How ‘Shared Equity’ in an arrears cases would(n’t) work

This piece is a demonstration of the way in which a a bank will opt for ‘shared equity’ with a home owner who is in arrears as means to keeping them in the property. It is important to remember, the ‘big bad bank’ wants people to stay in a property with arrears, only during a strong upward cycle do they tend to repossess property rapidly. What you will see next is in effect, a legal accounting trick, and one which actually leverages the individual even more.

So the situation at the start shows the asset value versus the value of the underlying security (in fact it is a little more complicated than this but for the sake of explanation the property and asset are the same value). Then along comes a property crash (we had a banking crisis thrown in for good measure).

Now the borrower is 200% leveraged, or at 50% in negative equity (their mortgage is €200k their value is €100k, look at it whichever way you like). The borrower is still paying the mortgage though so the underlying asset value isn’t overly important, instead it is the value of the performing loan that a bank will take into consideration.

But then if the person is unable to pay they might strike a deal with them – see the next picture – whereby they take ownership of a portion of the property in return for the person having a lower loan balance.

In taking €50,000 off the loan they now own 50% of the property (value €100k minus €50k debt reduction giving a balance to the owner of €50k as well). The full asset is still considered €200k so the bank are essentially sitting in the same position as before, €150k loan plus €50k of property ownership.

But the borrower isn’t sitting pretty, far from it, they are now 300% leveraged! And their total negative equity is the exact same at €100k. On the upside their mortgage payment comes down by c.25% but their overall position is worse and the bank have stayed somewhat the same because once again, they have convinced the borrower to stay in the property and in doing so commit their future income towards servicing their loan.

Bank now looks as follows:

Borrowers balance sheet is as follows:

The vexing thing is that if the market comes back (let’s say it bounced at a hypothetical rate of 10%)  the borrower would normally have €110k if they had kept their name only on the debt, but now the bank captures any of that value uplift meaning the person gets better slower if there is a market recovery.

This should help to expose the plan for what it is, namely an accounting trick that lets the bank keep their debts looking a certain way. And it is totally legal but that doesn’t make it right, it just helps to prove the point that banks are willing to do whatever it takes to keep people in the home, but not because they care, but because doing otherwise would mean they don’t have assets worth €200k, instead they have them worth €100,000k and in the process they take a painful writedown.

that would be capitalism, instead we have gotten something else entirely.

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