The Central Bank's views on the higher risk of mortgage lending in Ireland

Brendan Burgess

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From the Central Bank's report on Standard Variable Rates (PDF Page 16)

Cost of Credit Risks:
Following the financial crisis, the Irish mortgage market is characterised by one of the
highest mortgage arrears and default rates in Europe (Chart 9). The latest mortgage
arrears statistics (Chart 10) show that, as at end of December 2014, of the 758,988 private
residential mortgage accounts for PDH loans in Ireland, 78,699 accounts (10.4 per cent)
were in ninety days arrears or more. In balance terms, this is equivalent to 14.8 per cent
of the total outstanding balance on all PDH mortgage accounts (€104.9 billion).

While banks are beginning to reduce the number of non-performing loans, the extent of
the problem is such that it will take a number of years of sustained improvement to be
addressed. In the meantime, these problem loans leave the banks at risk of significant
impairment charges should the economic situation deteriorate or interest rates increase
materially.

One implication of the high level of non-performing mortgage loans in Ireland, the scale
of negative equity and the heavy indebtedness of so many household borrowers is that
the risk in lending to Irish borrowers must be considered higher than in most other
countries in Europe. While this situation has its roots in the housing bubble and the
crisis, and despite a recovery in the economic environment, the economy remains
vulnerable. The credit-risk premium now considered appropriate in Ireland post-crisis is
much higher than the corresponding premium built into pre-crisis loan pricing. This
reflects elevated expected losses (based on average historic losses) and the need for a
higher provision to meet losses going beyond what is currently expected (the so-called
‘unexpected losses’). Prudent approaches to mortgage pricing that account for risks and
uncertainties should result in banks not offering unsustainably low rates that could lead to
a recurrence of non-performing loans.

 
In the meantime, these problem loans leave the banks at risk of significant impairment charges should the economic situation deteriorate or interest rates increase materially.

This is nonsense. Surely the banks have already provided in full for these problem loans. Anyway, this has nothing to do with new business.


More nonsense. The bad loans made by the existing banks should have no impact on a new entrant to the market, or for that matter, to the assessment of a new loan being made by AIB or BoI.

Prudent approaches to mortgage pricing that account for risks and uncertainties should result in banks not offering unsustainably low rates that could lead to a recurrence of non-performing loans.

Why would "unsustainably low rates" lead to a recurrence of non-performing loans? Surely the high rates are increasing the likelihood of a recurrence of non-performing loans?
 
Brendan - is this credit risk driven by government policy, economic risk (economic stability) or by personal credit risk ?

I still believe LTI should be a factor in determining the interest rate applicable on a mortgage. This would at least help assess the personal credit risk element. Surely giving 200k to someone who has earned 150k for the last 3 years is lower risk than giving it to someone who has earned 75k.
 
Brendan,

I always wonder when the statistic of 10% of loans are more than 90 days in arrears or 14.8% of the total loan book what that actually means.

Arrears: Total mortgage arrears cases outstanding: 110,366 20,206,883 2,535,622
____________________No Balance Arrears
In arrears up to 90 days 31,667 4,679,496 50,413
In arrears 91 to 180 days 9,039 1,451,626 44,317
In arrears 181 to 360 days 12,565 2,178,977 123,885
In arrears 361 to 720 days 19,317 3,654,465 374,671
In arrears over 720 days 37,778 8,242,319 1,942,336
 
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Hi Joe

If every borrower had the same sized mortgage, 15% of loans would account for 15% of the amount lent.

But bigger loans are more likely to be in arrears, so 10% of loans accounts for 15% of the total amount lent.
 
Brendan,

I suppose my point is that arrears of more than 90 day is a very wide term, the bulk are in the more than 361 days at €11,896m.
 
Why would "unsustainably low rates" lead to a recurrence of non-performing loans? Surely the high rates are increasing the likelihood of a recurrence of non-performing loans?

I am still working my way through the report and have found the following on page 23

Much of the research which explores the drivers of arrears highlights that increases in repayment burdens and debt service ratios lead to increases in arrears through higher interest rates (Lydon and McCarthy, 2013; McCarthy, 2014). If fact, there is evidence to suggest that such effects are much larger than those of house price changes, in particular for very long term arrears cases (Kelly and McCann, 2015). While appropriate risk pricing is required to ensure banks build buffers against future defaults, if a lack of competition leads to increases in interest rates for borrowers, this can directly lead to elevated arrears rates. This is particularly important in a highly indebted economy
like Ireland.


In other words, higher interest rates lead to greater arrears.