Irish Mortgage Brokers Blog

We expected a 10% increase in mortgage arrears for the first half of this year, moving the total from 32,321 households to 35,531, however it increased 10.73% and the final figure was  36,438 [statistics for the last four quarters are below].

There is an ongoing inability for banks to deal effectively with people in arrears, both in terms of having the operational capacity or liquidity to offer debt relief in some form, and on the other side we have the Financial Regulator who is incrementally stripping away their power to enforce the mortgage via repossessions.

The arrears of the second half 2010 will go up again, there is no sign of either a slowing growth in arrears, or of a slow down in the rate of growth.

The only growth area in our economy at present seems to be in the deterioration of debt quality . . . but for the second half of the year it will not only be an ‘unemployment’ lead increase, rather it will be with the additional impact of lenders creating the problem via mortgage rate increases that have been independent of any European Central Bank moves (with an general move of c. 1.2% upwards in standard variable rates over the last 12 months).

The quarterly increase in arrears has been near or above 10% for the last three quarters, if this continues we can expect a further 20% by 2011 which would bring the total households in arrears to the region of 43,000 by year end and a likely figure of 50,000 by this time next year.

The solution for more than half of these owners would be repossession, in a functional market economy that is the end result. It is the fair termination of a contract where the borrower is unable to pay and it allows them to put distance between themselves and a financial obligation they can’t afford.

In the last 12 months 387 houses were repossessed, which is about 1% of the distressed stock, but according to the Irish Bankers Federation the rate of repossession by mainstream lenders has gone down in the last quarter to 86 properties, this is the third straight quarter of decline. How is this happening while the general mortgage situation is getting worse? Surely repossessions would go up at a time like this?

Unfortunately, the situation has turned entirely political, and the message that ‘keeping people in homes’ they cannot afford is the preferred solution, this in turn subjects them to endless calls, letters, form filling and stress in dealing with the banks on the basis that it keeps them in the home, but the statistics are showing that it isn’t changing the trend, or giving people the opportunity to get off a one way train. We have no metric of the family deterioration that occurs with financial problems, suffice to say, MABS, FLAC and other representative bodies say it is significant.

The question therefore must ask if a solution that keeps a person holding an asset they can ill afford to pay for is the humane approach, or would it be to release them from debt bondage as early as possible rather than to force them down a path that may have the same end result but with additional arrears interest and stress along the way?

We cannot be seen to encourage people to walk away from their debts, but we would be willing to say that when banks feel a deal may be turning against them in business that they will not continue to fund a project. We know of no reason for households to behave differently.

The rapid growth in mortgage interest supplement and applications for same is turning into a back-door bailout, non-performing loans extended by banks are being serviced by the taxpayer, banks are reluctant to take properties, not simply as a public service – that has never been their remit – rather it is so that the value of those properties do not need to be realised on their balance sheet. Banks assets are based on the value of the loans, not the value of the underlying collateral.

One view is that if you had a business and it didn’t look like it was working out a bank would have no issue in revoking credit lines or offering further support because in their opinion the proposal has soured. For the same reason it is fair to wonder why an individual would be asked to do precisely the same thing when the tables are turned?

A mortgage is ultimately a commercial arrangement and if it doesn’t work out the issue and duties are between the lender and borrower, not the lender, borrower and tax payer, but we are being dragged into the foray through mortgage interest supplement (taxpayer funded), through increased bank charges, through higher taxes which come about as a result of concern about our banking system/sovereign (and the arrears profile with lack of response is part of the issue), and directly by having a property market that is not adjusting in the time that it should.

When property markets reach clearing prices you have better odds of economic recovery (Kevin O’Rourke/ Barry Eichengreen and Agustin Benetrix all recently wrote on this topic), but we are not allowing this to happen, and it means that people who do buy today are paying too much because all of the properties that should be up for sale are not up for sale, it’s a modern ‘beggar thy neighbour’ scenario.

There are answers, but the cheap solution is denial, it has impacted 7bn of loans and only 500m in un-paids, compared to the likes of NAMA  it isn’t expensive, but the resulting reputational risk as a nation is pricey.

Brian O’Donovan of TV3 covered this story, which relates to a press release by the Financial Regulator.

The Financial Regulator has voiced ‘concerns’ over the manner in which disclosure and transparency are enacted when people move from a tracker rate onto any other rate in a press release yesterday.

There were no firm figures given, and no direct accusations (although the Financial Services Ombudsman has received c. 60 complaints). The release comes on the back of a story in the Sunday Business Post by Emma Kennedy which outlined that PTsb ‘misclassified’ up to 300 mortgages and put them on standard variable rates rather than trackers. The issue was spotted by PTsb and rectified by them, customers have been refunded (on average €5,000) the difference they paid plus interest.

The way in which people ‘come off’ trackers tends to be by their own volition, if they opted for a fixed rate while on a tracker contract they do not need to be re-offered their tracker rate at the end. If they were on a fixed rate and are coming off it they are given a selection of rates and although the tracker was offered in the contract, a lender might put several other rates on the same page and give the client the choice of ticking a box to decide which one they’d like to proceed with.

The guidelines issued yesterday will direct banks to give indicative comparisons of the monthly costs of each rate that may be on offer as well as an outline of the implications of moving away from a tracker rate, as well as details outlining the advantages of a tracker rate.

One lender had given a ‘cooling off period’ to people wishing to change rate from a tracker and the Regulator has determined that this may be put into the updated Consumer Protection Code.

Along with many others, I was confused at the fascination with EBS as a takeover target. You see, EBS’s best year recorded a profit of less than €50 million. Which given the size of its operation and loan book is rather unimpressive. The company is also heavily staffed by union members meaning it would be difficult for present management to wade in and cut the numbers in a meaningful manner.

So what is the obsession with private equity and EBS? And what about PTsb?

For a start, PTsb are not currently my lead favourite as a bidder, there are two reasons, one is that the bank rescue plans are being looked at from a competition aspect in Europe, and if PTsb were to take over EBS it would reduce competitive forces, secondly, PTsb may not be in condition to do a takeover. They have their stress-test due out in September and for now we have no idea of how that will look, EBS would add a large chunk to their loan book but deposits in the society are only c. €1bn and that may not aid in creating the loan/deposit balance that banks are looking for, especially given that PTsb are still firmly over the 200% mark. Lastly is a political consideration, every person working in EBS has a significant other in PTsb, if they were to take over it would make great sense from a costing perspective because you could literally fire almost everybody. However, the government are not likely to be in favour of that given the fall out that would result. If private equity took over EBS might (hypothetically) go from 1,000 workers to 700, but if PTsb took over it would go down to more like 200.

Which leaves private equity in the front line, for two reasons, they will bring some of their own capital (who ever wins the bid will be doing it with implicit state support included), and they will help to maintain competition while not reducing staff numbers as heavily as the first option.

Why would private equity be interested? Most of the distribution in EBS is via an agency network which is basically like having a lot of tied brokers?

The agency network does something brokerage in other institutions fail to do, namely raising funding. EBS have made good headway in that respect, bringing in €750m in 2008, €670m in 2009 and on target to do the same in 2010, but the real attraction is a relatively robust loan book with pricing opportunity.

The big banks have a loan book that roughly looks like this

Fixed Rates 20% (much of which may revert to tracker)
SVR’s           20%
Trackers      60%

EBS on the other hand has the inverse

Fixed Rates 20% (most of which revert to SVR)
SVR’s           60%
Trackers      20%

Which quickly explains the fascination, whoever takes over EBS has the ability to increase rates across the loan book in a manner which will have magnified results, much of the mature loan book will shoulder this quite well and ultimately create a profitable organization.

The three key factors will be to reprice the loan book, to lower deposit rates, and to find operational efficiency via staff numbers. A new owner will find it relatively easy to perform all three and to go on and sell the bank in a few years, that is the reason for the level of interest in EBS, they had low profits in the past because they were a mutual, but take the membership agenda out of the equation and you have a bank that is primed for making profit.

AIB have announced an increase in their Standard Variable Rates (SVR’s) as well as in their Loan to Value Standard Variables (LTV-SVR’s: which are tiered variables based upon your loan to value), effective from August 10th. Caroline Madden of the Irish Times and Charlie Weston from the Independent both carried the story today, this comes only days after Allied Irish Bank announced that they lost over €2,000,000,000 in the first half of 2010.

Their SVR now stands at 3.25% but where is it headed? For that it is important to look at several different factors, firstly, their cost to income ratio has gone from 48% in 2009 to 63% for 2010. That means that it is costing them €63 to turn over €100 in income, this is a 32% increase on last year in costs which is a bad indication.

There are a multitude of factors playing into this:

1. Guarantee/ELG costs: The bank must pay an insurance premium for the guarantees.
2. Higher deposit rates: Necessary to attract and retain depositors for the lender.
3. Higher wholesale funding costs: Interbank lending is currently only available at higher rates to Irish banks.
4. Returns on investment: Have been low year to date (reflected in the cost/income ratio)

The margin across the bank has dropped (despite rate cuts) from 2.03% to 1.56%, when they increased rates earlier in the year this brought them back by 14 basis points or 0.14%, so mathematically they have about three more such hikes to get back to 2009 levels; if rate hikes are their only action.

However, as likely is that of operational efficiency - namely job losses. AIB need to shed about 25% of its workforce and to take action fast.

They did this with the intermediary channel, in mid 2008 they cut commissions by 50% and later introduced a ‘cap’ so that even if a broker places a loan for €10,000,000 they can never make more than €1,500 from the transaction. This was hard to deal with as an intermediary but we took our medicine, the issue now is that AIB has scores of under-performing and non-performing branches, they should all be shut down, they should cut as deep into their branch distribution as they did on intermediary distribution in order to give the taxpayer value and in order to move away from a reliance on rate cuts as the only solution to their ills.

Where to from here?

Only 20% of the AIB loan book is on a standard variable rate so they are really lashing out at the only part of their residential loan book that they can, the remainder are 20% on fixed rates and a whopping 60% on tracker mortgages, that means they have no repricing capacity for 80% of their loans.

The balance sheet is screaming out ‘rate hike!’, with cost to income too high you have to do one of two things, cut costs or increase income, and ideally both: that signals a rate hike.

With margin across the group falling 25%, and to get it back up from its current 1.56% that signals a rate hike.

With a standard variable that is the cheapest in the market, nearly a full 1% lower than Ptsb it means there is plenty of room and scope for further rate hikes.

They have shown their willingness to address rate hikes and to hammer their customers in order to gain ground, the question now is whether AIB will demonstrate the same courage in dealing with their own staff who it seems are still enjoying gym membership and golf fees on behalf of the bank.

It’s time to make ‘hard decisions’ that might actually impact the people in AIB and not just the customers and shareholders of the bank.

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.