Irish Mortgage Brokers Blog

Anybody who follows the well known finance blog Credit Writedowns will know that one of the trends coming about (according to author Ed Harrison) is that we are going to see a competitive devaluation, where USD and Euro purposely look to go lower, the other alternative is that the Chinese opt to float their currency and allow some appreciation. This is happening right now, it is no coincidence that the Yuan is going to see some rule loosening, it is that or face the alternative which is a move by USD as low as it can go to re-establish equilibrium between the surplus/deficit nations.

While competitive devaluation is not the subject, it is touched on by several different facets of the conversation, well worth viewing.

I was interested in the front page of today’s Independent in which Charlie Weston broke a really big story about Irish banks being in advanced stages of designing ‘Negative Equity Mortgages’ (this is vastly different than the Negative Equity Loan/Short Sale Loan we have discussed previously). Essentially the bank will allow an individual to carry negative equity out of one property and move that onto another one within certain parameters.

This practice has already existed in the UK and is offered by Nationwide, Coventry and RBS, the schemes have not proved to be very popular, in part because of the stringent underwriting required. It is one thing for a client to fall into negative equity but another to actually facilitate them in compounding that fact and taking a further bet on their ability to repay. What do I mean by that?

First Loan: €200,000
Value: €150,000
Neg/Eq: €50,000

Then the €50,000 shortfall is passed into a second loan of (for example) €200,000 (which by nature will essentially be a 100% mortgage) and now they owe €250,000 with €50,000 negative equity in place the day they close.

In this case the borrower now owes more but they have a different property which they are more happy with and underwriting will ensure that they can still service the loan, but how many people will be willing to take up such a product? And who will the bank be willing to lend to on this basis? Credit is already tight, to trust a person with yet more money and negative equity in advance is a gamble, this beast is the evil love child of 100% mortgages - the very brand of lending that was a factor in the property bubble.

The sole saving grace is that people won’t opt for it, in the UK the uptake has been incredibly low, it is a niche product with little in the way of demand, it will help the people who are happy to use it and will be of little use to the average borrower, having said that, the Regulator recently said that banks have failed to learn their lessons from the crisis and that they don’t lend enough to business and rely to heavily on property, if this is the latest in financial innovation can we truly say they are learning anything at all?

Currently about 25% of the mortgages in Florida are delinquent, there is a huge amount of foreclosed property on the market, short sellers can’t offload fast enough, property prices are falling, and it is also a judicial foreclosure market meaning people have similar issues to the problems we have here when a home in negative equity is repossessed, they owe the difference.

A possible solution being tried there is that of mortgage mediation. This is vastly different than the scheme in place in Ireland, and perhaps active mediation with a set point of contact and a set representative would be a good idea, chances are we’ll never know because it is not likely to be rolled out in Ireland.

An article in the Independent yesterday pointed toward 100% mortgages being a significant attributer to the bubble, I would wager it was a symptom rather than a cause, the IBA meanwhile has called for all mortgages to be made on a non-recourse basis.

The good thing is that people and organisations are trying to find a way to avoid a repeat of the property bubble, and they are not one off events as the UK can testify.  There are however, significant factors contributing to what happened.

1: lenders didn’t price risk, they didn’t even ‘price at all’: Banks have utterly failed to do the job they were designed to do, namely that of profitable intermediation, we had huge amounts of competition on lending, that drove down criteria requirements and also compressed margins, then along came trackers, these had low margin price promises - Bank of Scotland brought them into Ireland and have since left. I spoke with a Bank exec. yesterday and he told me that his institution has €16bn in trackers at an average rate of 2.1% and cost of funding is 2.3%, that is a critical error. The other issue is that ‘risk’ wasn’t considered relative to LTV, while there were some bands on trackers that were LTV based, the 100% mortgage was in complete denial, they were the riskiest loans and yet they didn’t have lending charges far above loans with 85% LTV. You can’t expect people to do the pricing for you, banks should have done their job and they didn’t.

2. Insurance should be mandatory: We have mandatory life assurance with mortgages in Ireland and yet death is the least likely event during the term of a loan, unemployment, accident or sickness are far more likely. This would be akin to insuring a car but only for fire. Mandatory insurance should be of the type that covers these likely events as well, and a waiver should only be available at low LTV’s.

3. Recourse is wrong in Irl so even 110% is fine for the bank: In Ireland your gearing doesn’t matter, the recourse to the loan is with the individual to the bitter end, in that respect the call for non-recourse mortgages is well founded, but on another hand - it won’t fix the present problem nor will it prevent a bubble it will merely increase the price of mortgages and encourage reckless consumer behaviour. There is a belief that ‘it works that way in America’ and I can tell you in short, no it doesn’t. The USA is divided amongst judicial and non-judicial foreclosure states and that means vastly different results when they foreclose on you. We also don’t want it ‘like the Americans’ in every sense, in the US if you fail to insure your property they’ll initiate foreclosure on you, that would go down like a lead balloon in Ireland.

4. Higher LTV facilitates home ownership: Putting restrictions on LTV’s is not the answer, but perhaps having banks put aside a higher capital cushion for every loan that is over 75% would be of benefit, then they can price risk accordingly and behave in a competitive fashion without regulatory nooses.

5. Low LTV doesn’t protect against unemployment - it’s a life stage relation, in the 80’s they didn’t have as high price/ltv but rates were high and as a percentage of income mortgage payments were still as high. property is expensive, it’s meant to be. Many of the ideas have merit, but it isn’t as simple as stating that one fix is the ultimate solution, rather it is many fixes working together that is required, the single greatest oversight is that of a site value tax - that alone would perhaps solve more problems than any other idea put forward to date.

O.k. I lied, they care, but when it comes to new lending (and the secular trend that has already started in Irish lending rates) the underlying prices is of secondary concern as long at the loan (which is the banks asset) is performing.

There is a disconnect between the way that consumers think of property and the way that financial institutions think of it, the consumer thinks of price, the financial thinks of long term loan value. They are two different things, take the example below

Property price: €200,000
Loan (90%): €180,000
Term: 30yrs
Rate: 3%

Total Cost of Credit: €273,199
Credit Cost: €93,199

The bank have a buffer in terms of the quality of the underlying asset, but that isn’t of concern, as long as the loan is performing it will be valued at €180,000 (or whatever the balance is), which is why the lenders are instead going for a different approach. Values have dropped to the point where they believe that we are somewhere near the bottom, not there yet but equally not at the wild over-valuation stage either, if they underwrite strongly, and only lend to the best candidates then the property prices can fail and they don’t need to fear impairment.

Once the borrower continues to pay there is no impairment irrespective of the underlying asset value. The second wing of this is to find margin in lending, we reported in early 2010 that rates would go up this year by 100 basis points or 1% starting in the first quarter, this has turned out to be true, if they go up by a further 50 basis points next year and prices go down 10% look at what happens.
Property price: €180,000
Loan (90%): €162,000
Term: 30yrs
Rate: 4.5%

Total Cost of Credit: €295,498
Credit Cost: €133,498

The lender has made an additional €40,000 on this loan even though the property price was less - because the credit gain outweighs the difference. Consumers often confuse price with cost, the smart thing to do would likely have been to take out a loan in Q4 of 09′ or Q1 of 2010 - if you believe that over the long term that the property will increase in value, if you don’t believe that then stay out of the market. The ECB might stay at 1% until 2012 according to some commentators, even if that happens rates are still going to increase as banks look for ways to find profit to fill the ongoing holes in their balance sheets.

Which is why they don’t care about property prices for new lending, rather they care about the financial strength of the applicant and about how much margin they can obtain on lending to new applicants.

I used to be in a Chess Club, and one thing it taught me (apart from how to lose using the Kings Gambit) is that you can often see a general result long before you see it exactly, when you are a piece down and can’t control the centre of the board you know you are in trouble, but how and where the checkmate occurs is unknown, game theory can’t tell you precisely and reverse integration from the end game may not bring you to where you started from, but the player knows instinctively that they are up against the wall.

Sometimes appearances can be deceiving, you might think you are fine and you are not (2003-2009), other times you can get caught up about losing a pawn but you are in fact gaining ground (2010), albeit painfully and slowly.

I believe the same can often apply to markets. Today we will look at the reasons for why we believe the banks are going to survive and furthermore, what the results will be of their survival.

The core belief in this firm is that market rules should apply, the banks should have to stand on their own or or shut down or find a buyer, its just that simple, however, we have not allowed that to occur so we now have to find our way through having avoided that option. In chess this is the equivalent of trying to save the Queen instead of Castling - the Queen is just too important, or is she? Depends on who you ask. We think not, but the decision makers made the play.

Our primary belief is that the banks will survive. Sometimes the noise is hard to ignore, but this time last year there were many commentators saying that our banks would be nationalised within a month or two, then the we should leave the Euro, last month the Euro was going to collapse and now we are once again on the road to hell minus the Chris Rea soundtrack, the truth is we’ll muddle through and come out the other side one way or another.

So why will the banks make it? For no other reason than because we have pinned the hopes of this country upon their survival, to the point of no return. In the absence of a ‘Plan B’ the success of ‘Plan A’ becomes highly incentivised. The current big issue that some people are pointing to is that of the bond credit that has to roll over by the end of 2010, the figure was c. €74bn (previous calc’s said €71bn) which is made up of Interbank Lending €16,405m, Senior Debt €57,791m and Subordinated Debt €866m.

We’ll focus on the bond holders as they represent a foundational risk to the system, so… Will the bond holders stay the course and support Ireland? I would imagine the answer to be ‘yes’, but I’ll qualify it.

Reasons:

1. Guarantee
2. What failure would mean
3. ECB support & approach thus far
4. Shareholder support
5. Euro implications
6. Effect on cost

1. Guarantee: We have made a guarantee to world markets, world markets like that kind of thing, the state will ensure that no institution will not be able to come good on their liabilities and it is underwritten by the state guarantee (taxpayers), this kind of ‘can’t lose’ situation is preferable to fixed income markets, it is the reason the USD is a safe haven when you can’t trust much else (bar gold or perhaps Yen). No bondholders have been burned and they are generally satisfied that their capital values are safe, over and above coupon payments, bond buyers want to know that they are going to get their capital back (in full and on time). No bank has yet defaulted nor will they, as a default on a state guaranteed bank is essentially a sovereign default - it ain’t gonna happen.

Some people think a sovereign default might be just the answer, it is hard to disagree in many cases, it sounds like a nice plan to go and shaft those big faceless bond-holders, and many countries do, Greece (for instance) has made a career of it - which is why everybody there is so angry at the concept of actually having to get their house in order. Would it be a good idea for Ireland?

I doubt it - there is not only the implications of default to consider, firstly, the ECB would likely force non-default, taking up the slack and forcing us to pay eventually anyway, secondly, we export a lot of financial services and nobody wants to deal in serious finance services with a country that defaults (except of course those that make a profit from restructuring etc.).

Uruguay is a country that people point to as being evidence of the ‘correct’ way to default, having been to that country six times and studied it extensively I can safely say that we don’t want to go down that path (yet). The guarantee will stand and thus the Irish banks will stand. The one outlier in this is if there is some substantial credit event (either large institution or sovereign).

2. What failure would mean: An inability to refinance would be read internationally as a country being broke, believe it or not Ireland doesn’t matter to the international marketplace as much as we’d like it to. I speak to traders in the US regularly enough and they don’t know the difference between Anglo, BOI or AIB - nor do they really care, something bad happens in Ireland and the whole place is tarnished. Oddly we actually have earned great respect internationally for how we are handling our issues (I’m not talking about the OECD/IMF/WorldBank etc. - I’m talking about the opinion of the people who actually buy our bonds as opposed to those who make economic forecasts/comment), a credit event now would spell disaster, we wouldn’t be even be able to finance our public services.

Strangely, the Public Sector Unions are quite vociferous on how ‘angry’ the are about the ‘bank bailout’, failing to see that if the banks fail that their paymaster won’t be able to borrow to pay them, they didn’t cause the crisis but they are one of the primary beneficiaries and if one domino falls the next will follow, it isn’t different this time. Uruguay is testament to that.

3. ECB Support & approach thus far: Name a bank in Europe that was allowed to go to the wall? … Still thinking? After Lehman the banking bluff was seen for what it is, namely a ‘fairly real threat’, banks are not joking when they say ‘if we fail we can bring down the system’, that type of event may not bring the four horsemen charging out of the sky earth-bound and ready for destruction, but it can cause systematic distress which is far beyond the price of avoiding it.

This may not have been the case if we went for this option originally, but certainly now - as it would involve breaking our sovereign promise -it would ensure a far larger bank run than necessary and likely collapse. Bailouts sicken me, especially when I see competitors bailed out who are then able to unfairly chase the same clients we chase, trust me, nobody is angrier than intermediaries when it comes to life support to banger businesses that should have shut down but are instead artificially supported.

4. Shareholder Support: Bond holders are at the very end of the risk queue - the most senior ranking on par with depositors, shareholders on the other hand are the ones playing with dynamite, and despite this, the BOI rights issue was 93% subscribed with buyers for the remaining 7%. That means that people are more than happy to take the most risky asset available, that is the market speaking loud and clear that they trust in BOI’s ability not only to survive but to prosper, if people and institutions are willing to back the equity you can be damn sure they’ll back the bond debt. While the buyers are often of different mind sets (shares v.s. bonds), the fact is that it means there is a bigger buffer of safety for the bond holders, and a pre-auction phone call from the desk will likely help to assuage any fears ensuring that the debt rolls. Saying otherwise is like thinking a person wouldn’t drive a car when there are people trying to get to the same destination on uni0-cycles, the bonds are safe and will remain as such.

CDS’s are often news makers, hard to think that only a decade ago almost nobody even knew what they were, and a decade and a half ago they didn’t exist. CDS’s are like a secondary thermometer: let me ask you - is 30 degrees hot? Yes if you are in Ireland, yes if you are in the North Pole, but no if you are in Brazil and definitely no if you are trying to cook a turkey, but we often see CDS’ prices reported as if they are the one cooking the goose, it isn’t the case, often issuers realise that higher yields players will happily sacrifice some coupon for a hedge, and almost all the CDS’s are settled materially or manually (the actual asset passes to the issuer) rather than via a direct insurance payment.

The likelihood of a qualifying credit even for the reference entity doesn’t have to occur, it just has to be perceived as ‘a risk’, prices can be a reflection of yield sacrifice for a hedge, CDS’s are a secondary measurement, they are not the reference entity and cannot be seen as such, capital values are a better tool in our opinion than looking at the derivative values or bids where that capital value is the reference entity. If an LT2 bond is paying c. 11% then a CDS of 5% isn’t the end of the world, having said that, you would always wonder what might prompt an 11% payment to begin with! However, the main thrust remains - Shareholders have stepped up and that is like a wave of infantry charging over the top, which makes the bondholders who are still in the trenches feel much safer.

5. Euro Implications: Despite the hullabaloo being caused, the EU and even Germany all want a devalued euro, granted, German savers will be angry, but everybody else wins, low rates, quantitative easing and monetary policy that encourages exports will be of benefit to everybody, Germany gets their exports and output back up, Greece gets their bailout, everybody else gets some inflation which will hopefully feed into new employment faster than wage increases for existing employees and we all muddle on through.

This latest test isn’t testament to the failure of the Euro, it is rather testament to the success that it represents in converging largely disparate nations and economies- the USD does the same thing. While the current issues represent a test, it doesn’t represent a ‘failed test’, if a member leaves it won’t be the end of the world, but don’t bet on it, if you could just kick people out of monetary unions then Louisiana would have been kicked out and California would have seceded long ago, don’t doubt the staying power of EU members.

6. Effect on Costs: Far from seeing the present storm as a sign of imminent collapse, I see it as a signal that we are in for a period of much higher financial costs on any credit or financial transactions, banks are going to have to retrench, build deposits, build assets carefully and find operational gains (fire lots of people). The most likely outcome isn’t that a bank will fall, it is that they will find a way through via operational profits and price increases. Much of the past losses are paid for, NAMA has taken away a huge amount and they are jacking up mortgage rates to cover the lagging residential issues. It’s easy to cry ‘Uncle!’ now, or to believe it is upon us, but the fact is that we made it this far and both Ireland, and its banks are probably going to find a way to stagger through, punch-drunk and beaten, to the other side of this mess, I’m not saying it won’t hurt in the mean time, or that there won’t be further slaps to the head, but we’ll muddle through in spite of it, the markets have already spoken, it’s time to listen.

We had a busy month in the financial commentary world. A list of our press mentions is below

23rd May 2010: Sunday Tribune: Safe for a while against rate hikes

23rd May 2010: Sunday Times: A bad time to invest? Q & A with Jill Kerby

23rd May 2010: Sunday Tribune: Mortgage rate increases

16th May 2010: Sunday Times: Keep hold of your home

16th May 2010: Sunday Tribune: Mortgage group mull over Negative Equity Loans

16th May 2010: Sunday Tribune: Recession Rates

14th May 2010: Newstalk 106: Ivan Yates talks to Karl Deeter about Property Prices

15th May 2010: Independent: Property prices must fall to attract investors

13th May 2010: RTE Drivetime: Iain Nash and Karl Deeter talk to Mary Wilson about Negative Equity Loans

11th May 2010: Today FM, Matt Cooper on negative equity, featuring Alison O’Riordan and Karl Deeter

6th May 2010: Independent: Reducing debt can pay off for borrowers

5th May 2010: Independent: Banks restricting credit to the low paid

4th May 2010: Newstalk Lunchtime show, Eamon Keane talks to Gerald Kean and Karl Deeter

3rd May 2010: Irish Times: Trackers under threat

In the first quarter of 2010 there were c. 62 business days, and from this time frame we have gotten the most recent lending figures from the Irish Bankers Federation on mortgages in Ireland. Those figures stated that there were 6,954 mortgages drawn down in the first quarter of 2010 equating to €1.22bn in lending.

Those are the hard facts.

Then come the contradictions. AIB claim to have about 40% of the mortgage market - that headline is from last November but we can assume it should still remain at above 30%, an institutional contraction of 25% would be known because it would definitely make headlines (the 40% of the market AIB has is 100% to them so if it fell to 30% that would be a 25% reduction on their single institution figures). Back on topic - if we accept that AIB is holding at least 30% of the market then that means they were responsible for 2,086 mortgages.

EBS are saying they have about 28% of the market, up from 21% last year. The bit I like best is where they say that one in two people who go direct to a bank for a mortgage went to EBS. Sadly, this doesn’t factor in the reality on the ground - every broker in town has a back door with the EBS via one of their agent branches and clients are regularly sent to them for loans when their more conservative broker wing won’t do the mortgage [EBS are loose on policy when you go direct].  A 28% market share would mean EBS were responsible for 1,947 mortgages.

We didn’t find statements of market share from the other banks, but I think it would be fair to say that between PTsb, Ulsterbank, NIB, INBS and KBC that they were jointly responsible for perhaps 15% of the market? (1,043 mortgages).

So we are now looking at a picture like this: AIB 2086 mortgages + EBS 1947 mortgages + everybody except BOI 1,043 mortgages = 5,076 mortgages

Nothing spectacular there until you get back to the fact that we had about 62 banking days in the first quarter of 2010, because during that time Bank of Ireland were claiming they were doing 100 mortgages a day. That would equate to 6,200 mortgages.

BOI figures 6,200 + everybody else’s figures of 5,076 = 11,276 mortgages

Reality = 6,954 mortgages.

Difference between the two? About 4,322 mortgages or in the region of €870,000,000 in lending.

In a nutshell, somebody somewhere is telling porkies. Who even cares any more.

Currently banks are not interested in dealing with customers who ‘might go into arrears’, they tend to brush them off - instead focusing on the people who are already in actual trouble. This doesn’t seem rational to me from a business perspective - and this approach would fail any standard test of common sense - if you knew a storm was coming would you carry an umbrella? If you knew and were warned in advance that it was going to be a blazing hot day would you get some sun-cream? Oddly the Irish mortgage lenders defy logic when it comes to knowing that certain clients are going to fall into arrears, and this is going to ruin thousands of credit histories that could otherwise be maintained. Credit aversion might be the name of the day now, but these same consumers may feel differently in five years time.

Any credit crisis we have encountered on individual levels has always had a common symptom, that of overall indebtedness rather than it being a person who has only a mortgage, obviously there are many cases that fall into this category - all I’m saying is that we are not seeing any of them, and if this was the widespread situation you’d expect them to surface.

What could lenders do? For some borrowers a one month breather might help, for others a small interest only term of two or three months might do the trick, the issue is that forcing capital and repayment until arrears occur does two things: firstly it sends out a message that banks will only deal with you once you become delinquent and secondly that the bank is not interested in the plight of the individual, that is a mistake on both fronts. Ireland has not seen widespread strategic defaulters but it will become a risk if people become much more disillusioned with them because the truth is that there is a Rubicon people will eventually face - do I work in order to pay the bank or walk away and have a wreaked credit history with a judgement that will last 12 years? I have a feeling we’ll soon find out who wades in.

PTsb have been fairly honest in the way they have handled their loan book over the last two years, unpopular too, however it is important to look at what they are doing, why they did it and what they will do next.

Their first mortgage rate increase came in July 2009 and it was an additional 0.5% on top of the existing variable rate mortgage. The second PTsb rate hike came at the end of January 2010 and was effective from the 1st of February 2010.

PTsb are not part of NAMA, they are benefiting by the guarantee (as are the likes of Postbank) but they are paying for that guarantee - and the only way they can continue operations without requiring an outright bailout is to increase rates, shrink their loan book and reduce costs. In that respect they are to be admired, they are doing what is necessary to remain a going concern.

The trend to watch for however, is that they will continue to increase rates, and their fixed rate offering will remain high, their ideal situation is to ramp up assets and because of that you’ll probably see the conservative rate suite (5 & 10yr fixed rates) on very low LTV’s (<50%) coming in at market leading rates, that is part of the game plan, you can shrink your loan book (ratio’s not absolute terms) by attracting low LTV biz and this is precisely what PTsb plan to do.