Irish mortgage rates should be higher given the arrears profile

[Sophrosyne]

Sarenco,

I think you are over-playing risk and consequential outcomes.

Banks need to take a cautionary but balanced view.

The current lending criteria are prudent and while they do not fully eliminate risk, they reduce it considerably from the situation that obtained previously.

This should be reflected in current lending rates.

 

[Sarenco]

Hi Sophrosyne

Lenders certainly need to balance risk and reward in any underwriting decision. I don't think anybody would argue otherwise.

Colm McCarthy argues that it is far from clear that current variable rates are sufficient whereas Brendan states that it is obvious that current rates are grossly excessive. Both can't be right!

 

[Brendan Burgess]

Colm McCarthy argues that it is far from clear that current variable rates are sufficient

http://www.independent.ie/opinion/c...hide-full-extent-of-bank-losses-31248501.html

Hi Sarenco.

Although he does say:

It is not clear that the 4pc or so currently being charged on variable-rate mortgages is excessive, given the riskiness of mortgage lending in the new banking environment.

This sentence does not tally with the rest of his article. I suspect that what he means is that they are not excessive to capitalise the bank and pay for the losses on trackers.



But in a bust banking system, the discipline of competition is removed and the variable-rate borrowers have no escape. They are currently paying two unlegislated taxes: a tax to subsidise the lucky tracker borrowers, and a tax to help re-capitalise the surviving banks (or to boost hedge fund profits, as the case may be).


The banks ...are being rescued continuously by captive borrowers who can no longer escape to friendlier competitors, since there are none. Since the Government owns shares in the banks, these captive borrowers are involuntary investors in these shares. Why not acknowledge the reality of Irish-style bank re-capitalisation and reserve some free shares for the variable-rate losers in the Great Irish Mortgage Lottery?

 

[Sarenco]

Hi Brendan

I wouldn't agree that the first quoted sentence does not tally with the balance of the article which talks about the heightened risk of lending associated with government actions and inactions that have reduced the value of housing collateral, in addition to highlighting the lack of competition and past mis-pricing of loans.

In any event, mis-priced trackers written in the past are a reality that will take some time to work through the system (although they now represent a minority of outstanding mortgage loans by value). They can't simply be wished away.

 

[44brendan]

mortgages. To a certain extent, low LTV mortgages may be "subsidising" SVRs and higher LTV loans but I'm personally comfortable with that.

You may well be comfortable with it but that does not mean it is either equitable or sustainable in a normal banking environment. To some extent I feel that I am arguing against my core points on the initial post now, but to be fair I never postulated a position where low margin historic loans should be subsidized by higher margin current loans. I.e. the historic decisions made by banks in formulating the Tracker products were based on risk assessments made at that time together with an acceptance of a relatively low return on these products. Low profitability or even losses on these products should not be used as an excuse to increase rates on other clients who were not part of the Tracker agreements.

From a banking and commercial perspective I acknowledge and accept Brendan's point that SVR mortgages should be viewed on a stand-alone basis. Banks charge high SVR rates because they can!! Not because they are assessing their mortgage book on a holistic basis! This is simple economics. The banks currently have a Cartel and while competition is virtually non-existent they will charge their clients the highest price the market will bear. The rates now being applied to SVR's are based on that approach rather than a risk based one as postulated earlier. Naturally, risk is a factor in identifying the break-even cost of the mortgage product but the resultant additional margin is based on both competition and income growth. Competition is currently a non-factor so income growth is the predominant factor.

 

[Sarenco]

You may well be comfortable with it but that does not mean it is either equitable or sustainable in a normal banking environment. To some extent I feel that I am arguing against my core points on the initial post now, but to be fair I never postulated a position where low margin historic loans should be subsidized by higher margin current loans. I.e. the historic decisions made by banks in formulating the Tracker products were based on risk assessments made at that time together with an acceptance of a relatively low return on these products. Low profitability or even losses on these products should not be used as an excuse to increase rates on other clients who were not part of the Tracker agreements.

From a banking and commercial perspective I acknowledge and accept Brendan's point that SVR mortgages should be viewed on a stand-alone basis. Banks charge high SVR rates because they can!! Not because they are assessing their mortgage book on a holistic basis! This is simple economics. The banks currently have a Cartel and while competition is virtually non-existent they will charge their clients the highest price the market will bear. The rates now being applied to SVR's are based on that approach rather than a risk based one as postulated earlier. Naturally, risk is a factor in identifying the break-even cost of the mortgage product but the resultant additional margin is based on both competition and income growth. Competition is currently a non-factor so income growth is the predominant factor.

I think you may have misunderstood my post. I was talking about the rates charged on new loans.

Low margin trackers have already been written at the agreed margins - the banks cannot un-ring that bell - but they do have some scope to choose what rate to charge on low LTVs (for first time borrowers and switchers) and high LTVs/SVRs.

 

[Sophrosyne]

Perhaps I am just thick about banking, but to me the situation is fluid.

In relation to the total number of mortgages, the percentage of trackers should have and should continue to decrease incrementally as new mortgages are contracted.

The same should be true of the percentage of mortgage defaulters, given the new set of mortgage criteria.

I don’t think that banks can continue to act as if these changes did not occur.

 

[Sarenco]

Perhaps I am just thick about banking, but to me the situation is fluid.

In relation to the total number of mortgages, the percentage of trackers should have and should continue to decrease incrementally as new mortgages are contracted.

The same should be true of the percentage of mortgage defaulters, given the new set of mortgage criteria.

I don’t think that banks can continue to act as if these changes did not occur.

I absolutely agree that the situation is fluid.

The proportion of outstanding non-tracker mortgages by value has recently surpassed the proportion of outstanding (low margin) trackers and this trend would obviously be expected to continue. Assuming recently written loans prove to have a lower default rate than historic loans then this will also gradually feed into a lower cost of capital in the future.

However these changes will be gradual. Our banks, in aggregate, have only recently become profitable but you would expect that competitive pressures coupled with improving balance sheets will, in time, result in lower margins being charged by lenders.

To be fair, BOI and AIB have recently made rate changes, which is at least a move in the right direction.

Of course, a new entrant to the market without these legacy issues may be in a position to write loans at a lower margin which would potentially speed up this process.

 

[Brendan Burgess]

I spoke to a risk officer in a lender to clarify this issue.

The loss experience is relevant. Past default rates are the only thing we know.

If a person is borrowing 3.5 times their income, it's reasonable to use the default rates on similar LTIs in the past to estimate the probability of default. Likewise, we should use the default history of 80% LTV borrowers as a guide to the probability of default in the future.

He makes a very interesting point about new lenders. They would have to use the existing lender's default history in estimating their losses and capital requirements.

So the history of 100% mortgages is no longer relevant, because we are not doing them any more. The losses on mortgages at 6 times income is no longer relevant, because we are not doing them any more.

The loss experience of 80% LTVs and 3.5 times income is very relevant.

He said that they would not incorporate a 60% fall in house prices from here. I find this interesting, because I assume that they didn't factor in a 60% fall in house prices back in 2006 either. Which takes me off on another tangent. Do the banks and Central Bank have to estimate if the housing market is fairly priced?

He is of the view that all lending in Ireland should be priced as unsecured lending. Of course, I don't agree with that. Nor does his employer. But maybe he is exaggerating to make the point.

Brendan