cbpa.ie

13 Dec 2009
A complete ban or long delays on repossessions is going to be difficult for the banks who use their mortgages as collateral for their own borrowing, reports Jon Ihle

Last Wednesday, just in time for the budget, Moody’s issued a press release highlighting further deterioration in the quality of securities backed by Irish residential mortgages.

Delinquent loans – those overdue by three months or more – reached 2.9% of total loans in October, the agency said, double the amount from the year before. Borrowers more than a year behind on payments hit 0.7%, an increase of 300% over last October.

Why does Moody’s, a bond-rating agency, care about Irish mortgages? Because the banks who issue those mortgages use them as collateral for their own borrowing, which is done by wrapping the mortgages into bonds and either selling them or lodging them with a third party, such as the European Central Bank, in exchange for cash. So mortgages are crucial not just to a bank’s profits and capital, but for access to funding.

Although Moody’s acknowledged in the statement that Irish mortgage-backed bonds had not yet reported significant losses, the analysts worried that delays in foreclosure on bad loans – very common in repossession-averse Ireland – would only lead to higher losses later on. When that happens, the banks who depend on these bonds to raise money for new lending are going to face a funding problem as counterparties refuse to provide fresh cash.

So the banks are facing another conundrum: mortgage arrears are rising, but tough collection action is impractical due to social, political and economic reasons. Yet if they don’t curb loan-delinquency, the banks won’t be able to pledge mortgages for new money to fund lending. In fact, the various measure banks are using – and the government is insisting on – to keep delinquent borrowers from defaulting and losing their homes could ultimately cut off vital credit to the economy down the line.

Less than two weeks ago, Fergus Murphy, the chief executive of EBS, and his chief risk officer Fidelma Clarke met the Oireachtas Committee on Social and Family Affairs to discuss mortgage arrears and defaults and to consider ways banks, the government and borrowers could work together to address the problem.

Murphy and Clarke aren’t the only bankers interested in this issue. It’s an industry-wide concern. And government is waking up to the growing numbers of people – 35,000 at last count – who are missing payments on their mortgages and raising fears of a second-wave crisis in the banking sector.

The banks have so far tried to deal with rising arrears through borrower-friendly mechanisms, such as the Irish Banking Federation’s (IBF) protocol with the Money Advice and Budgeting Service (Mabs), which sets out a formal debt-recovery approach that seeks to avoid a more antagonistic method, such as repossession proceedings. But bankers are concerned that the clock is ticking on the various forbearance measures they use to keep from seizing loan security.

There is a recognition in the banking industry of the value of forbearance as a short- to medium-term measure to address difficulties some borrowers are having paying their mortgages, but in the long-term bankers say something else is required. Nobody has a definitive answer yet – although there are several strategies under consideration by lenders – but there is a realisation too that whatever replaces the current ad-hoc approach must avoid disrupting the banks’ funding, which depends on using mortgages as collateral for credit lines from institutional investors.

This is what Clarke had to say to the committee on the subject: “The way the system works is that institutions use loans as collateral for lines of credit for wholesale funding purposes and liquidity. Any damage to any contract as would be seen by an international investor, could have unattended negative consequences for the Irish banking system. If all covered bonds, securitisations or liquidity facilities with the ECB were no longer deemed to be of the quality people thought they were signing up for, they could be downgraded.”

The main concern emerging in the capital markets revolves around the uncertainties caused by forbearance measures such as interest-only periods, payment holidays and moratoriums on foreclosure. Bond investors want to be sure of their coupon payments; forbearance introduces some uncertainty. For example, last month when the IBF announced its members would extend delays on repossession action for an extra six months, a number of nervous UK bond analysts contacted the organisation with questions about how this would impact the funding side of the banks.

The ratings agencies who grade mortgage-backed bonds for their quality have picked up on this, too, as Moody’s recent attention shows. The ratings and the other bond analysts reflect a sensitivity in the bond and securities markets about the safety of any investment where the prospect for regular payments is uncertain.

Under normal market circumstances, the banks would be lending enough year-on-year to replace old loans as they matured. But because of the property crash, lending volumes are only about a quarter of what they were at the peak. That means as time goes on, more and more of the banks’ loan books are made up older loans, many of which were granted on overpriced properties during the boom. As unemployment, pay cuts and tax rises continue to wreak havoc on incomes, banks are naturally facing higher levels of arrears on these loans, leaving a smaller and smaller proportion of good loans to replace them.

According to Bloxham Stockbrokers, which was commissioned by EBS to research possible solutions to the arrears’ problem, there is a risk that concern about the potential reaction among bondholders could be used as an excuse for denying debate and evaluation. Bloxham seems to think alternative structures could be explored without spooking providers of long-term liquidity to the banking system and EBS brought several suggestions to the table, including the idea of a sector-wide refinancing plan for the hardest-hit borrowers and a more general mortgage insurance fund similar to the bank-deposit fund that traditionally has guaranteed savers’ money. Dolmen Stockbrokers analyst Oliver Gilvarry believes the government may ultimately have to set up a state mortgage bank to absorb troubled loans.

But both the banks and the government will have to tread carefully here, as the whole point of the bank-guarantee scheme and Nama is to assure funding lines into the Irish banking system so that normal credit is available to both consumers and business.

Momentum is gathering both in the financial industry and in government behind some form of mortgage rescue scheme. Since Green energy minister Eamon Ryan got the issue into the Programme for Government in October, it has become a significant issue on the political agenda. But the mechanics of any package – for borrowers or lenders – are far from being worked out. Ryan has put together an interdepartmental group made up of senior civil servants to assess option.

But capital markets and debt investors will have to be assured that any systemic solution to the mortgage arrears problem is sound, otherwise they could pull vital lines of credit from the Irish banks, which would prolong the recession and heap more misery upon cash-strapped mortgage borrowers.

Causes of rising mortgage arrears

» Unemployment: there is a direct relationship between the unemployment rate and mortgage arrears. With unemployment at 12.5% and due to climb in 2010, the outlook for arrears is getting worse. Even if the economy begins to grow towards the end of next year, bank analysts expect arrears to increase as job growth will lag GDP growth.

» Pay cuts: falling incomes mean the houses people bought at 2006 prices with 2006 wage expectations are a lot less affordable.

» Higher taxes: the crisis in the public finances has spilled over into household finances as new income and health levies have eaten into take-home pay.

» Non-mortgage debt: car loans, overdrafts, credit cards and personal loans add to the debt burden. While Central Bank figures show credit card balances, for instance, are declining, judgments on personal debt defaults are rising – and so are the amounts being sought.

» Falling house prices and negative equity: once the value of your house falls below the amount you owe on it, selling is no longer a viable option for getting out of debt trouble. The housing market is so sluggish that quick sales are all but impossible anyway, trapping even willing sellers.

Rules on repossession

Although repossession rates have been rising steadily over the two years of the recession so far, the gross numbers are still relatively low.

The reason for this is, firstly, the protocol agreed between the Irish Banking Federation and Mabs, which sets up a formal process for debt recovery designed to avoid foreclosure if possible, and delay it if not, and, secondly, the government code of conduct on mortgage-lending for banks under the guarantee scheme.

The IBF/Mabs protocol requires banks to adopt a partnership approach with Mabs when pursuing debts. It also lays out a five-step process leading to a formal payment plan for troubled borrowers which is then monitored and reviewed on a six-month basis. This approach meshes with the IBF’s own pledge to give six months’ grace on mortgage arrears on top of the statutory period.

The government’s code of conduct on mortgage lending says lenders must adopt flexible procedures for handling mortgage arrears and assist the borrower as far as possible with deferral of payments, extending term of mortgage, changing type of mortgage, or capitalising arrears and interest. They must also must wait at least six months (12 months for the two recapitalised banks, AIB and Bank of Ireland) from the time of arrears first arising before applying to the court to commence legal action for repossession.