Irish Mortgage Brokers Blog

Merrion
IRISH LIFE AND PERMANENT FY BROADLY IN LINE
* Profit After Tax (PAT) of -€279m better then our forecasted -€308.
* Divisionally, PAT for banking business -€270m better then our forecasted -€302m and Life APE sales (ex ILIM) also ahead at +€348m vs our forecasted  +€318m.
* loan loss provisions better at €376m vs our forecasted €400m
* Life capital stable
* Alliance disappointing-no surprises given recent results
* Tier 1 at 9.2% better then our forecasted 8.9%

OUTLOOK: 2010 to be broadly similar to 2009.  At first glance
we are likely to leave our forecasts unchanged.

NCB
FY Operating loss -€196m vs -€223m NCBe
FY Impairments €376m vs €433m NCBe
Impairment guidance unchanged at €800-900m to 2011 (NCBe €1.1bn)
Net interest margin 0.83% vs 0.85% NCBe
Loan to deposit ratio 246% vs 271% in 2008
Outlook - Banking business to be broadly similar to 2009 with significant
improvement in life business profitability.
Analyst comment to follow

Davy
ACTUAL      DAVY      CONS
PBT (€m)    -319.0    -389.0    -194.8
EPS (c )         -66        -69.4     -47.0

*Operating profits are better than expected due to lower impairment losses in  the bank but this may be a timing issue; still guiding €800m to €900m losses through the cycle
*APE decline of 32% is better than our 38% forecast; a bit behind market  decline of 38% due to distribution; brokers fared relatively better than  bancassurance/sales forces
*Bank Net Interest Margin in line at 83bps but life margin of 11.4% better
*On outlook expect bank result in 2010 to be similar to 2009 but ’significant’ improvement in life
*No news on Third Force; blaming NAMA delay for lack of progress

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.

Dan Mitchell of Cato (and the Centre for Freedom and Prosperity) is a guy I enjoy speaking and listening to as well, he is a great Libertarian thinker and regular commentator on Bloomberg, CNBC, CNN and Fox News. Here are two of his latest video’s, the first is on debt and the second is about money laundering laws.

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%

In this video Paddy Hirsch talks about Bonds, Notes and Bills helping to break down how debt is described based on its tenure and also a little about how they work. This is worth watching twice if you have heard ‘Government Bonds’ mentioned in the past but didn’t really get what they were talking about.

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.

Banks deny that they are cherry-picking applications and brokers say otherwise. What I can say is that we are going through a credit adjustment where there just isn’t the appetite for lending that used to exist. This is natural, it happened (for instance) in Finland in the 90’s, it took a decade for lending to reach bubble levels again. As well as this, when you have a rapid build up of borrowing, it is like people were reaching further and further into the future for greater amounts in order to spend in the present, that is a basic premise of lending, you give up future income streams in order to spend today and that applies to credit cards, personal loans, and mortgages as well. Finally, during a recession in which unemployment is rising, asset prices are dropping and many have taken wage cuts, appetite for high level financial obligations will be naturally surpressed.

So it is no surprise that annual lending for 2009 was only €8.1bn, that is broadly in line with our prediction set out in early January.

The question remains though, are lenders cherry-picking applicants? My opinion is ‘yes that is exactly what they are doing’, they have something with scarcity, mortgage credit, and this leaves them with two choices (remember: they don’t have endless amounts themselves), they either raise prices in order to weed out applications, or they pick only the very best applicants available and offer the line of credit to them.

The price hikes won’t come (yet), once assets are all gone over to NAMA two things will happen, mortgage rates will rise, and deposit rates will drop. So for now you can get good returns on deposit and good prices on mortgages. Anglo just passed €10bn over today, they didn’t operate in retail banking, so rates won’t move, but it means that the show is under-way and when the main street banks start to shift assets to NAMA it will be the starting point for those two trends to commence.