouldn’t have saved us but it would be a different landscape.

Banks are lending, they are just doing so in a cherry-picking fashion, and they are looking to reduce certain channels (primarily intermediaries) first after which direct channels (branches) will start to get shut down, all said, there will probably be 30% fewer bank employees in the institutions of the future.

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

In the USA the 30yr Treasury is often called the ‘long bond’ and it is watched (the yields) very closely as it is the indication on long term rate expectations from within the market. If the NTMA issue 30 year bonds as suggested by today’s Independent it could bring about an important development that we have been advocates of for some time, namely, that of long term fixed rate mortgages.

Banks have a certain level of ‘zero rated funds’, this is money that is not incurring cost in terms of interest payments to the customer, they generally tend to come about in current accounts. Many people keep a certain amount of money in a current account from month to month, when you add all of this together across the institution there is normally a certain foundation or base level of funds constantly there. The zero rated funds are generally where the funding area where fixed rates come from, and the fixed rate mortgage prices are based upon a comparable (normally a sovereign bond).

A bank will look at the coupon on a Government bond (we’ll say its 3.5%) and then decide that if they can put a risk premium on this by lending the money out instead (for a mortgage) that if they can earn 4.5% on that loan then it makes sense to take the risk and lend at that price as they are making 22% more than they would by opting for the bond. This difference is the risk premium, the justification for doing a loan instead of buying a security.

The reason we have a maximum of 10yr fixed rates in Ireland is because that was (until recently) the longest term bond the state issued via the NTMA. However, this has started to change, last July we issued a 15yr bond and now there is talk of a 30 year.

What this means is that for the first time there is a pricing comparable of greater than 10 years, we currently have a 15 year level to benchmark against and soon there could be a 30 year option. The good thing about this in the mortgage market is that it helps to avoid the credit risk to an individual when obtaining finance, people who got cheap mortgages in 2003 saw them get more expensive in the run up to 2008 then come down in price since, that attraction to variable rates is not healthy, it creates bad underwriting as stress tests come in too low during low interest rate environments and too high (this problem was best seen by the people who were forced into 5yr fixed rates at 6%+ during 2008) on the way up.

In the USA the markets least affected by the property crash were those that had predominantly long term fixed rate mortgage holders, those that have been the most catastrophic use ARM (adjustable rate mortgages - the American acronym for variables). If banks were to move toward long term fixed rates it would be a good thing, but short of this, we would be happy to see the possibility of a 20 year or longer fixed rate. People take on debts for 25 years but there is no guaranteed price and that exposes them to many ups and downs along the way.

Indeed, if this were the case perhaps there would be mortgage holders who would be in a pinch because they wouldn’t have gotten the downward advantage of how interest rates have moved, but at the same time, we shouldn’t have a system predicated on being bailed out by cheap money, in fact, cheap money was a large part of the problem that got us here!

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!

AIB announced today that they will be closed to switcher mortgage business effective immediately. We spoke to Mary Wilson from RTE’s Drivetime on the topic and we stated similar views to what you will read here.

The options open to a bank with limited liquidity are essentially ‘who do we lend to’, in terms of expanding credit or extending credit to where it may have a meaningful economic impact. Sadly (because I have to be honest, as a broker this really sucks for us) that means cutting out certain parts of the market such as switchers.

The rationale is that switchers already have the money, they are merely shopping around for a better price, first time buyers on the other hand, haven’t even gotten the money to buy a home with yet and if you have to choose between the two I think it is fair to say that AIB made the right decision. Their commitment to the state during their recapitalisation was to first time buyers, not refinancing applicants or people trading up.

This will reduce competition, it isn’t good for the market, but one of the hallmarks of 2010 will be a strategic reduction in services/products as well as an increase in the cost of the provision of same. We find ourselves repeating the same message again and again: do something about it now rather than waiting to see if you are affected in the future then feeling hard done by after the fact. People who took that advice in recent months have obtained favourable AIB fixed rates, those that didn’t are now locked out from them.

We got a mention in today’s Indo in the ‘Your Money’ section, the story is about the one year freeze banks
have on repossessions.

The article by John Cradden covers the main issues of the day in the repossessions arena as well as giving some great general advice on ways to protect yourself from potential rate hikes by lenders.

There is increased coverage of mortgages in the press of late in particular in the area of fixing or staying on a variable, below are the best rates available on the market by class of product.

Best Variable Rate with an LTV Restriction:   2.25%
Best Variable Rate with no LTV Restriction:   2.55%
Best 1yr Fixed Rate:   2.35%
Best 2yr Fixed Rate:   2.65%
Best 3yr Fixed Rate:   3.15%
Best 5yr Fixed Rate:   3.7%
Best 10yr Fixed Rate:  4.5%

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.

The Examiner carried a story about the number of options available to borrowers in the present market and the fact that they have dropped over 50% since 2008.

In 2008 there were 380 different mortgages available on the market across all banks and all rate suites, today, that number rests at 179 meaning that at least 50% of the choice is gone. That is also reflective of the fact that so many lenders have exited the market. Below is a list of several who are no longer lending here.

Halifax
Fresh Mortgages
Springboard
Stepstone
Nua Homeloans
First Active
GE Money
Leeds

Many of these providers were in the non-prime/specialist/sub-prime category, however, a drop of 50% in choice doesn’t mean that there are no options left. Certainly tracker mortgages are a thing of the past as are Standard Variables (referring to new business for these products, existing clients will keep their existing product).

The other factor that makes this less spectacular is that many lenders replicate offerings, so when each lender pulled out, their two year fixed rate product being discontinued means that there were 8 less two year fixed products available, but it isn’t the case that the market leading 2yr fixed was necessarily with any bank that quit the market.

The idea that the more mortgages there are, the wider the choice is true in respect of their being more ports of call, but if you wanted baked beans does it matter whether the shop you go to stocks 6 brands or 70 brands of the same thing? Mortgages are not rocket science, there are intricacies and nuances that a practitioner understands better than a day to day consumer but in terms of choice there are still plenty of options and navigating your way through them is perhaps made easier given that there are fewer choices, even if all of the players remained in the market tracker mortgages and standard variable mortgages would not be on offer, so it doesn’t mean that the consumer is definitely gouged when one or more banks stop lending or close up shop.