Bank of Ireland's justification of its high Standard Variable Mortgage rate

[Brendan Burgess]

The transcript from Richie Boucher's appearance before the Oireachtas Finance Committee is here I have extracted the bits relevant to the SVR

Chairman: http://www.oireachtas.ie/members-hist/default.asp?housetype=0&HouseNum=31&MemberID=1841 Before I bring in the other members, I wish to ask Mr. Boucher a question. In regard to the net interest margin on standard variable loans, the margin the bank has in respect of those loans at over 3% seems quite high.


Mr. Richie Boucher: The margin is not necessarily based on it because we have a liquidity risk with mortgages. A mortgage is a 20 to 25-year instrument and we take liquidity risk in the provision of mortgages. We look at those as they operate elsewhere. Yesterday the Irish Government, which is, in effect, the base risk-free investment, issued a 15-year bond at just under 2.5%. Our fixed rate offering is 4.99% and that is a 2.5% margin. For our margin, and, in particular, for our capital allocation models and the capital allocation the Central Bank requires to hold against our different books, we must take into consideration our loss experience.



Our loss experience on our Irish mortgage books has been different from what it has been in Europe. Another comparator I would note is that we have a business in the UK and our mortgage business in the UK is roughly the same size as our Irish mortgage business. It is a very similar type of market structure and I will return to why that is the case. The spreads and margins in the UK in which we operate are the same.


Some reference has been made to a comparison between Irish rates and European rates. A couple of features I would note in that respect is that the loss experience is different, so the capital allocation is different. However, a very significant feature of a number of the European markets is tax-based subsidies for bond markets. An example is the Pfandbriefe market in Germany where banks operate as originators and issuers and they sell their mortgages on to bond markets. If we take into account that there is tax-based or taxpayers' subsidy for those bond markets, it is not comparable. The more comparable market in terms of market structure and access to bond markets is the UK market against the Irish market.

Deputy Michael McGrath:
I welcome Mr. Boucher, Mr. Farrell and Mr McLoughlin. As my time is limited, I can only cover some of the key issues. I want to continue with the issue the Chairman raised, in particular about the pricing strategy for standard variable rate mortgages. The bank is currently charging in the region of 4.5% for a new mortgage if the loan-to-value is over 80%. How can Mr. Boucher justify that when his stated cost of funds is 1.15%, which have come down by about 30% in the past 12 to 18 months? The bank's margin has increased very substantially. Most people would regard a variable rate product as one where if the market conditions are bad, the rate is going to go up, but when the market conditions are good, people expect the variable rate to come down, but that has not happened. When was the last standard variable rate reduction by Bank of Ireland in respect of mortgage products?
Mr. Richie Boucher: The last reduction would have been in 2008 or 2009. There has been no significant interest rate cycle in that period. The group's net interest margin has improved in the 12 month period from 1.65% to 2.08%. That is progress but is certainly not an exorbitant margin. We have to get 98% of our credit decisions right before we can make any money or cover our costs at that particular margin. As I was trying to identify in my answer to the Chairman's question, the structure and liquidity risk one takes against mortgages are important. We are providing a mortgage which has a significant liquidity risk. We have a repricing opportunity but we are giving a 25-year commitment of money to the customer. We cannot raise that money so it is not necessarily comparable to look at our overall cost of funds. For example, if we issue a covered bond or unsecured debt in the markets, we are issuing it at about 2% to 3%. The Irish Government in raising 15-year money in the market at 250 basis points. One has to take account of the nature of the product one provides, the liquidity risks, the historic credit losses one has taken and the capital one applies. There are a range of factors in that. We have to enhance our margin but we try to ensure our products are competitive on an ongoing basis. We are a commercial business, we operate in a competitive market and we must ensure our products are sustainably competitive, that we can continue in the market, attract customers and do business.

Deputy Michael McGrath:
http://oireachtasdebates.oireachtas...&pid=MichaelMcGrath&year=2014&month=11&day=05 The bank's margin has increased very substantially. Its cost of funds has reduced very substantially by about one third in the past 12 to 18 months and yet Mr. Boucher is telling me it is about six years since Bank of Ireland has reduced the standard variable rate being charged. One of the bank's main competitors, AIB, has stolen a march on it in the market and has reduced its rate. I presume Bank of Ireland will have to follow suit. Mr. Boucher will not confirm that today but, ultimately, the market will dictate the bank's reaction. I submit to Mr. Boucher that the bank is taking advantage of variable rate customers. They are being exploited. It will come as a surprise to nobody that a bank seeks to maximise profits, but this bank is profiteering on the backs of variable rate customers. Mr. Boucher made the comparison with the UK market which he said is the best comparison with Ireland.

[Deputy Michael McGrath:
Across the Border, Bank of Ireland offers a 1.98% fixed rate up to January 2017 if I have a low loan-to-value ratio of 60% or a 2.09% fixed rate or a variable rate of just over 2% for at least two years if my LTV ratio is 75%. There is a more competitive environment in the North. If, after two years, Bank of Ireland does not keep the rate low for a customer, he or she can switch to another bank. Customers in the South do not have that option. How can Mr. Boucher justify such a massive difference between the rates Bank of Ireland charges in the Republic and the rates it charges in Northern Ireland and the rest of the UK, given his statement to the effect that both markets are remarkably similar?
Mr. Richie Boucher: Our average spread on new lending in our UK mortgage business, which is growing and developing, is between 3.99% and 4.5%. That is a factual matter.

Deputy Michael McGrath:
http://oireachtasdebates.oireachtas...&pid=MichaelMcGrath&year=2014&month=11&day=05 Bank of Ireland has advertised that it is offering a fixed rate of as low as 2% and a variable rate of just over 2% for defined periods of time where people have relatively low LTV ratios, but those rates are much more competitive than what Bank of Ireland is charging in the Republic.
Mr. Richie Boucher: I should note that the Deputy also cited our fixed rates. We can buy fixed rate money and we offer fixed rate mortgages. We are still surprised at the lack of take-up of fixed rate money in the market. We note that the Government has made a decision to try to fix rates over a period. We try to offer attractive fixed rates. We would encourage customers to consider fixed rates. A fixed rate gives a customer certainty and control of his or her finances in so far as that is possible. We provide attractive and competitive fixed rates.
As the Deputy stated, we operate in a competitive market. We review our rates on an ongoing basis. We also bear in mind our responsibilities to all of our stakeholders - our depositors, our shareholders and the taxpayers whom we have repaid. The strategies of other banks are something we keep an eye on, but we have learned not to follow them slavishly. We consider other banks, the sustainability of their propositions and their ability to attract capital to fund themselves and meet all of their commitments to their stakeholders.

Deputy Michael McGrath:
http://oireachtasdebates.oireachtas...&pid=MichaelMcGrath&year=2014&month=11&day=05 Has Bank of Ireland any intention of reviewing its standard variable rate on mortgages in light of current market conditions?
Mr. Richie Boucher: We consider what competitors do and review our rates on an ongoing basis.

Deputy Michael McGrath:
Is the bank open to switcher mortgage applications? If I am with another bank, in a healthy financial position and want to transfer my mortgage to Bank of Ireland, would it be open to that?

Mr. Richie Boucher: I will ask my colleague, Mr. McLoughlin, to assist Deputy McGrath.
Mr. Liam McLoughlin: Bank of Ireland is certainly open to new business from switchers. However, the Irish market is dominated by tracker mortgages, amounting to approximately 60%. The inclination to switch mortgages is not as it is in other markets, but we are keen to switch business into Bank of Ireland.

Deputy Michael McGrath:
http://oireachtasdebates.oireachtas...&pid=MichaelMcGrath&year=2014&month=11&day=05 When the committee asked that question of Bank of Ireland previously, the response was that switchers accounted for a low proportion of its mortgage business.
Mr. Liam McLoughlin: That is the fact. It is so low because keenness for switching mortgages when 60% of the market is on tracker rates is also low. Therefore, the quantum of switching in the Irish market is low. However, we are keen to-----
Mr. Richie Boucher: We have switcher products, but the desire of a customer to switch to a variable or fixed rate mortgage when he or she is on a tracker rate is very low.

Deputy Michael McGrath:
I do not find Mr. Boucher's argument about pricing policy convincing. He was the one who drew the comparison with the UK market, calling it remarkably similar to Ireland's. He stated that the average rate Bank of Ireland charged in the UK was approximately 4%. However, the offering it makes to new customers in Northern Ireland and the rest of the UK is remarkably competitive and strikingly different from the offering it makes in the Republic. Mr. Boucher has cited a rate of 4.5% at a time when its cost of funding is probably 1% or so. That is a remarkable margin to charge for variable rate products. I am not just referring to mortgages but also to personal loans for which Bank of Ireland charges approximately 12%, to credit cards for which it charges 20% or so and to loans to small to medium-sized enterprises, SMEs, which are paying way over the odds.
Mr. Richie Boucher: I will point out that the group margin is 2%. We must take into account liquidity risks, especially as regards mortgages. It is a 25 to 30 year proposition to customers. As such, we must take a liquidity risk for that duration. The Government has taken out a 15-year bond at 2.5%. It is difficult to compare one product or its features with another. We must have subordinated capital. We must have a range of instruments of various maturities to match our different products. We are also required to take into account the weighted cost of capital against products. This must also factor in loss experience. Our loss experience on our UK mortgage book is different. To assist the Deputy, though, we will provide him with our UK and Irish mortgage rates so that he can have an appropriate comparative.

 

[Brendan Burgess]

From Page 10

Deputy Kieran O'Donnell:
I welcome Mr. Boucher and his colleagues. Given the importance of having a functioning banking system, I welcome Bank of Ireland's recovery and return to profit. To take up Deputy Michael McGrath's point on interest rates and charges, an examination of the figures indicates that the standard variable rate across the Bank of Ireland group is approximately 4.5%. Is that figure correct? I refer to the rate available to first-time mortgage holders.
Mr. Liam McLoughlin: The answer to the Deputy's question is on page 9. A variety of factors that feed into the pricing of a mortgage, including, for example, the loan-to-value ratio. In terms of a variable rate-----

Deputy Kieran O'Donnell:
The figure is in or around 4.5%.
Mr. Liam McLoughlin: That rate applies to fewer than 50% of mortgages. The accounts show that our average loan-to-value for mortgages in the first six months of this year was about 72%. Based on this, that would be priced at 4.30%.

Deputy Kieran O'Donnell:
http://oireachtasdebates.oireachtas...&pid=KieranODonnell&year=2014&month=11&day=05 The point I am making is that the variable rates Bank of Ireland is charging first-time mortgage holders here and in the North are more or less comparable.
Mr. Liam McLoughlin: Based on the loan risk and loan-to-value, 4.30% is a fair number.

Deputy Kieran O'Donnell:
The two year fixed rate for a mortgage with a loan-to-value ratio of greater than 75% is 4.35% in the Republic and 2.09% in the North. Why is the rate charged in the North less than half the rate charged here? Is it the result of the lack of competition in the market in the Republic?
Bank of Ireland and Allied Irish Banks control a large part of the residential mortgage book in Ireland. The former has been ahead of the curve in that it has returned to profitability ahead of AIB, yet it is the latter bank that has seen fit to reduce its variable rate by 0.25%. Why has Bank of Ireland not followed suit and reduced its variable rate? Why is the two year fixed rate for a mortgage with a loan-to-value ratio of greater than 75% charged in the North less than half the rate charged in the South?
I do not wish to go over old ground but I wish to get to the nub of the issue. Bank of Ireland has increased its margin by 43 basis points or approximately 26%. This more or less corresponds with the reduction in the general cost of funds to the bank itself and Mr. Boucher might elaborate on that. The question simply is about what the bank is not doing. It strikes me as being reasonably logical, in that Bank of Ireland states it is a bank that is in pretty good nick and condition, yet its main competitor in the past week has given a reduction of 0.25% to hard-pressed mortgage holders and to first-time buyers. Moreover, in the North, Bank of Ireland is giving absolutely identical customers a fixed rate for two years that is half the rate it would give to them in Ireland.


Mr. Richie Boucher: First, I do not think we can compare the customer and our loss experience is quite different, so the capital required is different.

Deputy Kieran O'Donnell:
With due respect to Mr. Boucher, Bank of Ireland is, more or less, charging the same variable rate. This clearly looks to me-----
Mr. Richie Boucher: That is a fixed rate and it reverts.

Deputy Kieran O'Donnell:http://oireachtasdebates.oireachtas...&pid=KieranODonnell&year=2014&month=11&day=05 It appears to me that Bank of Ireland is pricing in the market.
Mr. Richie Boucher: When we quote the rate to the customer, the annual percentage rate, APR, is the reversionary rate.

Deputy Kieran O'Donnell:
I accept that but it is after the set period.
Mr. Richie Boucher: There are different attractive features. For example, in Ireland, we will waive 1% of the mortgage to offset stamp duty. We will make different offers in different markets.

Deputy Kieran O'Donnell:
The question I am asking is very simple.
Mr. Richie Boucher: We compete across every market.

Deputy Kieran O'Donnell:
http://oireachtasdebates.oireachtas...&pid=KieranODonnell&year=2014&month=11&day=05 But in the limited time. Therefore, does Mr. Boucher perceive that Bank of Ireland does not have enough competitors, whereby the bank is required to give a rate reduction to customers?
Mr. Richie Boucher: This is a competitive market. It is becoming an increasingly competitive market. The competitive intensity is increasing and will increase. Any business that does not think it faces competition today or tomorrow, particularly the latter, will go out of business. We must be competitive to remain in business.

Deputy Kieran O'Donnell:
Briefly, if one looks across the market here, the variable rates are more or less the same with all the banks. However, AIB has given a reduction of 25 basis points or 0.25%. This is a significant reduction for an individual. Why is Bank of Ireland not doing so?
Mr. Richie Boucher: It is using taxpayers' money. AIB owes the taxpayers €20 billion and has decided on how it is going to use some of that. We will remain competitive in the market.
Mr. Liam McLoughlin: If I may, Deputy O'Donnell asked about fixed rates and in the Republic of Ireland, Bank of Ireland in July reduced all of its fixed products, being one, two, three and five years, by between 20 and 55 basis points.
Mr. Richie Boucher: To reflect the cost of fixed-rate money going out, I was talking about-----

Deputy Kieran O'Donnell: http://oireachtasdebates.oireachtas...&pid=KieranODonnell&year=2014&month=11&day=05 It is the same cost of money in the North as down here.
Mr. Richie Boucher: Deputy, we have a liquidity mismatch.

 

[Brendan Burgess]

from Page 12

Deputy Ciarán Lynch:
I welcome Mr. Boucher, Mr. Farrell and Mr. McLoughlin. I wish to pose two questions, the first of which relates to the standard variable rate and the second to the recent announcement made by the Governor of the Central Bank, Professor Honohan, on loan-to-value ratios. We have been thrashing out these matters all afternoon and, as I understand it, the position is quite simple. If a customer is paying at a rate of 4.4% and the bank is borrowing money at 1.5%, the margin of profit for the bank is 3.25%. What is an acceptable margin of profit for Bank of Ireland in this matter? Where does the bank stand on the net interest margin? Is there a level of acceptability of profit and are there circumstances where the bank is taking too much profit and pushing customers too far in the context of the margin to which I refer?
Mr. Richie Boucher: The overall group margin is 208 basis points. It has improved, but if it had remained below 200 basis points, we would not be in profit. That is an important factor. We are obliged to consider different products in terms of their maturity profiles. It is important for us to bear in mind the fact that in the context of a mortgage, we are taking deposits short in the market and making a commitment to the customer that we will lend to him or her. Therefore, we have a liquidity risk. In our asset classes, mortgages drive the single biggest liquidity risk. In the context of the UK market, one of the biggest strategic mistakes the bank made and our largest single issue was related to the liquidity risk it faced with its mortgage book there. We had grown the book, depended on securitisation markets and taken money on a three to five year basis. Liquidity risk is a factor.


Mr. Richie Boucher: My point is that if one considers the position on a specific product, what the Deputy is saying might be true. However, we are obliged to look at the liquidity risk right across our profile.

Deputy Ciarán Lynch:
http://oireachtasdebates.oireachtas...165&pid=CiaranLynch&year=2014&month=11&day=05 I understand that. No one is going to buy a house for €200,000 tomorrow morning. People buy houses over a 20 or 30 year period, with an APR, a fixed rate or a tracker rate applying. The net sum of the final payment will be the actual amount a customer pays for his or her house. A mortgage has a running rate over its lifetime, as does the margin. At present, the margin is 3.25%. I understand the bank is obliged to make a profit, but I want to know if a review is required of the current level of profit. When Mr. Boucher appeared before the committee previously, we dealt with the issue of split mortgages and the manner in which Bank of Ireland was dealing with them. At the time it was retaining the interest on the warehouse portion of mortgages to the full extent. Mr. Boucher went away and reviewed the position and the bank then reduced the margin of profit on the split side of mortgages. In this instance Mr. Boucher needs to take the same approach because the margin of 3.25% is very profitable for the bank.
Mr. Richie Boucher: On the previous occasion I indicated that we would examine the matter to which the Deputy refers. However, I cannot make an absolute commitment on how we price our products. I gave a commitment on the previous occasion to consider the position because I figured we could do something. However, I cannot make a commitment to the committee in respect of how we price products. It would be disingenuous for me to leave anyone with the impression that I might be in a position to take action in that regard. We consider our products on an ongoing basis in order to ensure they are competitive and sustainable and that we can obtain good returns on them. If our products are uncompetitive, the bank, as a business, suffers.

 

[Brendan Burgess]

From Page 15

Deputy Michael McGrath:
http://oireachtasdebates.oireachtas...&pid=MichaelMcGrath&year=2014&month=11&day=05 I just want to ask a technical question. If someone is on a variable mortgage and when they got the mortgage they were in a certain LTV bracket of maybe over 80% but some years later the property value has increased, they have more equity in the property and they fall into a lower LTV band, which would attract a lower interest rate, can they revise what band they are in or are they fixed in the band at which they entered when the mortgage was drawn down?
Mr. Liam McLoughlin: They are fixed in the band they enter when the mortgage is drawn down.

Deputy Michael McGrath: No change.
Mr. Liam McLoughlin: No.

Deputy Michael McGrath:
http://oireachtasdebates.oireachtas...&pid=MichaelMcGrath&year=2014&month=11&day=05 That cannot be changed. What is the typical tracker rate being paid by Bank of Ireland customers? It is what plus ECB, typically?
Mr. Liam McLoughlin: It is in the public domain. It is 105 basis points above the ECB rate.

Deputy Michael McGrath: http://oireachtasdebates.oireachtas...&pid=MichaelMcGrath&year=2014&month=11&day=05 That is 105 plus the ECB rate. My final question is in the context of the Central Bank's proposed minimum mortgage deposit, which may or may not happen.

[Deputy Michael McGrath: Could I ask the bank what impact the introduction of non-recourse lending would have in Ireland? Would it have an impact on interest rates and the bank's disposition towards risk? It strikes me that if people are being required to stump up a deposit of 20%, there should also be a commitment on the part of the bank that the borrower's liability would end with the property.
Mr. Richie Boucher: In that case our loan-to-value ratios, LTVs, and income multiples would reduce and the rates would go up because it is a very significant change in the risk profile. That is off the top of my head but my gut feeling is that is what would happen.

 

[Brendan Burgess]

From Page 17

Deputy Richard Boyd Barrett:http://oireachtasdebates.oireachtas...=RichardBoydBarrett&year=2014&month=11&day=05 Many questions I have about the banking sector are directed more to the Government than to individual banks. However, I have a few questions for Mr. Boucher. Does he accept the proposition that his bank, along with others but his would be at the top of the league table, is profiteering in terms of the interest rates it is charging on loans compared to its European counterparts? This was raised earlier but I was not present, and I apologise for that. The evidence from the briefing we were given is that the bank is engaged in serious profiteering in respect of the interest rates being charged, compared to what banks in the rest of Europe are doing. How would Mr. Boucher respond to that? How does he consider it morally justifiable, given that the bank would not exist today without the bailout it was given by ordinary citizens of this country?
Mr. Richie Boucher: The Deputy would not expect me to concur with his assertions, but I will outline some facts. Our net interest margin is 2.08% across the group. If one compares that with banks in Britain, the US and many European banks, it is a low net interest margin. Relative to that, it is a recovering net interest margin, but it would not be construed as an exceptional net interest margin. That is a fact. There are different funding structures, different loss experiences and a range of things that impact on banks' pricing models. We compete for our business in Ireland and for our business in the UK, continental Europe and in the US in different parts of our businesses. We compete on the basis that we want our customers for the long term.
We must have products that are sustainable. We have seen entrants into markets, including this market, who have had unsustainable business models. They come in with pricing structures or business models that just do not work and they leave or collapse. Some of our competitors have collapsed.
As to the Irish taxpayer, one of the key focuses of this bank, perhaps distinguishing it from other banks, is the absolute focus we had on repaying the State aid and to bring the taxpayers a profit. The taxpayers have it.

[Mr. Richie Boucher:] What we have returned to taxpayers is cash that can be used for other purposes. Banks should never have been supported by or needed support from taxpayers. We must ensure we put structures in place to make sure that will never happen again. Part of the way we have to think about running our business involves the return of taxpayers' cash for them to do what they like with it, which is very important. This has been at the heart and a key component of our strategy in the past six years. To be quite frank, I do not see the same attention in other banks.

Deputy Richard Boyd Barrett: http://oireachtasdebates.oireachtas...=RichardBoydBarrett&year=2014&month=11&day=05 In the briefing document we have been given it is suggested the average rate for mortgage business in Ireland is 4.5% compared with 2.64% in the eurozone. Is Mr. Boucher disputing this figure?
Mr. Richie Boucher: I attempted to answer that question earlier.

Deputy Richard Boyd Barrett: I apologise, but I was not here.

Mr. Richie Boucher: There are very different features. In particular, in a lot of European markets there are state-sponsored and taxpayer subsidised bond schemes such as in the internal Pfandbriefe bond market in Germany. Similar schemes are operated in the United States - the Fannie Mae and Freddie Mac schemes. Our contiguous market with the same structures, in particular in terms of access to bond markets, loss experiences, etc., is the United Kingdom where there are equivalent broad spreads. It has a different currency, but the base rates are not and do not look a lot different. Let us look at the pricing of all of our products. Our net interest margin is 2.08%.

Deputy Richard Boyd Barrett: http://oireachtasdebates.oireachtas...=RichardBoydBarrett&year=2014&month=11&day=05 I am running out of time.

Mr. Richie Boucher: I have tried to help the Deputy as much as I can.

Deputy Richard Boyd Barrett: http://oireachtasdebates.oireachtas...=RichardBoydBarrett&year=2014&month=11&day=05 It probably comes back to what I said earlier - my beef with how banking works here has more to do with the Government and its policies. Mr. Boucher made an interesting comparison between the Europe-Irish and Europe models. It bears more discussion, but, unfortunately, we do not have the time to do so.