We have written in the past about tracker mortgages becoming an endangered species. It seems that now we are witnessing the demise of them, the interbank rates and the ECB have become so disparate to each other that one is no longer an accurate gauge of the other. What does that mean?

The ECB is the rate set by the European Central Bank, and it is the ‘base rate’ (currently 4.25%), but banks can’t generally borrow at that price and instead they buy on the ‘interbank‘ market, this is the largest market in the world in which over 1.9 Trillion is traded every single day! It is how banks access the ‘Euribor‘ market (European interbank offered rate). This is basically run as an auction and because liquidity is an issue we have seen the prices of the Euribor rise and rise, demand is outstripping supply.

Why is the Euribor rising? Simply put, fractional banking means that banks must have a constant inflow of money in order to stay in business, when money is scarce that gives it a higher value or a so called ‘scarcity value‘, anything scarce for which there is a demand will go up in price and that is the basis of what we have seen on the interbank market.

So how does this affect tracker mortgages? Tracker mortgages were marketed in the residential market as (almost exclusively) a loan that would ‘track’ the ECB by a fixed margin, this was as low as 0.45% above ECB with some banks, this mean that if the base rate was 4% your loans interest rate was 4.45%. A brilliant loan for Mr. Consumer and excellent value, and the banks were happy as well because they were able to provide these loans (albeit at low margins) and still find some profit from them.

Then along came the credit crunch, it started to show up in Euribor rates in July of 2007, and since then the old cosy relationship with the ECB is but a distant memory. The Euribor was typically ECB + 0.1 to 0.2%, since the credit crunch it is more like ECB + 1%. So do the maths, lending out at ECB + 0.45% and buying in your ongoing money supply at ECB + 1%. That instantly tells you that the bank is actually supporting lenders by 0.55% on these loans! And this is the case on many loans, on average trackers were sold out at ECB + 1% so although they might not all be making an instant loss on margin they are creating operational loss because banks can’t run their companies for nothing, although at least it’s not as bad as negative margin.

The Sunday Business Post (article by David Clerkin) wrote this week about the ‘End of the Tracker’ and quite rightly it was pointed out that lending at negative margins is a reality for many lenders. PTsb and IIB have stopped offering tracker mortgages altogether while Ulsterbank and First Active have instead used the blunt hammer of rate to control this, their margin is ECB + 2.25% (huge margins on those loans!). It is therefore fair comment to accept that new tracker borrowers with Ulsterbank and First Active are funding the losses being created by the past customers who are on negative margin loans, I guess even in finance the ‘sins of the fathers will be visited upon thy sons’. Unfair? Perhaps, but this isn’t about morals, it’s about margins.

Rates in general now with most institutions are hovering around the 6% mark, this is a full 1.75% above the current ECB, and almost 0.8% above the Euribor, so the margin is actually above where it used to be in 2006 yet this is no solace as every lender is still carrying negative margin loans that likely take the goodness out of higher rates over all. In the Irish mortgage market c. 50-70% of home loans are on the variable rate, so the variable rate hikes must have produced a windfall of additional income for lenders as this is all generally happening on the older developed book, however, liquidity is still an issue and that is what drives the interbank prices, you need interbank money for new loans so while they are gaining ground on one hand they are losing it with another.

One thing nobody is looking at is how this all relates to securitized books, you see, when banks start to raise their margins the effect on borrowers is that they can get less, borrowers who get less have to pay less or not buy at all, this means that property prices have to fall to meet the amount they can/will spend, and this in turn means that the equity of properties in general is lower. What does this mean for a bank? Margin call is what it means, as the asset upon which the mortgage is secured reduces in value it means that the bank (back to that fractional reserve concept) must actually become more liquid in order to maintain the loan, when they securitized their debt (i.e. sold their book of mortgages) there are margin requirements the same as there is in a stock holders position when leveraged.

So are we seeing the end of the tracker? Perhaps the real question here is are we seeing the ‘end of the low margin tracker’ and on that point I think it is fair to say ‘yes, we are’.