25/5/2012: Mortgages in Arrears: Q1 2012

Latest mortgages arrears data from the CB of Ireland came in with a slight surprise that most of the media should have anticipated. During the launch of the annual report, the CBofI has pre-leaked some of the top-level figures for arrears, with media reports of 10.5% (or ca 80,000) of mortgages in arrears expected in Q1 2012 figures. Of course, given the usual tactic of first exaggerating, then underwhelming (presumably there's some psychological strategy working its magic somewhere here), it should have been expected that actual numbers - bad as they may be otherwise - will 'surprise' to the positive side relative to the leak-related expectations. It might have worked.

Alas, the end numbers - whether or not they are better than leaked out 'estimates' - are pretty dismal.

In Q1 2012, there were 764,138 mortgages outstanding amounting to €112,688.5 million. The latter number is €789 million down on Q4 2011 and€3.27 billion lower than Q1 2011 figure. So in 12 months, with foreclosures and restructuring factored in, Irish mortgagees were able to pay down just 2.82% of the mortgages outstanding. This is not exactly a massive rate of de-leveraging for heavily indebted households.

Of these, 77,630 mortgages were in arrears over 90 days (up 9.4% qoq and 56.5% yoy), with total outstanding amounts of €15,386 million (up 10% qoq and 60.3% yoy). Previous quarter-on-quarter increases were, respectively, 12.7% and 13.1%.

Repossessions in Q1 2012 stood at 961 up from 896 in Q4 2011.

Restructured mortgages:

• At the end of Q1 2012, there were 38,658 mortgages restructured, but not in arreas, up 5.06% qoq (against previous qoq rise of 1.16%) and up 5.44% yoy.
• In addition, there were 41.054 restructured mortgages that were in arrears, up 9.23% qoq against previous quarterly rise of 12.67%, and up 56.25% yoy.

Overall, defining at risk or defaulted mortgages as those mortgages that are currently in arrears (including restructured and in arrears), plus restructured but not in arrears mortgages and repossessions:

• At the end of Q1 2012 there were 117,249 at risk or defaulted mortgages, constituting 15.34% of all mortgages outstanding and amounting to €21.72 billion, or 19.27% of total volume of mortgages outstanding.
• Number of mortgages at risk or defaulted has increased 7.93% qoq in Q1 2012 as compared to a rise of 8.39% qoq in Q4 2011. Annual rise in Q1 2012 was 34.83%.
• Volume of mortgages at risk or defaulted has increased 8.09% qoq in Q1 2012 as compared to a rise of 9.8% qoq in Q4 2011, and there was an annual increase of 37.67%.
• In Q4 2011, mortgages that are at risk or defaulted constituted 14.13% of the total number of mortgages, while in Q1 2011 the proportion was 11.11%, and this rose to 15.34% in Q1 2012.

CHARTS:

Note: more on this next week.

14/4/2012: Sunday Times 8/4/2012 - Irish banks: The Crunch is Getting Crunchier

This is an unedited version of my Sunday Times article from 08/04/2012.

A year has lapsed since the much-lauded publication of the first set of the Prudential Capital Assessment Review results – the stress tests – by the Central Bank of Ireland.

Covering the four core banking institutions subject to the State Guarantee, AIB, Bank of Ireland, Irish Life & Permanent and EBS, the tests were designed to be definitive. Once recapitalized by the Exchequer in-line with the PCAR, Irish banks were supposed to be returned to health – recommencing lending to the SMEs and households, returning to normal funding markets around 2013, while continuing to shed loans to improve their balance sheets.

The PCAR made some major predictions with respect to the banking sector performance over 2011-2013 that were not subject to Nama-imposed losses and, as such, are expected to continue into the future. Chiefly, the Central Bank allowed in its stress scenario for the lifetime losses of €17.2 billion on the residential mortgages books of the four institutions. Only €9.5 billion of these were forecast to hit in 2011-2013. Owner-occupier mortgages losses provided for 2011-2013 amounted to just 60% of the above. Post-2013, it was envisaged that the Irish banking system will be able to fund remaining losses out of its own operations with no recourse to the Exchequer assistance.

Having published the PCARs, the Irish Government proceeded to take a break from the banking crisis. Throughout the second half of 2011 there was a noticeable ‘We’ve sorted the banks’ mood permeating the refined halls of power.

Fast-forward twelve months. Annual results for the four domestic State-guaranteed banks for 2011 are, put frankly, alarming. Set aside for the moment the entire media spin about ‘lower 2011 losses compared to 2010 records’. Once controlled for Nama effects on 2010 figures, the data shows acceleration, not an amelioration of the crisis on the mortgages side.

Excluding IBRC, total amount of owner occupied mortgages that remain outstanding on the books of AIB and EBS, Bank of Ireland and PTSB comes to €71.8 billion or 63% of all such loans held by the banks operating in Ireland. According to the Central Bank of Ireland, 12.3% of all mortgages held in Ireland were 90 days or more in arrears – some €13.9 billion. Of these, the four State-guaranteed banks had €7.7 billion owner-occupier mortgages in arrears, representing 10.8% of their combined holdings. Given banks’ provisions, by the end of 2012, the expected combined losses on mortgages, can add up to 60% of the total 2011-2013 losses allowed under PCAR.

And this is before we recognise the risks contained in a number of mortgages restructured in 2009-2010 that will come off the forbearance arrangements. Many are likely to go into arrears once again in 2012 and 2013. Recall that the entire Government strategy for dealing with mortgages defaults rests on the extend-and-pretend principle of delaying the recognition of the loss by giving borrowers some relief from repayments, e.g. via interest-only periods. This approach is patently not working.

Looking at EBS and AIB results tells much of the story behind the forbearance risk factor. In 2010, the two banks had 16,992 restructured residential mortgages amounting to €3.7 billion. Of these, residential mortgages amounting to €3 billion were interest-only. Of all forbearance mortgages, 92% were classed as performing. By 2011, AIB and EBS held 32,266 forbearance residential loans totalling €6.2 billion – almost double the levels of 2010. Total amounts of mortgages in forbearance arrangements that went into impairment or arrears over the course of 2011 jumped more than seven-fold. One third of the forbearance mortgages are now in arrears.

While Bank of Ireland data is not as comprehensive on 2010 and 2011 comparatives, current (end of 2011) levels of restructured mortgages run at €1.25 billion, of which €249 million were impaired or past-due more than 90 days. This means that €999 million worth of restructured mortgages remain at risk of future arrears. PTSB report for 2011 shows restructured mortgages rising from €1.7 billion in 2010 to €2.1 billion, with those in arrears rising three fold to €524 million.

Taken together with the aforementioned 2010-2011 dynamics, changes to the insolvency regime imply that mortgages losses can exceed Central Bank’s forecasts for 2011-2013 period. Of all four banks, Bank of Ireland remains the healthiest, and the likeliest candidate when it comes to mortgages-related losses. Of course, the banks can continue extending recognition of the losses past 2013, but that will mean no access to non-ECB funding at the time when ECB is increasingly concerned about extending more loans to Irish banks. Worse, with the first LTRO maturing in 2014, Irish banks will be staring into a new funding storm, when their healthier competitors all rush into the markets to fund their exits from LTRO.

Which, of course, means that the entire Government exercise of shoving taxpayers cash into insolvent institutions is unlikely to resolve the crisis. The core banks will continue nursing significant losses well into 2014-2015, with capital buffers remaining strained once potential losses are factored in. And this, in turn, will keep restrained their lending capacity.

Recent Central Bank estimates show that Irish economy will require up to €7 billion in SMEs lending and €9 billion in new mortgages in 2012-2014, while banks are to accelerate deleveraging of their loans books to meet lower loans to deposits standards. At the same time, there will be huge demand for Irish banks lending to the Exchequer, once some €28 billion of Government debt come to mature in 2013-2015. As we have seen with the Promissory Notes ‘deal’, so far, the Government has difficulty getting Irish banking system to buy into Government debt in appreciable amounts.

In other words, we are now staring at the basic conflict inherent in running a zombie banking system that continues to face massive losses on core assets. At the very best, the choice is: either the banks’ will lend to the real economy, while foregoing their support for Exchequer post-2013; or the state uses banking sector resources to cover its own bonds cliff, starving the real economy of credit. The first choice means at least a shot at growth, but the requirement for more EFSF/ESM borrowing (Bailout 2). The second choice means extending domestic recession into 2015.

It is also likely that we will see amplifying politicization of the banking system, with credit allocated to ‘connected’ enterprises and politically prioritized sectors, at the expense of overall economy. Reduced competition – from already below European average levels, judging by the ECB data – will continue to constrain credit supply.

The lesson to be learned from the 2011 full-year results for Irish banks is a simple, but painful one. Banks going through a combination of a severe asset bust and a massive debt overhang crisis are simply not going to survive in their current composition. We need to carry out a structured and orderly shutting down of the insolvent institutions, in particular, IBRC, EBS and PTSB. We also need to restructure AIB. At the same time, we should use the process of liquidation of the insolvent banks to incentivise emergence and development of new service providers.

This can be done by using assets base of the insolvent institution to attract new retail banking players into the market. This process can also involve enhancing the mutual and cooperative lenders models.

Given current funding difficulties, it is hard to imagine any significant uptick in lending in the Irish economy from the traditional banking platforms. Thus, we need to create a set of tax and regulatory incentives and enablers to support new types of lending, such as facilitated direct lending from investors to SMEs. Such models already exist outside Ireland and are gaining market shares around the world, in particular in advanced Asian economies.


The State Guaranteed banking model is, as the 2011 results show, firmly bust. Time to rethink the strategy is now.


Charts:

Box-out:

On the positive front, Q1 2012 Exchequer results released this week showed total tax take rising to the levels, not seen since 2009. Total tax revenues came in at €8,722 million, just below €8,792 in 2009. Year on year tax take is up 16.2%. But hold that vintage champagne in the fridge for a moment. Tax revenues for Q1 this year include reclassified USC charges which used to count as departmental receipts instead of tax revenues. The department of Finance does not provide estimates for how much of the income tax receipts is due to this change, but based on 2010 figures it is close to ca €525 mln. They also include €251 million of corporation tax receipts from 2011 that got credited into January 2012 figures. Netting these out, tax revenues are up 8.2% year on year – still appreciable amount, but down 7.6% on 2009. Compared to Q1 2008 – the first year of the crisis, we are still down in terms of tax receipts some 26.2%. Even at the impressive rate of growth, net of one-off changes, achieved in Q1 this year, it will take us through 2017-2018 before we get our tax take to 2007-2008 levels. As the Fianna Fail 2002 election posters used to say “A lot done. More to do.”

18/2/2012: Mortgage Arrears Q4 2011

The Central bank of Ireland has published Q4 2011 stats for mortgages arrears. And it's a trend-breaking one. Not quite touching my forecast from Q3 2011 data for 114,000 mortgages at risk (see definition below), but jaw-dropping 108,603 and counting mortgages that were written off since Q34 2010 when more detailed records were first published - closer to 102,200.

Now, let me run through the core details of the data.

The number of outstanding mortgages accounts has fallen from 786,745 in Q4 2010 to 768,917 in Q4 2011 - a drop of 2.19% or 17,247. In previous quarter, yoy decline in mortgages numbers was 1.94% or 15,325. The outstanding balance of mortgages has dropped from €116,683.25 mln in Q4 2010 to €113,477.28 mln in Q4 2011, so yoy Q4 2011 decrease in mortgages balances was 2.75%, against 2.55% decrease yoy in Q3 2011.

Of all mortgages, 17,825 mortgages were in arrears 91-180 days in Q4 2011, an increase of 7.39% qoq and 35.35% yoy. In Q3 2011, qoq increase in same type of mortgages was 5.6% and yoy increase was 33.62%. So the rate of mortgages in arrears 91-180 days category is accelerating in qoq and yoy terms. Mortgages in arrears 91-180 days have accounted for €3,273.8 mln in Q4 2011, which is 7.02% ahead of Q3 2011 and 34.37% ahead of Q4 2010. This means than we are now seeing smaller mortgages (in absolute size) on average entering into arrears. Amounts of arrears in this category rose 10.04% qoq and 13.61% yoy in Q4 2011 to €89.15 mln. This represents another acceleration from Q3 deterioration.

Mortgages in arrears over 180 days (usually seen as mortgages that are extremely highly unlikely to ever rise from the ashes) now stand at 53,086 up 14.5% qoq and 69.4% yoy. Yep, that right, in Q4 2010 there were just 31,338 mortgages in this category. Compare these dynamics to Q3 2011 when same category of mortgages in arrears rose 15.8% qoq and 65.32% yoy. So the dynamics are slightly shallower on qoq but are sharper yoy. Balance of all mortgages in arrears over 180 days now stands at €10,667.02mln - up 14.56% qoq and 72.34% yoy. The dynamics are very much the same as with the number of mortgages - qoq slightly slower growth, yoy accelerating growth.

So total number of mortgages over 90 days in arrears is now 70,911, up 12.61% qoq and 59.32% yoy. In Q3 2011 the quarterly rate of increase in these mortgages was 12.92% and yoy increase was 55.59%. Balance of all mortgages over 90 days in arrears is now €13,490.8mln - up 12.7% qoq and 61.62% yoy, compared to Q3 2011 increase of 14.14% qoq and 58.69% increase yoy. Total amount of arrears registered is €1,117.12mln which is 12.7% ahead of Q3 2011 and 61.62% higher than Q4 2010.

 The above means that a massive 12.29% of all mortgages accounts in Ireland are now in arrears 90 days or over by total volume of mortgages in arrears and 9.22% by the number of mortgages accounts in arrears.

Now, take all mortgages in arrears 90 days or over, add to them those mortgages that were restructured, but are currently not in arrears and the mortgages currently in the process of repossessions. Call this 'mortgages at risk of default, in default or defaulted' or for short, mortgages at risk. Chart below illustrates the stats:

 In Q4 2011 total number of mortgages 'at risk' stood at 108,603 - a number that represents 14.12% of all mortgages in the country. This represents an increase of 8.35% qoq (in q3 2011 qoq rate of increase was 4.44%) and 35.25% yoy.

As chart above shows, there is deterioration in mortgages performance even amidst those mortgages that have been restructured.  Total number of restructured mortgages in Q4 2011 was 74,378, which represents an increase of 6.66% qoq and 25.58% yoy. In Q3 2011 there was a qoq decrease of 0.15%. Of the restructured mortgages, 36,797 were not in arrears in Q4 2011 - an increase of 1.16% qoq and 4.52% yoy. However, while number of restructured mortgages not in arrears rose by 421 in Q4 2011 (qoq), the number of total restructured mortgages rose by 4,644. Which means that some 4,223 restructured mortgages went into new arrears in Q4 2011. Overall, percentage of mortgages that are restructured but are not in arrears has dropped from 59.44% in Q4 2010 to 49.47% in Q4 2011. Restructuring of mortgages now works for less than 50% of restructured mortgages - and that is only within 2 years of the beginning of the entire data on these!

Now, do keep in mind that restructuring was quite severe in many cases. See bottom of CBofI release on this here. And it doesn't seem to work all too well for just over 50% of those entering new temporary arrangements. So what will happen to these families when the 'temporary' arrangements expire?

20/12/2011: IMF IV Review of Ireland Programme

Fourth review of Ireland's programme under the Troika package is out and makes for some interesting reading. As usual, between-the-lines reading skills required. This is the first post on the report, focusing on housing markets and mortgages arrears.


The review is overall positive, complimentary and almost glowing. This warrants a number of caveats:

• The review is based on QNA data through H1 2011, so Q3 2011 fall-off in GDP and GNP are not factored in
• The review is based on the general data sources through mid-October, so November Exchequer results do not appear to have been factored in either

Aside from the strengths highlighted in the media, here are the critical points of the report. Mortgages arrears first, with subsequent posts dealing with other core issues covered.

"However, housing market and household debt indicators continue to deteriorate (Figure 2). With the fall in house prices accelerating in October to 15.1 percent on an annual basis, prices are down 45.4 percent from their peak in 2007. The rate of mortgage arrears by value continued to rise, reaching 10.8 percent in September 2011 (8.1 percent in terms of the number of mortgages), up from 6.6 percent in September 2010. With the share of longer-term arrears (greater than 180 days) continuing to rise, the authorities have deepened their analysis of the mortgage arrears problem (Box 1)."

Of interest here is the analysis the IMF refers to. Here is the summary (quoted from the IMF report, my comments in italics):

1. Aggregate mortgage arrears continue to rise sharply and in September 2011 reached 8.1 percent by the number of loans to owner-occupiers. 
2. To better understand the nature of mortgage distress, the CBI has utilized loan-by-loan data from end-2010 that were collected as part of the review of banks’ capital needs published at end-March 2011. [I am puzzled with this statement. CBI clearly stated at the time of PCARs that they did not analyse individual loans data for mortgages, but considered samples of mortgages. At a later date - in September 2011, CBI gave a presentation of a study based on the specific loans data, but this was also based on a sample of data, a large sample, but still a sample, not the entire population of the mortgages on the books of 4 banks.]
3. Of those households in arrears over 90 days, almost 40 percent have been in this position for a year or more. The average amount of arrears on these loans is €27,000, compared with an average outstanding balance of just over €200,000. [Please, keep in mind, per IMF, this is data through the end of 2010, so it is, by now - one year old!]
4. On top of arrears of 90 days or more, there are a significant number of borrowers who have restructured loans or delinquent payments of less than 90 days, bringing the total affected to about 20 percent of borrowers at end-2010. [These figures - 20% of borrowers either in arrears or restructured, or as I call these 'at risk' - is much greater than reported by the CBI in their quarterly report, showing for Q3 2011 that only 12.96% of all mortgages outstanding were either in arrears, restructured or repossessed]
5. Arrears tend to be highest in relation to buy-tolet properties and first-time buyers, as these purchasers took on large debts owing to high house prices during 2005–08. 
6. Negative equity is extensive. It is estimated that 36 percent of owner-occupier households with mortgages in these institutions are in negative equity (at September 2011 house prices). [This, of course, is now higher again, as October and November price declines totalled 3.71%] 
7. For owner-occupier loans taken between 2005 and 2008 (half of outstanding loans), 48 percent of properties are in negative equity, while 52 percent of buy-to-let loans are in negative equity. [The two numbers are remarkably close to each other.]
8. Negative equity does not imply arrears. Despite widespread negative equity amongst borrowers, the vast majority of negative equity borrowers, over 90 percent, were not in arrears at end-2010. 
9. About half of owner-occupier borrowers in arrears at end-2010 had positive equity, with around 38 percent having at least 20 percent equity in their homes. The average negative equity of owner-occupiers without arrears is €68,000, modestly smaller than the average of €84,000 for owner-occupiers in arrears. [Which, of course, means that these arrears can be dealt with at no loss to the banks via a combination of restructuring, equity stakes assumption by the banks and/or foreclosures. In the end, this also means that significantly less resources will be needed to help those who are in negative equity and at risk of arrears - i.e. those who are subject to punitive provisions of our personal bankruptcy code]
10. Buy-to-let properties. Of the total loan book analyzed, 22 percent (€20 billion out of €87 billion), relates to buy-to-let property debt. The average outstanding balance for the 52 percent of buy-to-let properties in negative equity is about €320,000 and the average negative equity is just over €100,000.
11. Within the four institutions covered by the Financial Measures Program, 33 percent of buy-to-let borrowers also have an owner-occupier mortgage with the same lender.  

Some very interesting observations from the IMF summary of the CBI evidence on drivers of arrears: 

• Studies, including from other countries, point to unemployment, debt service, and loan-to-value ratios as key determinants for arrears, although geography and loan vintage are also important, as are rental and payment rates for buy-to-let properties. 
• Data availability can be an issue, however, especially for current income. 
• An alternative approach developed a transition matrix for predicting mortgage arrears based on loan vintage, borrower type, interest rate type, and region.

There's no summary of the transition matrix provided.

Here are three more interesting charts relating to the Irish property market:

18/11/2011: Mortgages Arrears for Q3 2011

Data for Irish Mortgages defaults for Q3 2011 was released today by the Central Bank and is already causing some commotions. That is because by the broader metric I deployed recently, including in last week's Sunday Times article (see here), we are now beyond 100K number when it comes to mortgages at risk.

let me un through the figures. Note that the CB has changed methodology for reporting back in Q3 2010, expanding reporting. So I estimated some of the sub-series back to Q3 2009 when the narrower reporting was first introduced. Thus, caution should be applied to taking Q3 2009-Q2 2010 data. Also, note that 2011 figure - corresponding to Q4 2011 - is a forecast based on mortgages arrears dynamics by each subcategory of mortgages.

• In Q3 2011 there were 773,420 mortgages outstanding in Ireland a decline of 3,901 on Q2 2011 (-0.5% qoq) and 15,325 yoy (-1.94%). This represents a drop of 2.7% or 21,189 mortgages on Q3 2009.
• The outstanding value of mortgages has declined €676,166 or 0.59% qoq to €114.41bn down from €115.09bn in Q2 2011 and €117.40bn in Q3 2010. Note that in Q2 2011 Irish household deposits were €87.00bn which implies that Mortgages to Deposits ratio in Ireland is at 131.5% well ahead of the LTDs mandated for the irish banks for all loans at 125.5%.

Of the above mortgages:

• In Q3 2011 there were 62,970 mortgages in arrears 91 days and over with the balance of €12.37bn. This represents an increase of 7,207 mortgages qoq (+12.92%) and 22,498 mortgages yoy (+55.59%). Compared to Q3 2009, the number of mortgages in this category is estimated to have risen by 36,699 mortgages or 139.7%. In terms of value of the mortgages in arrears, the value rose 14.13% qoq and 58.7% yoy. I mentioned in the previous articles on the subject that we can expect faster increases in mortgages in arrears values, rather than numbers as arrears primarily hit most those households that tended to borrow more in the years around the peak of the property markets.
• Repossessions also rose from 809 in Q2 2011 to 884 in Q3 2011 (+75 or 9.27% qoq). Repossessions are now up 69.7% yoy (+363) and are estimated to have risen 501% on Q3 2009 (+737).
• Restructured loans that are no in arrears are down from 39,395 in Q2 2011 (value of these loans was €6.66bn) to 36,376 (€5.93bn) - a decline of 3,019 mortgages qoq or 7.7%. Year on year these mortgages are up 9.7% or 3,212.

Based on the above we can define mortgages at risk and defaulted to include all mortgages that are currently in arrears, all mortgages that are restructured, but are not in arrears and mortgages that went through the repossessions. 

• In Q3 2011 total mortgages at risk or defaulted stood at 100,230 with the total value of €18.3bn, up 4,263 mortgages (+4.4%) qoq and 26,073 mortgages (+35.2%) on Q3 2010. Since Q3 2009 these mortgages rose in number some estimated 125.9%. In value, mortgages at risk or defaulted have risen €803mln qoq (+4.6%) and €10.5bn yoy (+134.7%).

As chart above summarizes, percentage of mortgages at risk relative to overall number of mortgages has risen in Q3 2011 to 12.96% from 12.35% in Q2 2011. The value of mortgages at risk has increased from 15.2% of all mortgages value to 15.99%.

It is worth noting that Q3 dynamics represent a marked slowdown on the rates of increases in mortgages at risk in previous quarters. This decrease is accounted for as follows:

• Total number of mortgages outstanding paydown slowed from -0.65% in Q2 2011 relative to Q1 2011 to -0.50% in Q3 2011 relative to Q2 2011. This means that the base decline was slower, pushing down the percentage change in the relative share of mortgages at risk.
• Number of mortgages in arrears rose +12.9% in Q2 2011 relative to Q1 2011 and this rate was +12.4% in Q3 2011 relative to Q2 2011 - hardly a marked slowdown here.
• Number of mortgages restructured but not in arrears rose +7.5% in Q2 2011 relative to Q1 2011 and declined -7.7% in Q3 2011 relative to Q2 2011 - this is the core driver of mortgages at risk growth slowdown. Unfortunately we do not know if this decline was driven by these mortgages exiting the restructuring arrangement by going into arrears, or returning back to performing mortgages (for how long can these be expected to remain there is another question), or going into new renegotiations for further restructuring.

16/11/2011: Irish Mortgages Crisis

Unedited version of my latest Sunday Times article (November 13, 2011).

Per latest data available to us – at the end of June 2011, there were 777,321 outstanding mortgages in Ireland. Of these, 55,763 mortgages were in arrears more than 90 days, up 53% on same period a year ago. In addition, 39,395 mortgages were ‘restructured’ but are currently ‘performing’ – in other words, paying at least some interest. Adding together all mortgages in arrears, repossessions, plus those that were restructured but are not in arrears yet, 95,967 mortgages (12.3% of the total) amounting to €17.5 billion (or 15.2% of the total outstanding mortgages amount) are currently at risk of default, defaulting or have defaulted.

Given the trend in these developments to-date, we can expect that by the end of 2011 there will be some 114,000 mortgages in distress in Ireland. By the end of 2012 this number can rise to over 161,000 or some 21% of the total mortgages pool in the country.

This is a staggeringly high number. When considered in the light of demographic distribution and vintages, 21% of all mortgages that are likely to be in arrears around the end of 2012-the beginning of 2013 will account for up to 30% of the total value of mortgages outstanding.

Mortgages at risk of default

Source: Central Bank of Ireland and author own calculations

This is a simple corollary from the fact that mortgages crisis is now impacting most severely families in their 30s and 40s, with more recent and, thus, larger mortgages signed around the peak of the property bubble. These households are facing three pressures in today’s environment.

Firstly, they are experiencing above-average unemployment and income pressures. Per Quarterly National Household Survey, in Q2 2011, unemployment rate for persons aged 25-34 was 16.5% and unemployment rate for those in age group of 35-44 was 12.4, both well ahead of the 8.95% average unemployment rate for older households. By virtue of being more concentrated in the middle class earning categories, they are also facing higher tax burdens than their lower-earning younger and more asset-rich older counterparts.

Secondly, they are facing higher costs of living, further depressing their capacity to repay these mortgages. More likely to live on the outer margins of commuter belts, our middle-income earners are facing more expensive cost of commute, courtesy of higher energy prices, high taxes associated with car ownership and the lack of viable public transport alternatives. In September this year, prices of petrol were 15.4% above their levels a year ago. Inflation in diesel prices is running at 14.8%. Cost of road transport increased 5% in a year through September, and bus fares are up 10.8% These households are also facing higher costs associated with raising children. Since the time these families bought their houses (e.g. 2005-2007), primary and secondary education costs went up 21-22%, and third level education costs rose 32%. On average, larger families require greater health spending, the cost of which rose 3.4% year on year in September and now stands at 16% above 2005-2007 levels. The three categories of costs described above comprise ca 19% of the total household budget for an average Irish household and above that for a mid-aged household with children.

Thirdly, as their disposable incomes shrink and mortgage costs rise (mortgages-related interest costs are up 17.2 year on year and 11% on 2006), the very same households that are hardest hit by the crisis are also missing vital years for generating savings for their old age pensions provisions and most active years for entrepreneurship and investment.

In short, courtesy of the crisis and the Government policy responses to it to-date, Ireland already has a ‘lost generation’ – the most economically, socially and culturally productive one. And this generation is now at the forefront of the largest homemade crisis we are facing – the crisis of mortgages defaults and personal bankruptcies.

Against this backdrop, the forthcoming Personal Bankruptcies Bill should form a cornerstone of the Government’s policy.

This week, the media reported some of the specifics of the forthcoming legislation, which include two crucial details: the 3-years release period for personal bankruptcy and the non-recourse nature of the arrangement. Under the former, the current period of bankruptcy will be cut from 12 years to 3 years, while under the latter, the new bankruptcy law will limit the extent of the household liability to the current value of the property underlying the mortgage. It is uncertain, at this stage, what claims, if any, can be levied against personal and family savings and other assets.

The provisions, as reported in the media, appear to be well-balanced for a normal bankruptcy reform, but remain excessively harsh for the legislation designed to tackle an acute crisis. Here’s what is needed.

A conditional bankruptcy release period for mortgages taken in the period of 2003-2008 should be set at 12 months subject to satisfactory completion of court-set conditions. Full release should apply after 3 years. There should be no restriction on companies directorships for those in the process, so as not to reduce entrepreneurship and small business ownership.

The lien against the personal income and assets should be designed as follows. No more than 25-35% of the after-tax disposable income can be diverted to the repayment of the mortgage, to allow for private sector rent payments. No more than 30% of the household assets below €25,000 can be used to repay the residual mortgage post-foreclosure. The amount can rise to 50% for assets valued between €25,001 to €50,000 and to the maximum of 70% for assets valued over €50,000. This will minimize losses to the banks, disincentivise strategic defaults and reduce moral hazard, while still allowing families to retain safety cushion of savings to offset the risks of sudden income losses or illness.

Banks objections to relaxing bankruptcy laws, raised this week, is that the new law will trigger a significant demand for capital as losses due to non-recourse clauses will be borne by the lenders. This is simply not true.

Firstly, with some claim on family assets in place, bankruptcy process will still be used only in the cases of extreme financial distress. A combination of a limited liability applying to some family assets and a 3-year repayment period will create both a disincentive to abuse the system and a cushion of burden sharing, reducing the end losses to the banks.  Savings on interest payments supports and legal costs will further reduce taxpayers potential exposure.

Secondly, the stress tests carried out earlier this year were supposed to provide ample supports for the banks against mortgages defaults. Blackrock estimates of the worst-case scenario losses on Irish mortgages over the life-time of the loans amount to €16.3 billion split between €10.2 billion owner-occupier and €6.1 billion for buy-to-let borrowers. Central Bank of Ireland assumed 3-year losses amount to the total of €9 billion. Reformed bankruptcy law is unlikely to raise the Blackrock estimates for life-time losses, but is likely to push forward the defaults that would have occurred outside the Central Bank-assumed time frame of 2011-2013. In other words, unless the stress tests performed were not rigorous enough, or the Central Bank assumptions on 2011-2013 defaults were not realistic, capital supplied to the banks post PCARs already incorporates expected losses.

Either way, there is neither an economic nor moral justification for using bankruptcy laws as a tool for locking borrowers in servitude to the lender. During the boom, the Irish state and banks have acted recklessly toward the very same borrowers. The duty of care to protect consumers and investors was abandoned by the previous Financial Regulator, the banks, public authorities in charge of regulating property markets and, ultimately, the Governments that presided over the system, which put full burden of risks associated with property purchases on the buyers. Remedying this requires giving distressed borrowers some powers to compel burden sharing vis-à-vis the banks.

Box-out:

This week, the entire world was consumed with the saga of Silvio Berlusconi’s resignation. Played out across the media – from print to facebook – the story of the ‘departing villain’ was almost comical, were it not tragic in the end. Tragic not so much in the inevitable rise in Italian bond yields, but in the sense of denial of reality that the media and political circus that surrounded Mr Berlusconi’s departure from power. Italy is a Leviathanian version of the zombie economies of Greece and Portugal. Between 1990 and 2010, Italian real GDP grew at an average rate of less than 1% per annum, less than half the rate of Spain, Greece and Portugal. Italian growth in exports of goods and services, over the same period was roughly one half of the rate of growth in Spain and 1.5 times lower than that for Greece and Portugal. Italy’s unemployment rate averaged just below that for other 3 countries. Italian fiscal deficits, at an average of 5.2% per annum, were greater than those of Portugal (3.3%) and Spain (3.1%), but lower than those in Greece (7.8%). Ditto for structural deficits. These are hardly attributable to Mr Berlusconi alone and are unlikely to be altered dramatically by his successors. While it is easy to point the finger at the internationally disliked leader, the truth remains the same – with or without Berlusconi, Italy is a nation with a dysfunctional economy.

16/10/2011: Negative Equity and Debt Restructuring

This is unedited version of my article in Irish Mail on Sunday (October 16):

This week, we finally learned the official figure for what it would cost to address one of the biggest problems facing this country.

According to the Keane Report - or the Inter-Departmental Mortgage Arrears Working Group Report - writing off negative equity for all Irish mortgages will cost “in the region of €14 billion”. Doing the same just for mortgages taken out between 2006 and 2008 would require some €10 billion.

These numbers are truly staggering, not because of they are so high, but the opposite: because they contrast the State’s unwillingness to help ordinary Irish families caught in the gravest economic crisis we have ever faced with the relatively low cost it would take to do so.

Let me explain.

Firstly, the figure of €14billion itself is a gross overestimate of the true cost of dealing with negative equity. This is because this figure appears to include not just owner-occupiers but also people with buy-to-let loans in his sums.

Secondly, the real amount required to get rid of negative equity where it matters most – for ordinary first-time buyers - is lower still. For example the scheme could be set up in a sliding scale based on value of house compared to average house prices. This would reduce the final cost of the scheme and help those who need it most - moderate income and younger-age households.

In other words, a realistic and effective debt cancellation scheme can be priced at closer to €6-8 billion instead of the €10-14 billion estimated in the report.

In its simplest form it would work like this: say you bought a house for €300,000, with a mortgage of €250,000, and it is now worth just €150,000. The government, or the bank using the recapitalisation funds they have received, would pay off the €100,000 difference.

By doing this your monthly payments would be less, and you could now sell up to pay off the debt or move house, and in the meantime the extra money you have to spend could go back into the economy.

The scheme could even be set up so that write downs would be smaller on houses with above average values so as to prioritise young and low-earning families. In the above example, if the house was purchased for, say €500,000 and is no worth half that amount, the bank would write-off, say, €200,000, leaving the household with residual negative equity of €50,000. This would still improve affordability, but will also cut the overall cost of the scheme.

So why did the report completely rule this out? It was very clear on this topic: “a blanket debt or negative equity forgiveness scheme would not be an effective use of State resources and would not solve the problem,’ it says.

But it goes further, claiming that “the primary driver of mortgage arrears is affordability, not negative equity. While a write-down of negative equity would help mortgage holders in arrears, in many cases it is unlikely to create an affordable mortgage”.

I believe this rejection betrays the overall lack of understanding by our senior civil service officials of the problems we face.

The Irish economy is suffering primarily from three things. The biggest is excessive household debt.

While this would be bad enough, it is exacerbated by two additional factors. The cost of the government’s policy of bailing out our banks, which is being paid for with higher taxes on ordinary working households. And the rising cost of mortgagesdue to aggressive drive by Irish banks to improve their profit margins at the expense of the most vulnerable mortgage holders - those with adjustable rate mortgages who cannot protest. Both contribute to mortgages defaults.

By saying that cancelling negative equity will not be a magic bullet solution to the problem of the defaulting mortgages, the report is simply referencing the smaller problem of mortgage affordability to evade addressing the effects of the much larger crisis facing us.

Negative equity is the single most egregious and damaging segment of the debt problem faced by Irish families.

It is the most egregious because it was caused not by reckless borrowing, but by reckless lending by the banks - actively supported at the time by the Irish Government.

The problem of negative equity is the result of state policy in the first place, and it is up to the state to rectify it.

And contrary to the assertion of the report and Government claims, we do have the funds to deal with negative equity. Freeing these funds to help ordinary families is just a matter of priorities for the Government and the state-controlled banks.

To-date, the Irish Government has injected €63 billion worth of taxpayers’ funds into Irish banks.

Various other commitments, and the banks’ own state-guaranteed borrowings from the Central Bank bring the total cost of keeping our banking sector working to a gross figure of about €125 billion.

Yet while they have saved the banks, all of these measures have acted to increase, rather than reduce, the level of debt being carried by the households of this country.

In addition to their own household borrowings like credit cards or credit union loans, mortgages-holders are now in effect liable both for banks’ debts and their losses on property development and investment.

In contrast, even at Keane’s upper estimates, the cost of paying off negative equity liabilities for household mortgages would require just one ninth of the funds we have made available to the banks.

Last July the Government injected some €19 billion worth of capital into Irish banks. This capital is provided to cover potential future losses on loans. This included €9.5 billion, which was the estimated worst-case scenario for losses on residential mortgages. It also included another €8.9 billion to cover remaining expected losses on commercial property.

If some of these funds were used instead to restructure negative equity mortgages on family homes it would do two things for the banks.

Firstly, because the banks would now have securities as valuable as the mortgages they have given, a mortgage default would not be such a threat in terms of losses. This then reduces the bank’s need for further capital.

Secondly, the writedown of the mortgages will prevent defaults in the first place, at least for some families.

This implies that prioritising how that money is used to help mortgages rather than losses on commercial property loans, will be a more effective way to improve their balance sheets.

And it’s not like the money is not there. Our banking system currently has surplus capital available. Since August this year, our ‘pillar’ banks, instead of helping the struggling households, have used taxpayers funds to quietly buy high-yield Irish Government bonds.

Some €3 billion worth of Government debt was bought by the banks using our money in order to beef up their own profits. Don’t tell us that the banks cannot afford negative equity restructuring when they clearly can afford buying junk bonds in the markets to book higher profits.

And the farcical nature of Irish government responses to the mortgages and personal debt crises continues.

The Keane report ruled out increasing tax relief on mortgage interest finance for first time buyers during the boom, 2004-2008. Why? Because the estimated cost each year would have been €120 million.

Yet, come November, the very same state will pay in full the unguaranteed and unsecured €737 million debt of the bankrupt zombie Anglo. Between Anglo and INBS, the state has also committed to repaying in full €2.4 billion more of similar bonds in 2012.

Instead of repaying un-guaranteed bondholders, the Government should use the funds available to the banks to cancel commercial property-related losses on banks books, freeing the capital injected for this purpose in July this year to restructure negative equity mortgages.

Earlier this year, I proposed that Irish Government impose an obligatory restructuring of all mortgages to achieve a maximum Loan-to-Value ratio of 110%.

This would reduce the problem of ‘moral hazard’ because households with greater borrowings will still be left with more debt than their more prudent counterparts. But it would also reduce the overall debt burden faced by our families, freeing them to return to active economic and social life, helping to restart the Irish economy. Based on the Keane Report’s own estimates of the cost of such a scheme we have more than enough money to make this choice.

All we need is the will - the will to free hundreds of thousands of Irish families from the negative equity jail that was built by reckless banks which lent the money with explicit approval of the previous Governments.

13/10/2011: Mortgages report - offensive & ineffective failure

Inter-Departmental Mortgage Arrears Working Group report, released yesterday is a truly abysmal document that neither delivers meaningful solutions to the problems it sets out to tackle, nor provides any really new solutions that were not already discussed in the Cooney report of 2010.

Let’s consider the ‘solutions’ advanced by the Report. Let us also juxtapose these ‘new’ proposals against the existent means for alleviating stress on households finances arising from the excess debt or lack of debt affordability, which are enumerated in the Report.

An excellent additional analysis of the report is provided by Namawinelake blog (here) and I am broadly in agreement with its author conclusions.

Note that, unlike the Report authors, I view two problems as separate, but related.

The problem of debt overhang is the problem of too much debt carried by the household preventing this household from accumulating pensions and precautionary savings, reducing its ability to provide insurance cover for catastrophic losses of income due to illness or unemployment, restricting reasonable investments in household members’ education and skills (children education, but also adult education – both of which require outlays from the household finances), extending care for incapacitated relatives, saving for potential investment in family business etc.

The problem of debt servicing is the problem whereby debt to income ratios rise to levels whereby debt financing becomes unbearable for the household. This can arise due to any of the following factors or a combination of several factors, such as: loss of income due to unemployment, loss of income due to wage cutbacks or decline in bonuses and commissions, loss of income due to higher taxation burden, loss of income due to illness, increase in expenses due to birth of a new child or arousal of new dependency from, for example, ill close relative, etc.

What solutions does the Report propose?

Solution 1: Forbearance.

This is not a new solution and the Report states that as a part of the “wait and see approach” already adopted by the Government, they are not always appropriate. In other words, one of the solutions presented by the Report is already deemed by the very same Report not to be sufficient. Forbearance is ‘extend and pretend’ type of a ‘solution’ that temporarily reduces the mortgage burden in the hope of short-term return to affordability. It does not deal with the problem of excessive debt carried by the household. Instead it actually exacerbates the problem by accumulating retained interest and extending over time the period of principal repayment, as in the case of forbearance households are mostly excluded from counting their repayments against the principal. It is a very short-term measure (extending the period of forbearance will have a compounded effect of increasing the overall debt level of the household).

As an extension of the Forbearance scheme, the Group notes that Deferred Interest Scheme has already been introduced in the state. The Group fails to provide any meaningful assessment of the scheme claiming that it is too new to allow for such assessment. In reality, deferring interest repayment implies accumulation of higher debt over time through compounding and roll up of interest into the future and has exactly the same shortcomings as the general forbearance scheme discussed above.

Another major issue with both schemes is that they do not alter life-time affordability of the mortgage, which is reflected in their temporary nature. Temporary nature of these schemes, in turn, implies that households entering into these arrangements cannot be expected to meaningfully engage in the economy as savers and consumers. They are suspended in a debt hell limbo for the duration of the scheme and face uncertain future as to their ability to return to normal functioning.

What we need is: conversion of the existent mortgages pool into non-recourse mortgages only for the amount of negative equity. To deliver this, mortgages outstanding should be seen as split between those covering 90% of the current value of the asset (10% cushion provided for future decreases in valuations) and the residual. The 90% current value of the mortgages is recoursed against the value of the home. The excess amount of mortgages outstanding is non-recourse.

Solution 2: Mortgage Interest Supplement.

A measure that provides cash flow support to households that are on public assistance due to unemployment or disability. The Group identifies this scheme as in the need of alteration and suggests that mortgage-to-rent (MTR)schemes (see below) can be used to move long-term recipients of MIS off the temporary measure. This implicitly suggests that the Group sees MTRs as a long-term default option.

Amazingly, the Group provides un-backed and un-specified estimates for writing down the entire pool of negative equity or writing down the most severe negative equity cases (2006-2008 mortgage originations) at €14 billion and €10 billion. The Group states in a blanket fashion that “scheme would not be an effective use of State resources and would not solve the problem”.

Worse than that, the Group has managed to produce not a single meaningful or even token debt relief measures. The Group “examined the proposal to increase mortgage interest relief to 30% for First Time Buyers in 2004-08 but it was considered that this change should not be recommended. The proposal would give increased relief in an indiscriminate manner as it would give benefits to all who took out mortgages in the relevant years, regardless of their economic circumstances. The proposal would cost the Exchequer approximately €120m in a full year and it would not be appropriately targeted at those who need the support.”

This is an extraordinarily bizarre statement. The Group on objective – as stated – included to consider measures “to reduce the drag on the economy from a significant cohort of over-indebted people whose spending is constrained by mortgage debt obligations.” And yet, the Group passed on the only solution they considered to deliver some relief here. Reducing effective cost of mortgages interest financing would have improved significantly many, more stretched, households cash flows, especially for those early into the process of mortgages repayment. In other words, it would have had a compounded effect of reducing interest payments when these payments are the largest proportion of the mortgage itself, potentially improving repayment of capital. The scheme would have had no adverse impact on moral hazard and would have been politically acceptable as a partial compensation for tax increases suffered by the very same households. It is cheap (could be financed for 6 years out of just one unsecured unguaranteed bond repayment by Anglo due this November at €737 million) and effective in reducing the most egregious share of the debt incurred – interest charges. It also could have served as a buffer for future interest rate increases, thus effectively helping more, in the longer term, those on the adjustable rate mortgages who are currently subsidising tracker mortgage holders.

The fact that these considerations were omitted by the Group shows that the Group was not fit for purpose – its members had no sufficient financial insight into the debt issues and mortgages finance to make any reasonable assessment of the situation.

What we need is: extended Interest Tax Relief scheme covering all first-time mortgages for principal residences issued in 2004-2008 with extension for 5 more years at 50% of the total interest paid. The cost of this scheme should be in the neighbourhood of €250 million per annum and it should be financed through writedowns of unsecured bondholders in Irish banks.

Solution 3: Introduce New Bankruptcy Legislation.

This is hardly a new solution and as such the Group was expected to provide more robust guidance as to the terms of reform of existent bankruptcy laws. The Group correctly identifies one major part of the problem with existent legislation as: “Given the full recourse nature of mortgages there is no current insolvency option for many mortgage holders who are in difficult or unsustainable mortgages – they could face permanent bankruptcy”. In other words, the problem is in the full recourse nature of the mortgages and the long-term or permanent nature of the bankruptcy.

The Group comprehensively fails to address both sides of the problem in its recommendations.

With respect to the length of the bankruptcy status and associated claim on the debtor income, the group states:

“The group understands that the automatic bankruptcy discharge period under the judicial process could be set as low as 3 years”. In other words, the Group fails to make any proposal as to the length of bankruptcy period. It simply defaults to 3 years as the only option because it is what it being discussed elsewhere.

What we need is a two-tier approach to the bankruptcy reforms:

Tier 1: Emergency level legislation covering mortgages taken prior to 2009 which will have automatic release after 12 months of compliance with court-ordered repayment schedule and zero recourse thereafter. In the case of non-compliance with repayments, the bankruptcy period can be extended to 3 years and then to 5 years. There should be no recourse on assets outside the mortgage, but access to bankruptcy should be granted only to those unable to pay their mortgages through current income as supplemented by a reasonable drawdown of existent assets. For example, a household savings should not fall below 20% of annual pre-tax income so as not to deplete insurance buffer against household loss of income in the future due to illness or unemployment. The households can be required to sell any other property assets they hold if this releases funds to aid repayment of mortgage. The legislation should apply only to primary residences and can be staggered to reduce its applicability to ‘trophy’ homes, so that only part of the family home mortgage under, say, the threshold of €500,000 can be covered by such process.

Tier 2: Long term legislation covering all mortgages taken since 2009 that will include, 3 year term for automatic release, recourse against other assets and restriction on mortgages issued in the state to non-recourse mortgages only, for all new mortgages going forward.

Instead of robust proposal for reforming the bankruptcy law, the Group report produces extraordinarily woolly wish list of non-judicial process proposals for dealing with defaults.

This includes a non-judicial settlement process that is not backed by any compulsion on behalf of the lender to engage in such a process or to deliver any specific targeted means for reducing overall debt burden of the household. Instead of specifically calling for lenders being required to write down some minimum share of debt, or some debt linked to, say, income and affordability metrics, the proposal simply waffles on about “mortgage lenders will need to make allowance within their mortgage solutions, on a case by case basis, to make some funds available to facilitate unsecured debt settlement”.

And there’s more: “Uncertainty exists as to how the courts will deal with an income earning bankrupt – it could require them to make payments to the creditors beyond the discharge period.” Now, this begs a question: why on earth did we need the Group report if all it can tell us is that the courts will decide? And how can the report make a claim that this entire strand of bankruptcy resolution has any whatsoever validity as a tool for alleviating currently draconian bankruptcy conditions if it is left up to the courts to decide?

Another ‘measure’ proposed by the Group is Debt Relief Order (DRO), which will “allow persons with “no assets – no income” to fully write-off unsecured debt within a short period of time”. How? No information is given. How long is the ‘short period of time’? Unspecified. But the Group refers to the UK DRO equivalent of €17,000. So, let’s summarize this ‘measure’ – under DRO, once you are bled dry, the Government will facilitate (legislatively, presumably) an up to €17,000 writedown of your debt alongside the loss of your home, your assets and your income, while levelling you with the very same bankruptcy burdens as above. The whole mechanism would constitute a reasonable measure only in a lunatic asylum.

Solution 4: Mortgage to Rent Scheme (MTR)

This implies converting existent mortgage to a lease with the mortgage holder losing all future claim on equity in the property.

The problem is that, as the Group states: “The group recommends the introduction of two mortgage to rent (MTR) schemes aimed at those people who would qualify for social housing if they lost their home and where their house is appropriate to social housing”

So explicitly, there is no cover for anyone who does not qualify for social housing. In brief – you are either broke or you are not covered. Which automatically means the scheme does no work to alleviate constraints on future savings and investment, pensions provision, education investment etc.

“The schemes should be subject to an initial review after 12 months and a value for money review after 24 months” In other words, the scheme is non-permanent and cannot be considered a solution to the long term problem. It is simply ‘extend and pretend’ type of a solution with the worst possible outcome – all future uncertainty is loaded onto the mortgage holders.

A person entering the scheme, in effect, surrenders any legal claim on the asset and any leverage for dealing with the default-related loss once he/she signs the papers as the state can simply deny the benefit in 12 months or later.

Worse than that, “There may be a mortgage shortfall that will still need to be dealt with” in other words, the negative equity component of the mortgage remains unaddressed, i.e. it remains the liability of the original borrower. This provision is simply mad, given the Group set out to resolve the problem of defaulting mortgages.

Solution 5: Trade-down Mortgages (TDM)

Trade down mortgages is in itself not a solution to the debt crisis, but an affront to those currently struggling under the weight of debt. It ignores the fact that majority of those heavily indebted (relative to their incomes) are younger families who bought their first homes – small, usually out of town, lower-end-of-the-market dwellings trading down from which is an equivalent to telling them to pitch a tent in a bog and call it a “more modest home”.

Worse, the proposal admits that the scheme would increase, not decrease, the overall debt burden carried by the mortgage holder as LTVs are going to rise and not just by the amount of negative equity carried over, but also by the closing costs which the Group has no grace to advocate forgiveness for. Negative equity is then crystallized into real debt. In medical terms, it is like advocating cutting both limbs for a patient with one gangrened arm!

The Group’s brain-dead - and I cannot call it any other – ‘logic’ is such that they actually state: “While the increased LTV is relevant, so long at the mortgage holder can afford the new mortgage and the ratio is not so high as to be a disincentive to the mortgage holder, it is a secondary factor”. In other words, higher debt is a secondary issue from the Group’s point of view, despite the fact that it clearly contradicts their own objective of reducing the negative debt effects on the economy.

What we need here is an explicit cap on carry over of negative equity under TDM scheme. In other words, cap the amount of negative equity to be carried to new ‘smaller’ dwelling mortgage to not exceed 10-20% of the total new loan, with additional ceiling on combined new mortgage not to exceed 110% of the current value of the new property bought. This will provide both an incentive to engage in trade down for the household and a finite cap on debt limits. It will also reduce future default risk for lenders.

Solution 6: Split Mortgages (SM)

Split mortgages proposal allowing the household to split existent mortgage into ‘affordable’ part to be subject to continued repayment and the ‘unaffordable’ part to be either warehoused until repayment environment (income) improves or until the mortgage holders is forced into other types of arrangements.

This, of course, presents a number of problems. Firstly, it is another extend-and-pretend measure not dealing with debt overhang, as the overall level of debt carried by household remains identical to pre-restructuring. Secondly, it introduces an incentive for the banks to hold mortgagees in constant fear of foreclosure, especially if the property prices rise or if the banks find capital to writedown the foreclosed mortgage. Thirdly, there is no provision for the interest rate relief in the scheme, implying that interest rate will roll up on both sides of the split mortgage. This means, the banks can ‘warehouse the principal’ while forcing households to pay interest on full amount of the mortgage. In other words, effective interest rate payable on mortgages will rise and the present value of the lifetime debt will rise as well.

The Group failed to see any of these possibilities in their report.

What we need here is a New Beginning type of a solution with added caveat that the warehoused part of the loan does not involve roll up of interest for 3 years and that the part of the loan due for continued repayment be structured in such a way as to payments covering at least 50:50 the interest due on overall mortgage and repayment of the principal. In other words, at least every €1 of each €2 of repayment has to be used to reduce principal amount under mortgage. Furthermore, we need protection of borrowers from increases in the interest rates, with warehoused mortgage converted to fixed rate or tracker mortgage at inception.

Overall, therefore, the Keane report utterly and comprehensively fails to deliver any new and/or meaningful measures for dealing with the crisis. The Report is extremely weak on analytical details (using nothing more than publicly available data from the CB of Ireland, without even applying CBofI own model for dynamics of future mortgages distressed available from the PCAR/PLAR exercises). It is a lazy, write-off piece of work by people who appear to have no understanding of the realities of the problems they discuss.

The failure of this report is so comprehensive and represents such a direct affront to the nation burdened with unprecedented debt overhang that the entire report must be binned – publicly and irrevocably – by the Government and a new, independent and broadly authorized commission should be set up to produce real measures aimed at alleviating both problems:

Problem 1 – financial sustainability of currently distressed borrowers, and

Problem 2 – overall debt overhang in the household economy.

Some of the possible measures aiming at dealing with the above problems are already outlined in my comments above. More proposals will follow on this blog in the future. Stay tuned.

29/08/2011: Mortgages Arrears - 2Q 2011 data

The Central Bank of Ireland today published the latest data on mortgage arrears and repossessions for 2Q 2011. Per CBofI data (note, much of the analysis is my own):

• At the end of June 2011 there were 777,321 private residential mortgage accounts held in the Republic of Ireland to a value of €115.089 billion.
  
• 55,763 accounts (7.2% of total) were in arrears for more than 90 days, up from 49,609 accounts (6.3% of total) at the end of 1Q 2011. Accounts in arrears have balances of €10.838 billion as of 2Q 2011, up on €9.599 billion a quarter before. Thus percentage of outstanding amounts that represent mortgages in arrears of 90 days and over is now 9.42% against 1Q 2011 percentage of 8.28%.
• Percentages of loans in arrears more than 90 days have risen from 5.1% in 3Q 2010 to 5.70% in 4Q 2010 to 6.30% in 1Q 2011 and to 7.20% in 2Q 2011. Hence, the increases here are accelerating as of last quarter.
• Percentages of loans volumes in arrears 90 days or more have risen from 6.64% in 3Q 2010 to 7.39% in 4Q 2010 to 8.28% in 1Q 2011 and to 9.42% in 2Q 2011. Again, increases here also accelerated, with 4Q2010 on 3Q2010 rising by 0.75pp, 1Q 2011 on 4Q 2010 rising by 0.89pp and 2Q 2011 on 1Q2011 rising by 1.14pp.
  
• 69,837 residential mortgage accounts were categorised as restructured at the end of 2Q 2011, up from 62,936 restructured accounts at the end of 1Q 2011.
• Of the restructured mortgages total, 39,395 are not in arrears and are "performing as per the restructured arrangement"
  
• 30,442 of restructured mortgages "have arrears of varying categories (arrears both less than and greater than 90 days)"
  
• Therefore, 95,158 accounts are either in arrears greater than 90 days or have been restructured and are not in arrears as at the end of June 2011.
  
• Arrangements whereby at least the interest only portion of the mortgage is being met account for over half of all restructure types (52%).

Now, let me run though the figures in more aggregate detail. Take together all loans that are in arrears 90 days or more, plus repossessions and loans that are restructured, but are not in arrears. Clearly, these loans represent some indication of mortgages either at risk or defaulted. Let's call these such.

• In 2Q 2011 a total number of 95,967 mortgages were either at risk or defaulted, up on 86,963 mortgages in 1Q 2011.
• Between 1Q 2011 and 2Q 2011, the number of mortgages at risk or defaulted has risen by 9,004, which is a faster rate of increase than in the period between 4Q 2010 and 1Q 2011 when the rise was 6,665 mortgages.
• In 2Q 2011, the percentage of all mortgages that were at risk or defaulted was 12.35%, up on 11.11% in 1Q 2011 and 10.21% in 4Q 2010.
• In 2Q 2011 a total volume of mortgages at risk or defaulted was €17.493 billion, up on €15.774 billion of mortgages in 1Q 2011 and on €14.525 billion in 4Q 2010. Also, note that the rate of these mortgages increases is accelerating as well.
• In 2Q 2011, the percentage of all mortgages value that was at risk or defaulted was 15.20%, up on 13.60% in 1Q 2011 and 12.45% in 4Q 2010.

Let me sum the above up: in 2Q 2011, the value of mortgages that were either in arrears 90days and over or were restructured and not in arrears accounted for 15.2% of the entire mortgages pool in Ireland.

Here's the summary:

Note that in the above table, the rates of risk increases are outpacing the rate of households deleveraging almost 15 times to 1.

We sooooo obviously don't have a mortgages crisis on our hands, that it all looks rather sustainable, ...if you stick your head deep into the sand bank... kinda like this...

Economics 27/05/2010: Mortgages arrears

RTE reports on the CB data on mortgage arrears, stating that:
"New figures from the Central Bank show a 13% increase in the number of mortgages [90-days or more] in arrears [relative to December 2009]. However, the figures also show a fall in the number of legal actions taken by financial institutions to enforce outstanding mortgage debt."

At the end of Q1 2010, over 4% of all private residential mortgage accounts in Ireland were in arrears - the total of over 32,000 of 791,000 mortgages worth €118bn. Median duration of arrears was in excess of 180 days.

"The Central Bank notes a drop of 4.8% in the number of arrears cases in which legal proceedings have been issued. There are just over 3,000 such cases. During the first quarter of this year, 91 properties were repossessed by banks, 26 on foot of court orders and 65 by voluntary agreement of the borrowers or by abandonment. At the end of March mortgage lenders held 456 repossessed residential properties."

The issues not raised by either the CB or RTE are:

1. Have the banks willingness to pursue cases in court been impacted in any way by Nama operations? Nama is a political entity, with potential to influence banks internal decisions.
2. With median duration of mortgages arrears of 180 days, can we expect the number of cases heard in courts to dramatically accelerate in H1 2011?
3. Mortgages reported in arrears do not include mortgages where lender and borrower have renegotiated mortgage covenants, avoiding arrears by switching to interest-only mortgages and/or changing maturity profile of the mortgage, and/or extending a payment holiday.
   
4. What is the median/average size of the mortgage in arrears. It is likely that mortgages currently under stress are larger and cover properties with much more significant extent of the negative equity.
5. What is the sensitivity of arrears to interest rate changes. The statistical eagles in the CB - we do have some there, right? - can easily compute the sensitivity of mortgages default to changes in retail interest rates. All they need for this is longer-run data on mortgages defaults, retail rates, macroeconomic parameters, housing prices etc. Shouldn't take much of time or effort for the CB to get this useful estimate. We can then see just how damaging the ongoing increases in mortgage rates by the banks will be to this society and economy.
   

In effect, we are only seeing the tip of an iceberg here.

Now, one interesting revelation that comes on the foot of these figures is the spread of mortgage debt burden in the country. 791,000 mortgages are outstanding, involving on average more roughly 2 individuals, majority of whom are in employment. This implies that mortgages debt cover in the workforce accounts for roughly 1,580,000 individuals, or 73% of the entire labor force.

Another thing - with 73% of working (or able to work in theory) households already carrying a mortgage (or two), and defaults on mortgages rising 13% per quarter, I guess two natural questions to ask are:

• In the short run: What stabilization in the property markets can one discern here?
• In the long run: what hope can the Government have to collect any sort of serious wealth tax, when most of our wealth has been tied up in, by now, largely devalued property?
  

Economics 22/12/2009: On-line advertising, Mortgages Arrears and Exports

Few interesting bits of news.

Chart below (courtesy of Economist, hat tip to Ronan Lyons) shows the sorry state of affairs in the 'knowledge' economy. Online advertising is an instrumental indicator for the extent of e-commerce in the country. Although rising this year (the only area of advertising holding up in this recession), our online advertising is lagging that of other countries.
In fact, we are languishing at the bottom of the league table - next to South Africa and way off from the peer group of advanced economies. One can only speculate as to the causes of this underperformance, but here are the potentials:

• conservative attitude by advertisers (anecdotal evidence suggests that Irish advertisers are yet to seriously commit to the web even in the context of market research);
• lack of infrastructure (my own experience shows that even having two connections to 'broadband' - with one through optical cable to boot - at home does not guarantee that you can sign onto the web);
• lack of competitiveness (years of roaring Celtic Tiger have resulted in lazy and uncompetitive attitude by retailers);
• inability to offer tax free shopping on the web (American retailers use the web to reduce the cost of goods to consumers by availing of the 'no sales tax' clause which allows them to ship goods tax free from one state to another);
• lack of anything to sell (with indigenous brands squarely concentrated in the area of butter, cheese, milk, crisps and the likes - what's there to advertise to the global web-based market place?)

Whether these are the real reasons or not, the signs are not good for Ireland's efforts to enter information age.


On finance side - the FR issued new data on mortgage arrears today (the details are here). You've heard the main headlines by now (note: the actual data was released once again in the same un-usable pdf format as the one employed by the DofF - another sign of information age illiteracy, one presumes).
Table above summarises FR's data. Given that we have no time series to compare against, the only thing one can say is that the data above, as bad as it might appear, is lagged by some 6-12 months in the case of court proceedings and by around 1-2 months in the case of arrears. This suggests that as time elapses, the above numbers will rise substantially.

Other reasons to expect significant increases in distressed mortgages:

• hike in the mortgage rates in January-February 2010 as the banks go on offensive to rebuild profit margins after Nama is fully operational (nothing to hold them back once taxpayer cash is flowing in); and
• over time, as redundancy payments and savings are exhausted, more households will fall into distress.

The only net positive in today's news is that after 29 months of financial crisis, FR finally decided to collect data on mortgages distress. Where were they over the last two years, one might inquire.


External trade data released today by CSO is showing that our (seasonally adjusted) exports were down 14% in October, relative to September 2009. back in September, exports rose by a robust 11% compared to August.

Imports fell by 7% in October 2009 relative to September and were down 1% in September
compared with August.

The value of exports in September 2009 was stable compared with September 2008 (down just €35 million from €64,469 million) and the value of imports was down 25%.


Computer equipment exports fell 25%, Electrical machinery by 28%, Industrial machinery by 33%. In contrast, medical and pharmaceutical products increased by 22%, Organic chemicals
by 11%, and Professional, scientific and controlling apparatus by 14%. The MNCs, in other words, were still firing on all cylinders in the pharma and pharma-related sectors, and medical devices.

Goods to Great Britain decreased by 15%, Germany by 21%, Northern Ireland by 22%, but goods to Belgium increased by 30% (a transit port for much of our trade with the rest of the world), the United States by 14% and Japan by 10%. So, apparently, there is little evidence of lasting adverse effects of the dollar devaluation on Irish exports then? Not so fast - remember that MNCs book transfer pricing through exporting to the US, and the strong Euro is just the added ingredient they need to cover the tracks.

Charts below show the trends (these are not seasonally adjusted, but the trends are exactly identical to those in the seasonally adjusted series) - falling exports and collapsed imports.
Of course, the trade balance is rising which is due to the facts that

• as consumers we are worse off today than we were a year ago (consumer-related imports are down),
• as exporters our MNCs are really, really good, and
• transfer pricing is rampant (driven by the rising gap between imports of inputs and exports of outputs).
  

I leave it to the readers to make a call if these are the signs of an economy in a recovery.