If I ran a bank (and many of you are already grateful I don’t) I would be giving out 100% mortgages to beat the band at the moment because lending shouldn’t be pro-cyclical only, and in this post we’ll consider some of the reasons why.
1: Spreading risk. This is the main reason I would start to issue 100% mortgages, maybe even 102% (to cover closing costs). Why? Because there are developers who are on my hypothetical banks book who are not going to be able to service their debt, on one side of my balance sheet I have this loan asset, but the integrity of it is in doubt and all of my eggs are in one basket with this single developer and his 100 house scheme.
If instead we get 100 different people to take these properties the risk is well diversified, the integrity of the loan is much more likely to remain intact, with the rate of unemployment slowing it would be realistic to expect that there won’t be mass lay-off’s specific to the particular demographic which take on these properties (we’ll assume the 100 house scheme isn’t right next to some large multi-national about to close).
2. Maintaining Asset Quality: If we could get people to take these properties today at today’s valuation then two things occur, firstly there isn’t a further deterioration in the valuation, when the asset is a development loan it can only be repaid upon successful sales of the development as this could take time due to bank criteria being harder and larger deposits being required. If it was diversified out rapidly to buyers then a further reduction in the underlying asset would be less likely given the manner in which residential mortgages in Ireland tend to operate – namely that the majority of people repay their home loans and our balance sheet isn’t about negative equity or property values, its about loan values.
3. Buyer benefit: By now you have realised this is satire, but there would potentially be buyer benefits in this scenario as well. For a start, full TRS (tax relief at source) would be available to buyers meaning that they may actually get a place for cheaper than it is to rent a comparable. A 5yr fixed rate of c. 4% on a loan of €250,000 would cost a couple €985 per month, that is comparable to a property that would likely rent for €1,200+ (using the investor method of valuations-albeit ambitiously at 17x earnings). The likelihood of TRS being scrapped soon is strong so there may be an argument for getting the credit while it is available.
The other benefit to the buyer would be that of taxation v.s. property values relationship, many people are holding out because they feel property values will drop further. You can assume we are only halfway there, or near the bottom or at a bear market trap or anything else – that is one side of the issue, the other is funding a deposit.
Even if property prices decrease a further 15 or 20% you still need to save up a deposit. So take that example of a house for €250k. A 15% deposit would be €37,500 to save that up you would actually have to earn around €60,000 if you were getting your deposit from earnings, you can round that down to €50,000 though because you would probably have earned some interest that would compound up over the years.
If instead you wait (paying rent during this time) you might pay less in the future but you might not have the benefit of TRS, you will also not be able to obtain the cheap fixed rates available today – these won’t be coming back any time soon, risk is and will be repriced accordingly. As well as that larger deposits may be required depending on how the market moves. And of course, you would have had to save to beat the band in order to get your after tax money saved for a deposit. Does long term interest outweigh medium term cash-flow? A valid question.
So why aren’t banks opting for the counter-cyclical lending that could actually help their balance sheet? Simple answer – they don’t have the readies. One bank is doing this, Ulsterbank are offering 95% on ‘certain developments’ (i.e.: developments where the developer in question borrowed the money from UB!), it is surprising others have not followed suit.