Repaying Mortgages in BOI

The annual reports of Bank of Ireland gives some insight into the changes in mortgage balances on their accounts. The 2012 interim report has tables that report the balance outstanding on mortgage accounts (both owner-occupier and buy-to-let) by year of origination at the end of 2011 and the end of 2012.  See section on mortgages beginning on page 321.  The figures in Table 2 from both years are reproduced here.

For example, using the first row of figures we can see that at the end of 2011, BOI had €123 million of outstanding mortgages which had originated before 1996.  The Dec 2012 column shows that repayments during 2012 reduced the outstanding balance on these mortgages to €94 million.  Thus €29 million or 23.6% was paid off the balances of these mortgages.

In 2012, the total amount of mortgage credit issued in Ireland by BOI fell by €369 million or 1.3%.  However, if we account for the €981 million of mortgages that originated from 2012 this means that of €27,854 million of mortgage debt outstanding at December 2011, €1,350 million was repaid during 2012.

The reduction in the outstanding balance could be due to:

• repayments on the existing loan
• re-mortgages to a new loan or new provider
• write-downs on the existing loan

It is likely that the first of these is the main source of the balance reduction in BOI mortgages.  This means that around 4.9% of the outstanding mortgage balance that BOI had at the end of 2011 was paid off during 2012.

On a simple straight-line basis this would mean that the stock of debt could be fully paid off in 20 years, however, over time the capital portion of repayments will increase as the interest due falls (due to capital repayments). 

This would suggest that the average duration of BOI’s mortgage book given the current repayment pattern is around 15 years.  This is pretty standard.

Of course, averages can be misleading.  There will be some mortgages which will be repaid much quicker than that, many others which will require much longer and others which will likely never be repaid at all.

The report doesn’t provide the amount of arrears owing on the mortgage accounts.  What we can see is that during 2012 around €1.3 billion of capital repayments were made on BOI mortgages.  During the same period mortgages with a total balance of €0.9 billion fell in arrears of more than 90 days, bringing the total to €3.6 billion.  The amount of missed payments (capital plus interest) is significantly smaller than the amount of capital payments made.

Unmodified Mortgages

The latest mortgage arrears statistics from the Financial Regulator show that there were 83,000 mortgage accounts in arrears of 90 days or more in June 2012.  The numbers on modified mortgages show that 45,000 of these have been adjusted in some way.  We looked at those in an earlier post and saw that around 75% of modified loans are meeting the revised commitments under the restructuring.

What about the other 38,000 of mortgages with 90 day arrears, those that are in arrears but haven’t being restructured?  Is anything being done for them?

From the way the arrears statistics are presented it is impossible to tell how much distress these accounts are in.  As the explanatory notes say:

The arrears figures denote the value of arrears (payments not received by the contractual due date) expressed as equivalent days past due. Partial payments received from borrowers will be credited to the oldest arrears amount which will have the effect of reducing the balance of arrears.

Arrears of over 90 days past due do not necessarily signify that borrowers have not made mortgage repayments for the last three months. For example, a borrower can be making partial repayments on a monthly basis but may still be in arrears of a value equivalent to over 90 days past due. In the same way, arrears of over 180 days past due does not necessarily signify that borrowers have not made mortgage repayments for the last six months.

At the recent Finance Committee sessions with the AIB and BOI the emphasis of the mortgage arrears discussions was on modified mortgages as highlighted in the earlier post.  The 38,000 unmodified loans are likely to contain some borrowers who have entered arrears by missing some payments in the past, but have now resumed making full payments without clearing the accumulated arrears.  This might describe some of the cases but it could be very few.

Here are some indicators on the mortgages that are more than 180 days in arrears.

The number of accounts in this category has increased each quarter since the statistics began.  The inflow peaked in Q4 2011 at 6,749 and has fallen slightly in each of the last two quarters.

Unsurprisingly, as the number of accounts in this category has increased the total amount of arrears owing on them has increased and is now nearly €1.4 billion.  However, the pattern in the average arrears owing per account is less consistent.  By Q2 2011 the average arrears was nearly €21,500.  This group are significantly behind on their mortgage payments and these arrears cannot be allowed to accumulate indefinitely.

The question is whether these arrears are still accumulating. In 2010 and up to the middle of 2011 the average arrears amount was showing an annual increase of around 10%.  Since then this is moderated significantly and in the past two quarters there has been a annual reduction in the average arrears amount.

What does this tell us about mortgages in this category?  Very little.  The average arrears will be brought down by the new entrants to the category who will have arrears just over the lower limit of six months, while continued deterioration in the performance of those already in the category will push the average arrears up. 

It is also the case that the most extreme cases could have had their arrears capitalised into the principal.  In June 2011 there were 8,994 mortgage accounts that had arrears capitalisation applied to them.  By June 2012 that had increased to 10,228.

Also it is clear that something happened in Q4 2011 when the increase in arrears was €80 million.  In each of the three preceding quarters and in the two subsequent quarters the increase averaged €130 million.

The key point is that the arrears statistics don’t tell us what is happening to mortgage accounts now.  The overall trend clearly indicates that things are getting worse, and they will continue to do so, but it impossible to gauge from the arrears statistics how many borrowers are in distress now. 

We know that around 75% of the 85,000 modified mortgages are performing in line with the new arrangements provided for them.  We don’t know anything about the performance of the 38,000 mortgages with 90 day arrears that have not being modified.

What we need is a measure that tells us whether the monthly interest charge on the mortgage is being covered now, not a historical measure of performance relative to somewhat arbitrary contract obligations.  The “who is in arrears?” question in this post highlights the problems with using arrears as a measure of distress.

Modifying Mortgages

The latest mortgage arrears statistics from the Financial Regulator show that 84,941 of mortgage accounts have had their terms modified in some way.  Of these, 40,221 of these are recorded as not being in arrears and 44,720 are listed as being in arrears.  The numbers here are taken from slide 9 from Fiona Muldoon’s recent presentation to the Irish Banking Federation.

It is commonly stated that this means that the almost 45,000 mortgages recorded as being in arrears after a restructuring "have fallen back into arrears" post the restructuring.  There  are many examples of reports like the following:

Furthermore, 84,941 mortgages have been classified as restructured at the end of June, which was a 6.6% increase on the 79,712 restructured at the end of March. Of the total restructured mortgages, 44,720 had fallen back into arrears of more and less than 90 days. The remaining 40,221 were sticking to the restructured terms.

This is not true.  In reality the splitting of modified mortgages in those in arrears and not in arrears tells us very little.  The 45,000 will include mortgages which have fallen back into arrears after a restructuring, but it also includes mortgages that had arrears on them before the restructuring which was not cleared.

If an account is in arrears and the amount of these arrears are not cleared when the account is restructured then the account continues to be counted as being in arrears.  This will be the case even if the borrower fully meets the adjusted payment obligation.  The borrower has not fallen back into arrears; they just have not made good on the arrears they accumulated before the restructure.  This is confirmed in the notes accompanying the release from the Financial Regulator:

Restructured accounts in arrears include accounts that were in arrears prior to restructuring where the arrears balance has not yet been eliminated, as well as accounts that are in arrears on the current restructuring arrangement.

Recent statements from the banks at the Oireachtas Finance Committee indicate that for AIB/EBS and BOI something around 75% of modified loans are performing in line with the revised terms. From AIB:

“Between 69% and 70% of our 33,700 customers who are in forbearance are affording the new restructured loans we have put them into.”

And BOI:

“We have more than 16,000 customers who are currently subject to mortgage forbearance or who have had their mortgages restructured. Our mortgage forbearance and mortgage restructures are based on customers who can meet, in our estimation and theirs, at least the full interest on their mortgages. Some 86% of those customers who are subject to forbearance or restructuring are fully meeting the revised arrangements.”

Between them they account for 50,000 of the modified loans and 37,500 are satisfying the terms of the modification.  All other banks have 35,000 modified loans and 95% of these would have to be underperforming the new conditions if the “fallen back into arrears” description of the Financial Regulator’s statistics is to be true.  It is not and it is likely that 60,000 or so of the 85,000 modified mortgages are performing in line with the revised terms.

That is not to suggest that these modifications will be successful.  Around half of the modifications involve a payment moratorium (4%), a payment less than the monthly interest charge (15%) or a move to an interest-only repayment (35%).  The majority of these borrowers may be performing in line with the adjusted terms but these changes can only be a short-term stop-gap solution. 

These modifications can offer relief to a borrower in temporary difficulty but unless the borrower can resume paying the full interest and at least some capital they will not be effective in the long run.

For borrowers with longer-term problems the forbearance modifications that have to be considered are (in increasing order of effectiveness):

1. term extensions (for those with remaining terms of less than 20 years),
2. interest forbearance (lower interest rates for non-tracker rate borrowers) and
3. principal forbearance (split mortgages with no interest on the shelved portion).

It is noteworthy that the latter two are not in the current list of modifications reported by the Financial Regulator.  The final one has been proposed on here since at least November 2010.  These will cost money but the cost of default would be even greater.  Unless borrowers are put on a manageable path in the medium term of making interest and some capital repayments the mortgage will not be sustainable.

The objective of the restructuring has to be to establish a capital and interest repayment that is below a certain income threshold.  This doesn’t have to happen immediately but there has to be a reasonable probability that this can be achieved. 

There is of course a fourth modification that could be used to reduce the monthly repayment: principal forgiveness.  There has been plenty of other discussion about that one.

If the mortgage cannot be modified to create the reasonable expectation of full interest payments and at least some regular capital repayments in the medium term then the mortgage is likely to be unsustainable.  Such mortgages should be ended via formal repossession or schemes such as Mortgage-to-Rent.  If the banks are left with a shortfall after setting the value of the surrendered house against the mortgage, this balance should be written off after a short period.

Mortgage Arrears as a Measure of Distress

There are 22% of mortgage accounts exhibiting some form of difficulty according to the latest mortgage arrears statistics published by the Financial Regulator.

The mortgage crisis a huge problem (c. 130,000 households) and is not new, but 78% of mortgage borrowers are meeting their mortgage commitments according to the original terms.  These number almost 470,000 households.   The number of households in the table above is estimated using the fact that the average number of mortgage accounts per household with a mortgage is 1.27.

There are also 580,000 households who own their homes outright with no mortgage liability and 450,000 who rent from local authorities or private landlords.  Of the 1,700,000 million households in Ireland, around 1 in 13 are in mortgage difficulty.

From the bank’s perspective the key measure is not the number of households but the proportion of the loan book that is in distress.  It can be seen that over 27% of mortgages by balance have been modified or are in arrears.

Here is a set of five representative borrowers who each begin the year with a starting balance of €100,000 on their mortgage. 

They all have loans with an interest rate of 4% resulting in an opening monthly interest charge of €333.  The borrowers are making monthly repayments of nil to €823.  The closing balance is the principal after 12 months and the current monthly interest is the monthly interest charged on their mortgages after 12 months of these repayments.

Which of these borrowers is in the most mortgage distress?  Which of these borrowers are in mortgage arrears?  Are these the same question? Look at the five borrowers above and then check below the fold to see who is in arrears.

The only one in mortgage arrears is Borrower Five.  This is the borrower who is making the largest monthly repayment and has repaid the largest amount of the opening balance.  This borrower is in arrears because the original contracts specifies that the remaining €100,000 balance should be paid in ten years.

Borrower One who has seen the balance owing rise by €4,000 and now has an increased monthly interest charge is clearly the borrower exhibiting the greatest distress.  However they have been granted a payment moratorium by the lender, and thus are not in arrears even though no repayments are being made. 

The latest release from the Financial Regulator shows that a payment moratorium has been granted on 3,180 mortgage accounts.  The release doesn’t say how many of these are in the arrears figures but if there borrowers in this group not in arrears it is still the case that they are in severe difficulty.

Being in arrears does not tell us anything about what is happening to the mortgage account now.  A borrower could have missed three full payments in the early part of 2010 but has resumed making full payments for the past two and a half years.  This borrower is three months in arrears but is unlikely to be much concern to the lender.

A borrower could have reduced their payment to 87.5% of the required payment two years ago.  Over the course of those two years they will now be the equivalent of  three full payments in arrears (24 x 0.125 = 3) but again this borrower is unlikely to be flagged as a major concern.

The arrears statistics excludes borrowers who are not in arrears because they have been granted a payment moratorium but are likely in severe difficulty. It includes borrowers who are classed as in arrears but who are now making their full repayments or close to it.

The arrears statistics are important and the quarterly changes are a very strong indication of the deteriorating nature of the mortgage situation.  However, the statistics are not necessarily the best indicator of the extent of borrower distress.

A truer level of distress, would not be payment arrears relative to somewhat arbitrary contract obligations, but a measure of accounts where the monthly interest charge is not being covered by the monthly repayment.  People should not be classed as in mortgage distress because of the length of their term.  Borrowers are in mortgage distress if they cannot service their mortgage.

Borrowers are definitely in severe mortgage distress if the balance owing on their mortgage is increasing and are almost certainly in mortgage distress if the balance is non-reducing.  Borrowers making only occasional inroads in reducing their outstanding balance may be in distress. 

The key issue is the persistence of these problems.  Temporary difficulties for six or nine months in a contract that was due to last 300 months (25 years) should not be a source of terminal concern.  In their 2011 Annual Accounts, BOI said that 98% of borrowers with rescheduled mortgages were making interest only payments or greater (see page 75).

There are borrowers in huge difficulty, who cannot, and are unlikely to be able to, meet the monthly interest charge on their mortgage for a period of years.  If the interest on a mortgage cannot be covered for an extended period, with no sign of a recovery, then that is an unsustainable mortgage which should be ended. 

Repossessions and Mortgage-to-Rent need to gain wider acceptance as solutions of the mortgage problems we face.  In increasing order of effectiveness, term extensions (for those with remaining terms of less than 20 years), lower interest rates (for non-tracker rate borrowers) and split mortgages (with no interest accruing on the shelved portion) can help borrowers who need some assistance but who can avoid repossession. 

Forbearance measures and repossessions are the solution to the mortgage crisis.  It is likely that these will be on a ratio of around four-to-one across maybe 100,000 households.  There is no need to complicate it further.

Reducing Mortgage Balances

The previous post looked at the household balance sheet and the declining levels of household debt in particular.  At the end of 2011, the household balance sheet has €179 billion of loans.  This can roughly be broken down as:

One aside of the above table relates the graph of debt-to-gross disposable income for the household sector at the end of the previous post.  As can be seen above about one-fifth of the debt in the household sector relates to buy-to-let mortgages.  These debts are not dependent on gross disposable income to be serviced; they are dependent on rental income.  These are not typical household debts; they are business or investment debts.

The buy-to-let sector will come into focus in the next few weeks with the first official release of arrears statistics from the central bank.  The sector is apparently in turmoil (see slide 7).  Apparently, because in Census 2006 there were 145,000 recorded as renting from private landlords while in Census 2011 the equivalent figure is that 305,000 households are now renting from private landlords.  There are more thoughts in the BTL sector in this comment.

The focus here is on the largest item of household debt; owner-occupied residential mortgages.  The Financial Regulator has been providing mortgage arrears statistics since the third quarter of 2009.  The following table combines this with data on mortgage lending from the Irish Banking Federation.

At the start of the mortgage arrears statistics in the Q3 2009, the aggregate balance on all owner-occupied mortgages was €118.7 billion.  In the 11 quarters since this balance has fallen by €6.7 billion to €112.0 billion.

This alone does not reflect capital repayments by borrowers as additional lending by new and existing borrowers will offset these repayments.  The IBF dataset breaks down owner-occupied mortgage lending into four categories.  Here they are with the amount of lending that has taken place since Q4 2009:

• First-time buyers: €4.3 billion
• Mortgage top-ups: €0.9 billion
• Mover-purchasers: €3.4 billion
• Remortgages: €0.9 billion

The first two are unambiguously new lending and are summed in the column labelled ‘New’ lending in the table.  Payments by existing borrowers must exceed these new drawdowns to reduce the overall balance outstanding.

The latter two are less clear cut. It is impossible to tell if mover-purchasers lead to an increase in mortgage debt.  This depends on whether they sell they existing home and on whether the new loan is greater than than the original loan.  Remortgages won’t reduce the amount of debt but it is impossible to tell if they increase it.   These are summed in the column labelled ‘Other’ lending and to be conservative it is assumed that they add nothing to new lending.

The Capital Repayments column is thus made up of the reduction in the overall outstanding balance and new lending to first-time buyers and top-ups.  With no allowance made for mover-purchasers or remortgages this is likely to be lower limit of actual repayments.

In this case there has been nearly €12 billion of capital reducing payments made in less than three years, an average rate of almost €1.1 billion per quarter.

At the start of the arrears statistics in Q3 2009, the total amount of arrears that had accumulated at that time was €354 million.  Since then it has risen to €1,439 million, an increase of €1,084 million.

The €1.1 billion rise in arrears in the 11 quarters since Q3 2009 is equivalent to the average amount of capital repayments that takes place in one quarter.  Also, the arrears figure includes arrears on capital and interest repayments on the mortgage.  Using the retail interest rates data from the Central Bank we can roughly gauge the interest component on mortgage repayments:

We can see that since September 2009 households have made repayments of around €21 billion on their home mortgages.  This is 20 times greater than the arrears that have accumulated over the same period.

This is not to dismiss the severe distress that thousands of households are suffering as a result of excessive mortgage debt.  There are huge difficulties and addressing these has to be a priority.  But there are many more households meeting their mortgage commitments.

Defusing ‘The Mortgage Timebomb’

In this weekend’s Sunday Business Post, commentator David McWilliams has an article under the title “It’s time to defuse the mortgage timebomb”.  The piece concludes with:

“In addition, the longer this goes on, the more the banks become zombie banks incapable of breathing credit into the market.  A deal must be done right now.

The banks set aside €16 billion in the last capitalisation round to cover bank loans in the residential market.  Taking the total mortgage lending book of €112 billion, the implied total default on the entire book is where we are now in terms of arrears, 16 per cent.  However, not all these arrears will be total write-offs, so there is enough cash in the tank now to do a debt for equity at 50/50 right now.  The gives the punter a break and the bank an upside option over time.

But maybe the reason the banks have been tardy in moving – after all, they were dressed down by the Central Bank last week – is that they think €16 billion isn’t enough.  If it isn’t, we need to go back to Frankfurt and come up with a figure that covers all bases and say to the ECB: “We need more cash and you will have to cough up”.

We know the Germans need a success in Ireland.  We know that we can only have success if the total banking problem is solved, and we know that the pending mortgage crisis has not been addressed yet.

Wouldn’t it be sensible to put it all in one big bang solution?”

The trouble with “big bang” or soundbite solutions is that they are rarely effective for complex problems.  At the top-level it seems the problem in the residential mortgage crisis is simple – too much debt – but there are a number of subtle complexities that mean top-level solutions will be ineffective.

At the end of June this year, the total amount of residential mortgages in Ireland was just under €112 billion.  This is down from €119 billion in September 2009.

The banks did not “set aside €16 billion in the last capitalisation round to cover bank loans in the residential market”.  Table 9 on page 21 of the stress tests document from March 2011 shows that the consultants BlackRock Solutions estimated that the banks could make total lifetime losses of €10.2 billion on their Irish residential mortgage book in the adverse scenario.  The Central Bank took this total adverse scenario loss over the next two decades or so  and estimated that there would be €5.7 billion of losses in the three-year horizon used for the recapitalisation calculation. 

The stress tests included €5.7 billion for the recapitalisation of the banks due to losses on their owner-occupied mortgages in Ireland.  This is a long way from €16 billion.

Table 9 also shows that the €5.7 billion was 7.6% of the December 2010 loan book on which the loss estimates were based.  Assuming a conservation average recovery rate of 50% on the defaulted mortgages this means an estimated default rate of 15.2% on residential mortgages.

This 7.6% figure also means that the total amount of residential mortgages looked at the stress tests was just under €75 billion.  This is confirmed in Table 7 which puts the Irish owner-occupied mortgage book for the stress tests at €74.4 billion.  Separate data from the Central Bank show that there was €116.7 billion of owner-occupied mortgages outstanding in Ireland at the end of 2010.

This is one of the subtle complexities that can sometimes be ignored.  The March 2011 stress tests concerned only four banks – the four viable covered banks – BOI, AIB, PTSB and EBS.  The non-viable covered banks, Anglo and INBS, as well as all the non-covered banks such Ulster Bank, National Irish Bank, KBC and the now-defunct Bank of Scotland (Ireland) were excluded.  The stress tests also excluded sub-prime mortgage lenders such as Start Mortgages. 

One-third of the Irish residential mortgage market is outside the covered banks.  Any top-level solution must be applicable to both the covered and non-covered banks.

The solution proposed is that “there is enough cash in the tank now to do a debt for equity at 50/50 right now”.  Any debt-for-equity proposal has very little going for it as a solution to the mortgage crisis in Ireland.  The problem with it is that in the most severe cases there is no equity to swap for.  The most severe cases are those who are in the double bind of significant mortgage arrears and substantial negative equity.

Consider the case of an arrears household with a €300,000 mortgage outstanding on a house with an estimated value of €200,000.  Assume now that the bank does a debt-for-equity swap on €100,000 of the loan.  This involves the bank reducing the mortgage by €100,000 in return for 50% equity in the house (€100,000/€200,000 = 0.5).

This might improve the arrears situation as the household now needs to service a mortgage of €200,000.  However, the value of the asset supporting the loan has also fallen and 50% of the house means they have an asset worth €100,000.  The household are still €100,000 in negative equity.

In the original scenario, assuming no capital repayments on the €300,000 mortgage, they would need nominal house prices to rise by 50% (€200,000 x 1.5 = €300,000) to eliminate their negative equity. 

After the debt-for-equity swap with a €200,000 mortgage and a 50% stake in the house they would need nominal house prices to rise by 100% (0.5 x (€200,000 x 2) = €200,000) to eliminate their negative equity.

The question the household must answer before accepting this proposal is whether it better to repay €300,000 on an asset worth €200,000 or to repay €200,000 on an asset worth €100,000? 

In the first case every €100 of capital repaid gets them €66 of the asset.  In the second case every €100 of capital repaid gets them €50 of the asset.  Neither is great, and in time, nominal price growth would reduce this negative equity gap, but I know which one is better.

The only way a debt-for-equity swap can offer anything to these households is if it is not a debt-for-equity swap at all.  Assume instead that the bank writes down the mortgage by €200,000 in return for a 50% stake in the house. 

After this the household is left with a €100,000 mortgage and their 50% of the house is also worth €100,000.  They have no negative equity and a much smaller mortgage to service.  The household also gets 100% of the use of the house with only half the ownership so it is win-win-win for the household.

However, from the banks’ perspective a €200,000 asset has been written off the original mortgage and in return the bank has received a stake in the house worth €100,000.  The bank has paid €200,000 for something worth €100,000.  The bank is in negative equity.  Also unless they can charge rent, their 50% ownership stake is worth much less than €100,000. The bank will also be being interest on the €200,000 money used to “buy” this asset.  For the bank it is lose-lose-lose.

The banks are going to make substantial losses on the mortgages they provided during the boom years that are now unsustainable but this sort of 2 debt-for-1 equity swap is little more than debt forgiveness in fancy dress.

Cases between these two extremes can be considered such as a €150,000 mortgage reduction for a €100,000 stake in the house.  The is equivalent the 50/50 proposal suggested by McWilliams as it involves a 50% writedown in the mortgage in return for a 50% stake in the house. 

It is easy to work through the numbers for this as above and it would be seen that this proposal doesn’t eliminate the problems for the households and the banks but it does split them more evenly between them.  Most of the problems persist and in cases where there is no equity a debt-for-equity swap cannot solve them.

The key problem that needs to be addressed in the Irish mortgage crisis is the problem of unsustainable mortgages.  Writing almost a year ago I said:

The group that are in real danger are those who are in negative equity and in mortgage arrears. Using September 2011 house prices this group is estimated to be contain between 25,000 and 37,500 households. The deteriorating trend in house prices and mortgage arrears means the number of households in danger will increase.

However, it is likely that some people in this group will be able to get back on track but it is undeniable that there are many borrowers who have unsustainable mortgages – loans that will never be repaid.

Some commentators have claimed that there are 200,000 mortgages in serious trouble. There are not. There are many mortgages in some trouble, but there are probably around 20,000 to 30,000 households in serious trouble who need a dramatic intervention.

These unsustainable mortgages will never be repaid no matter what short-term forbearance measures are provided by the banks.  The losses on these mortgages need to be faced up to.  This can only be achieved in one of two ways:

1. The house is surrendered and the realisable value of the house is set against the mortgage balance.  There will be a shortfall, and in some cases it will be substantial, but it should written off in no more than two or three years and the person allowed make a fresh start.
2. The current mortgage is written down to a level the borrower can afford.

It is up to the banks to choose which of these options they use but they must use one of them because no matter how long they wait the money will not be repaid.  The losses are there and must be faced up to.

Option 1 involves repossessions but is objective and there is little doubt that repossessions will have to form a greater part to the solution of this crisis.  Option 2 is subjective and may distort the incentives for other participants in the market.  The non-covered banks can use whichever option they want but the covered banks must also take into account the owner of the capital that these losses will erode.

For people who are in arrears but who, in time, will be able to meet their mortgage commitments a suite of measures can be offered to help them.  These include relatively straight-forward things such as interest-only periods and term extensions etc. and more involved measures such as split- mortgages and debt-for-equity swaps for those in positive equity.  In many cases these will be sufficient to allow people to get back ‘on track’.

The key issues have got to be to reduce the pressure on those who are struggling with their mortgage repayments now and to identify those who have unsustainable mortgages which will never be repaid.  This is not easy and a “big bang” solution will not address the complexities involved.  Although written nearly 12 months ago the piece for the Irish Independent linked above highlights some of these complexities and is still relevant now.

Fitch on Mortgages

A report on the Irish mortgage market has attracted a lot of attention and in particular one projection contained in it.

• RTE News: One fifth of mortgages expected to default, Fitch
• Irish Times: 20% of Irish mortgages to default, predicts Fitch

These reports accurately reflect the press statement released by Fitch.  However, in an examination of the full report it is difficult to find the projection that 20% of mortgages (owner-occupied and buy-to-let) are expected to default.   Here is the first ‘key highlight’ on page 1:

Increased Foreclosure Frequency Expectations: The foreclosure Frequency (FF) assumptions for ‘Bsf’ and ‘AAsf’ rating categories have been adjusted upwards, due to worse-than-expected mortgage and house price performance. The ‘Bsf’ base FF for a standard mortgage portfolio has been increased to 10.0% from about 7.5%. The ‘AAsf’ base FF assumption is now 25%, up from 15% in the 2011 criteria.

To explain this a bit on page 6 we are told a bit more about the base foreclosure frequency expectations:

The expected FFs at the ‘Bsf‘ rating level, [.], reflect the default risk of an Irish residential mortgage loan with the following characteristics (‘standard loan‘):

• loan is not in arrears;
• full-time employed borrower with full income verification and no adverse credit history;
• amortising loan paying monthly; and
• loan purpose consisting of purchase/refinancing of the primary residence.

Thus, Fitch have increased their default expectation on what would be considered currently performing loans to 10%.  Fitch then adjust the foreclosure frequency from this base level of 10% based on the characteristics of the loan.  For example, loans with a poorer performance will be assigned higher default expectations.  The table on page 12 reflects this.

The base category for performing loans is reflected in the 10% figure in the bottom left hand corner.  The increase in the default expectations can be seen by moving out along the row.  At the end of the row it can be seen that there is a default expectation of 70% for loans that are more than 3 months in arrears. 

The rows further up the table reflect different risk scenarios with the highest risk ‘AAsf’ scenario is “commensurate with a severe continued economic downturn” which includes a “peak-to-trough house price decline assumption is 72%”.  Fitch believes this and other assumptions are “sufficiently remote” for this high rating scenario.  In the ‘AAsf’ the base foreclosure frequency used is 2.5 times that in the ‘Bsf’ scenario, i.e 25%.  The intermediate risk scenarios have multiples of 1.1, 1.6 and 2.1 for their base foreclosure frequency on the ‘Bsf’ rate.

Fitch also make adjustments based on the original loan-to-value of the mortgage and a debt-to-income ratio based on an imputed monthly repayment and monthly net income of the borrower (at the time the loan was taken out).

For example, the foreclosure frequency for borrowers with an original loan-to-value of 75% and a monthly repayment which consumers between 30% and 40% of their net income is expected to be 8.1%.  The highest risk loans are clearly those with the highest original loan-to-values (now more than likely in significant negative equity) and the highest repayments relative to their income.

The imputed monthly repayment used to calculate the debt-to-income ratio could be a little high as the interest rate used is the “higher of 5.0% plus stabilised margin or the current Euribor rate plus stabilised margin”.  With about half of Irish mortgages on ECB tracker rates the current rates are far lower than the equilibrium rate used by Fitch. 

The ECB rate is not going to stay at the current lows but it will be some time before it is 5%+.  This won’t change the relative risk of borrowers and is primarily used to put the borrowers into different debt-to-income classes.  The default probabilities are also calculated using the base 10% foreclosure frequency as the starting point.

Fitch also make adjustments to the foreclosure frequency using a wide variety of other factors:

• Self-employed with/without verified income
• Prior bankruptcy or court judgement
• Interest only loan
• Payment holidays/restructured loans

Fitch don’t use an institution factor to distinguish between the banks.  Although all mortgages are relevant only those in the covered banks will have an impact on the government’s accounts.  The covered banks make up two-thirds of the Irish mortgage market and have a lower rate of arrears than the non-covered banks.

In last March’s stress tests carried out on the covered banks for the Central Bank, the base scenario used by BlackRock Consultants projected lifetime losses for the covered banks on the Irish mortgages of €9.7 billion.   This was a 10% loss on the €97.5 billion of losses that were on their books at the time of the stress tests.   Assuming a 50% recovery rate on defaulted mortgages this would be equivalent to a 20% foreclosure frequency.

The expected scenario of 20% mortgage defaults reported by Fitch yesterday is very similar to the base scenario used in the stress tests last March.  In fact, under the stress tests the banks were recapitalised to satisfy an adverse scenario with a 16.7% lifetime loss rate, implying a default rate of nearly 35% of the loan book, well in excess of the rate expected by Fitch.  As a result of last year’s recapitalisation the banks were covered for “three-year losses” under the adverse scenario and these were projected to be equivalent to 9.2% of the loan book.

The full document released by Fitch collates a lot of frequently used data on Irish mortgages and is an interesting read. We don’t get the details but it is clear that the headline 20% overall default rate for Irish mortgages is possible given the starting 10% default rate for ‘standard’ or performing loans in their expected scenario.

Mortgage Arrears in the Covered Banks

The release over the past few weeks of the Financial Reports of the covered banks has given a useful insight into the mortgage books of the covered banks.  All have generally followed the same template and have provided similar detail.

• AIB (+EBS) (pp. 112-122)
• BOI (pp. 87-102)
• PTSB (pp. 171-177)
• IBRC (pp. 169-173)

Here is a summary of the headline figures.

The full market figures come from the Financial Regulator’s Mortgage Arrears release.  The figure for the non-covered banks (Ulster Bank, National Irish Bank and other lenders) is the residual after the reported totals for the covered banks are subtracted.

It can be seen that there is a wide variation in the loan book performance for owner-occupied mortgages in Ireland across the covered banks.  AIB report the lowest level of arrears of 90 days or more with the highest level by far in the mortgage book of Irish Nationwide which has been subsumed into the Irish Bank Resolution Corporation.

The loss provisions follow a similar pattern with AIB allowing for a loss equal to 1.6% of the mortgage balances at the end of December.  The IBRC have allowed for a loss of over 20% on its owner-occupied residential mortgage book.

The level of arrears is higher in the non-covered banks and they make up about 35% of the market by mortgage balance.

Here is the projected stress-case loss rates from last March’s stress tests and the losses covered under the Central Bank’s three-year loss forecast on which the €24 billion recapitalisation sum was based.  Note that the figures in the stress tests relate to the 31st of December 2010 rather than the end of 2011 as with the figures above.

There is some disagreement between the tables.  Outside of the Irish Nationwide loans, AIB has the highest projected loss rate.  The projected losses are still significantly above the provisions currently being made by the banks.

BOI: An insight into mortgages

The annual results for 2011 published by Bank of Ireland earlier in the week provide a interesting insight into the detail of the mortgage market in Ireland.  The detail from pages 67 to 82 is something that has rarely been made available.

The Q4 2011 update of the Financial Regulator’s Mortgage Arrears Statistics showed that there was €113,477 million of owner-occupied mortgages in Ireland and that 12.3% by loan amount are in arrears of 90 days or more with 5.4% also by loan balance having been restructured in some way and not in arrears.  The figure for arrears under 90 days are not provided but it is likely that somewhere close to 25% of owner-occupied mortgages by balance have experienced some difficulty.

Here are the equivalent figures for Bank of Ireland’s Irish owner-occupied mortgage book.

Bank of Ireland has 18.4% of all owner-occupied mortgages in Ireland.  We can see that the levels of distress of significantly below those seen for the market as a whole.  In BOI, 7.4% of mortgages by balance are in arrears of 90 days or more compared to 13.4% for all other lenders in the market.

The restructured mortgages includes mortgages which may be less than 90 days in arrears so about 85% of Bank of Ireland’s mortgages are currently being repaid according to the original terms of the mortgage.  There are huge problems in the mortgage market in Ireland but BOI is still in the position of having 17 out of every 20 mortgages being repaid on time.  And it is also noteworthy that the bank says that among all restructured mortgages

“98% of this balance are paying interest only or greater on their balances.
16% are paying full principal and interest having had their mortgage term extended.”

A mortgage will be in arrears if a monthly payment is partially or fully missed.  A mortgage that is 90 days in arrears is the equivalent of three monthly payments in arrears, i.e. it would take the payment of a lump-sum equal to three monthly payments to bring the mortgage back on schedule. 

A mortgage can be 90 days in arrears if 75% of the agreed monthly payment has been made each month for a year.  The mortgage has not had a full payment made in 360 days but is the equivalent of three monthly payments or 90 days in arrears. 

A mortgage will also be 90 days in arrears if three full monthly payments are missed at any stage.  For example, if a mortgage had nothing paid on it between January to March 2011 and has had every monthly payment made in full since then it will be 90 days in arrears even though full payments have been made for the past year.

It is likely that there are very few mortgages on which nothing is being paid.  The majority of mortgages are likely to be in arrears because only partial payments were made or a number of payments were missed in full for a period.  There are likely some mortgages which are classed as being in arrears but full payments have resumed but the arrears continue to be outstanding.

The report also provides some useful insights into these figures.  Of the €2,405 million of owner-occupied mortgages that in some form of arrears, €582 million are impaired and have some loss provision made against them up from €440 million at the end of 2010.  Somewhat interesting is part of the explanation given for this increase in non-performing loans.  At the start the report says that “this increase is primarily attributed to the general economic downturn in Ireland and affordability issues including falling disposable incomes and high unemployment levels” but then adds:

In addition to the factors mentioned above, the increase in past due and impaired since August 2011 appear to have been impacted by the implementation of the new code of conduct on arrears and the considerable public speculation about potential Government policy measures regarding customers in arrears.

Of the €1,823 million of mortgages which are more than 30 days in arrears and not impaired, Bank of Ireland estimates using initial values and subsequent CSO and ESRI house price data that €778 million of the delinquent loans have properties that are not in negative equity.  This indicates that if these mortgages do default, the capacity for them to generate losses for the banks is limited as the secured collateral exceeds the size of the loan.  The current trajectory of house prices suggests that this will likely deteriorate.

There is €1,045 million of non-impaired mortgages in arrears and negative equity.  BOI estimate that the total negative equity on these loans is €261 million.  The loan-t0-value of these loans is 133%.

BOI has €582 million of owner-occupied mortgages that are impaired and estimates that these mortgages have €171 million of negative equity.  The loan-to-value of the impaired mortgages is 142%.

If all the €1,627 million of the owner-occupied mortgages which are impaired or both in arrears and negative equity were defaulted on then BOI estimates that the value of the properties secured against those loans would leave a shortfall of €432 million.  With costs and other issues it is likely that BOI would be looking at a loss of around €500 million if all mortgages currently in danger were to default.

As it is BOI has made a provision of €489 million against its owner-occupied mortgage book in Ireland.  This seems appropriate given the current level of arrears, impairments and house prices.  With most of these measures set to deteriorate it is likely that this provision, and subsequent actual losses, will increase.

The banking stress tests from last March provided for €2,075 million of lifetime loan losses on BOI’s owner-occupied mortgage book in Ireland under the stress scenario with €1,115 million of those projected to occur in the three-years from 2011-2013.

The annual report does not tell us the level of actual losses BOI incurred on its owner-occupied mortgage book in 2011.  Bank of Ireland has a policy of no debt write downs for mortgage holders. 

During 2011, BOI repossessed 90 owner-occupied homes.  The number of owner-occupied homes on its balance sheet increased from 65 to 99 during the year (up 34) and there was 56 disposals of repossessed owner-occupied homes during the year.  It is not clear what level of shortfall was left on these repossession (an average shortfall of €200,000 would leave a total of €18 million) or if the borrower is still liable for the shortfall. 

It is pretty clear that the level of owner-occupied mortgage losses in BOI is still significantly below the levels allowed for in the stress tests.  This will change as the 12 month moratorium for borrowers in the Mortgage Arrears Resolution Process will end in many cases but it could be 2013 until the measures in the Draft Personal Insolvency Bill become active. 

The report also gives an insight into the origination of the loans in BOI’s mortgage book.  This table includes the €21 billion of owner-occupied mortgages and some €7 billion of buy-to-let mortgages.  Click to enlarge.

Although mortgage arrears are clearly concentrated in loans that were issued between 2004 and 2008, there is arrears right across the loan book.  This means that the increase in Mortgage Interest Relief did not benefit all those who have fallen into arrears.  At a minimum around 27% of BOI’s mortgage accounts which are in arrears will not benefit from the increase in MIR as they did not originate between 2004 and 2008. 

The measure also excludes non-first-time buyers from between 2004 and 2008 so it is likely that only a fraction of BOI’s mortgage arrears accounts will benefit from the increased MIR.  It is also likely that many of those who gained were not in arrears and are now benefitting from increased interest relief and lower interest rates.

We also get an insight into negative equity and arrears by equity from this table.

In total, the loan-to-value of BOI’s owner-occupied loan book is estimated to be a rather convenient looking 100%.  The negative equity of the €10,567 million of loans with LTVs of greater than 100% is estimated to be €2,474 million.  The aggregate loan-to-value of the loans in negative equity is 131%.  On the other hand the aggregate loan-to-value of loans not in negative equity is 81%.  The final columns give the spread of arrears and impairment across the different LTVs.

Unsurprisingly, arrears and impairment are more likely amongst those loans that are in negative equity though almost one-third of those in arrears are not in negative equity.  The portion of the loan book that has a loan-to-value of more than 181% has arrears of 15.5% by loan balance compared to just 4.8% for all loans which are not in negative equity.

If the €2,474 million of negative equity on mortgages in BOI’s owner-occupied Irish mortgage book is representative of the overall market then, being 18.4% of the total market, this would imply that the level of negative equity in the residential mortgage market is around €13,500 million.  As BOI’s loan book is better performing than the rest of the market, and also has loans from before 2002 that newer entrants to the market do not have, this is likely to be an estimate from the lower range.

New Beginning Mortgage Proposal

We have previously looked at the mortgage proposal from the New Beginning group (here and here).  Revised details of the proposal have been circulated.  Following our previous analysis the key peace of information is that the interest rate on the example we worked through is 3.55% rather than the 4.29% that was assumed in the previous posts.

“Compound interest” is the answer attributed to Albert Einstein when apparently asked what he thought mankind’s greatest invention was.  Just three-quarters of a percentage point may seem like a small change but in a mortgage such a difference can have a massive effect.

Our initial assumption came from the fact that Ken’s repayment was given as €1,450 per month and that he had borrowed €315,000 over 35 years.  If you plug these into a mortgage calculator the required interest rate is 4.29%.  This was further supported when the starting payment of €840 was the interest-only payment on the non-shelved mortgage of €215,000 at 4.29%  but this appears to have been nothing more than a remarkable coincidence.

The updated information indicated that Ken’s actual mortgage payment is €1,387.61 per month rather than €1,450, that the interest rate is 3.55%.  It is still assumed the case that the €315,000 is to be paid off over 31 years.

If the interest rate was 4.29% it would take total payments of €570,000 to repay the full amount over 31 years under the conditions of a typical mortgage.  If the interest rate is 3.55% the same mortgage can be repaid with €520,000.

The New Beginning proposal is that Ken’s monthly payment be immediately reduced to €840 and that this is applied to a mortgage of €235,000.  Ken monthly payment increases by 3% per year and the €80,000 of the mortgage that is “shelved” is repaid in instalments beginning in year 10.

First up here is what happens to the €235,000 loan using the New Beginning figures.  The actual annual payment increase is 3.0595% rather than just 3% and this continues until the payments reach €1,135.48 from the start of year 11.

The €235,000 is paid off over the 31 year term of the loan (with eight months to spare).  This requires payments of just over €402,000.  Again it should be remembered that the loan can be paid off for less if a standard mortgage repayment schedule is applied.  However, in this case a typical mortgage of €235,000 at 3.55% over 31 years would require €388,000 of repayments.  The difference is only €14,000 and the benefit of the reduced payments early in the term is likely to be useful to someone who is having temporary difficulty in meeting their mortgage commitments now.

What about the €80,000 that was put on the shelf?

This is repaid in four short-term loans beginning from year ten.  These are five-year loans where some of the €80,000 is taken off the shelf and repaid at 3.55%.  The rest of the money stays on the shelf and no interest is charged.  The proposed repayment schedule is

Essentially Ken the borrower gets €80,000 interest free for ten years (cost €34,034 at 3.55%), €97,778  (equal to €80,000 + €34,034 – €16,256) interest free for a further five years (cost €18,961), €98,207 interest free for a further five years (cost €19,044), €96,124 interest free for a another five years (cost €18,640) and €90,679 interest free for ever more but the cost for the final six years of the mortgage is €17,584.

All told the bank has foregone €108,263 of payments over the 31 years of the mortgage.  The interest costs of this will continue into perpetuity.

All told the borrower will have made €402,000 of payments on the mortgage and €87,000 of payments on the shelved loans over the 31 years of the plan.  If this €489,000 had been used to repay a standard mortgage over the same time it would repay a mortgage of €296,000 at 3.55%, just €19,000 below the original loan of €315,000.

How much of the €315,000 if the New Beginning repayment schedule was applied to the full amount of the loan?   In this instance the repayments will be around €103,000 short of repaying the mortgage in full.

The benefit of the New Beginning scheme to the borrower is just over €100,000.  This can be shown as either the benefit of having borrowed money put “on the shelf” at no interest cost or the amount that would be left on the mortgage if the New Beginning repayment schedule was applied to the original loan.

It should also be remember that most of the benefit accrues to the borrower from having money borrowed from the bank for longer.  The total amount of repayments are very similar: €520,000 to repay a standard €315,000 mortgage at 3.55% over 31 years versus €489,000 to repay under the New Beginning split mortgage scheme.

The borrower gains around €30,000 from making lower repayments, but because more of the payments are made later the actual benefit is north of €100,000.  The power of interest rates is shown when compared to our previous analysis.  With an interest rate of 4.29% the benefit of the scheme was estimated at around €280,000 for Ken.

A truer measure of the benefit of the scheme to the borrower (and hence the cost to the bank) is just over €100,000.  The overall cost of implementing such a scheme depends on how many “Ken’s” there are.  For every 10,000 that enter the scheme the cost to be covered is €1 billion.

The scheme is not as off the wall as the original analysis indicated.  €100,000 is a lot of money but it may be a price worth paying as a solution to the current crisis.  The scheme has some merit and it could be adapted so that some of the costs incurred early in the term can be recouped with higher payments later in the term of the loan – 31 years is a long time.

Still, though if we are going to reduce the mortgage burden on some people why make it so complicated?   If we want to save someone €100,000 on their mortgage why not just reduce the balance upfront.  Ken would save €100,000 on repayments over 31 years if his current mortgage was simply reduced from €315,000 to €255,000 – it’s just debt forgiveness.

As we said above the borrower also benefits from the reduced payments early in the term so the reduction will be less, probably to around €275,000.  So we could follow the New Beginning repayment scheme or just knock €40,000 off the mortgage now.  There is no difference.

‘New Beginning’ Mortgage Proposal – it’s just debt forgiveness

New Beginning appeared in front of the Dáil Finance Committee today.  It will be early next week before the transcript is released.  From the details I have heard, the New Beginning mortgage proposal was compared to one of the Split Mortgage proposals in the Keane Report.

It is not clear that a fully worked example of the proposal was presented.  The best example I have seen remains “Ken” as shown in a recent episode of The Frontline.   Here is the description as provided by Pat Kenny that was part of a previous post on this topic.

“He borrowed €315,000 [..] Currently his full payment is €1,450 but if it was interest only and he did a deal with the bank that would be €917.  If some of the interest was deferred, which the banks will do, to 66.66%, that would bring it down to €605.”

“But under the New Beginnings (sic) solution Ken would pay 35% of his monthly net income.  That would be €840, which is more than the deferred interest payment. But that would be equivalent of paying a mortgage worth €235,000.  Now the payment would then gradually increase by 3% a year over ten years.”

“In the meantime, the balance, that is €80,000.  That is placed on the shelf.  No payment on that shelf money for ten years at all, and it doesn’t accrue interest.”

“After ten years it comes into play and his repayment would have increased to, a maximum, a maximum ever, of €1,572.  And the whole mortgage would be paid off in 31 years which is already the agreed term of the mortgage.”

Now there are three winners in all of this.  The lender would stand to lose €225,000 today if he just walked away and handed back the keys.  This way it’s all paid except the interest on €80,000 for ten years.  He has the satisfaction of paying out his mortgage. And thirdly, the State would not have to house Ken if he had nowhere to go and he becomes a functioning spender in the economy.”

“So it’s win, win, win.”

What I want to do here is work through the numbers of the New Beginning plan.  We are not given the interest rate but the current repayment implies a rate of 4.29% and that is what we will use here.  As per the description we will apply the repayments to €235,000 and “shelve” €80,000.

The starting repayment of €840 is the interest only repayment on a loan of €235,000 at 4.29%.  The payment increases by 3% per year thus allowing some of the capital to be repaid.  Here is what happens to the €235,000 over the first ten years.

After ten years nearly €116,000 of payments have been made but interest has consumed €99,000, leaving a reduction in the outstanding balance of less than €17,000.  In the first ten years the balance has fallen from €235,000 to just over €218,000.

At the start of year 11 we are told that the €80,000 that was shelved “comes into play” and we are told the repayment increases “to a maximum” of €1,572.  Both of these are subject to interpretation.  Initially I will assume that the €80,000 is added to the balance at the start of year 11 and that the repayment increases immediately to €1,572.

We now have 21 years to repay a loan of €298,105.80 with a monthly payment of €1,572.  If we again use an interest rate of 4.29% how far will this get us?

After 31 years and with almost €512,000 of payments there is still nearly €92,000 owing on the mortgage.  Ken still has a bit to go until he has his mortgage paid off.  And this is also with the benefit of having paid no interest on €80,000 for the first ten years.  The compound interest on that money for ten years is €41,273.

If this interest was considered deferred rather than written off and was added to the outstanding balance at the start of year 11, then €339,379 would have to be repaid with monthly repayments of €1,572 over the next 21 years.  What would be left after 21 years in this case? Answer: €193,085.  Table here.

One of the key principles of the New Beginning plan is that the borrower repays 35% of the their net disposable income.  As pointed out in the comments the jump in year 11 to €1,572 would actually be 49% of net income with the assumed 3% annual growth rate from year 1.

What happens if we limit the monthly repayments to 35% of net disposable income but continue to increase them by 3% per year?  To help make this a simpler calculation the €80,000 that is placed on the shelf is ignored in the following table.

As before the payments start at €840 and rise by 3% per year.  This continues for 22 years by which time the payments have reached €1,563 per month.  From year 23 onwards the payments are capped at €1,572.

This looks good.  Here we can see that the mortgage is fully paid off four months into the 30th year.  The plan works!  However, there is always a ‘but’.  In this instance it is “but what happened to the €80,000?”  In the above table no payment is made on the €80,000 that is shelved. 

There is still €80,000 of the original mortgage to be repaid.  If that has been sitting on the shelf for 30 years accumulating interest it would be a huge sum.  In fact, if compounded at 4.29% over 30 years, the €80,000 would have become €282,000.   Calculated here.  Who is going to pay that?

The New Beginning plan can pay off Ken’s mortgage but only if €80,000 of debt is written off now.  The New Beginning plan combines debt forgiveness and then a graduated payment mortgage to pay off the remaining balance.

As the final table here shows New Beginning have a plan that will result in a mortgage being repaid.  On a typical mortgage of €315,000 over 31 years at 4.29%, a borrower would repay about €570,000.  As we can see in the table above the New Beginning plan has the mortgage paid off with payments of around €459,000.

It is worth noting that a typical €235,000 30-year mortgage at 4.29% can be paid off with monthly payments of €1,143 and a total cost of €388,000.  If Ken could get his mortgage reduced to €235,000 he should ignore the New Beginning “35% of disposable income” principle and repay his mortgage in the usual fashion.  This would save him a further €71,000.

The benefit to the borrower of the New Beginning plan is not the new repayment schedule they are trying to introduce.  That actually costs the borrower money.  A benefit only arises in the New Beginning plan because €80,000 of the debt plus interest is not paid at all.  

On a cash payments basis Ken is better off by €111,000 under the New Beginning plan compared to his existing mortgage (€459,000 versus €570,000 ).  As we will see below the actual benefit is much greater as Ken also benefits from a greatly decelerated capital repayment schedule.  He has the money borrowed from the bank for longer but has to pay less for it.

In the description of the plan given by Pat Kenny it is said that:

“This way it’s all paid except the interest on €80,000 for ten years.”

That is not true.  There is no interest ever paid on the €80,000, and the €80,000 itself is never paid off under the repayment plan that is presented. 

To see the full benefit for Ken we must apply the €840 + 3% repayment schedule (up to €1,572) to the original mortgage of €315,000.  To do that I combined results from the previous calculator with this calculator, which produced this repayment schedule.

The interest-only payment on €315,000 at 4.29% is €1,126.12.  By starting at €840, the monthly repayment would be below the monthly interest amount so the balance on the mortgage would actually be increasing.  In fact, the monthly repayment would not get above the monthly interest amount until the start of year 14, by which time the balance due would be €343,000.  After this the balance would begin to fall as the payment continues to rise by 3% per annum.  By year 22 the payment would again have reached the cap of €1,572.

After 30 years the amount owing on the mortgage would be €274,000.  The balance on the mortgage would have fallen by €41,000, yet €461,000 of repayments would have been made.  In fact to repay the remaining balance of €274,000, the monthly payment 0f €1,572 would have to be continued for another 22 years and a half years. 

If Ken applied the New Beginning repayment plan to his current €315,000 mortgage it would take 53 years to repay it. He would have to make €894,000 of payments, and would have a total interest bill of €576,000.  See fairly large table here.

Ken is presented with this repayment plan on the show.  As we have seen over 30 years this would see about €40,000 paid off if applied to his current €315,000 mortgage, but pays the mortgage down to zero if applied using the modifications (i.e. debt forgiveness) of the New Beginning scheme.  When he is asked for his reaction he said:

I’m very impressed. [..]  It seems like an excellent solution.  I didn’t do honours maths in the Leaving, but if the figures add up, it looks very good.”

Of course it looks very good for Ken but the figures don’t add up.  Someone else is making around €111,000 of mortgage payments he should be making.   Over the 30 years of the mortgage the scheme is worth about €280,000 to Ken.  We have worked out this two ways:

1. €80,000 compounded at 4.29% for 30 years is €282,000
2. If the €840 + 3% repayment schedule is applied to the €315,000 mortgage for 30 years at 4.29%, there will be €274,000 outstanding after 30 years.  Under the New Beginning scheme the balance is zero.

If Ken can’t meet his mortgage repayments something needs to be done (and also remember that in his case his father signed as guarantor on the loan) but this New Beginning plan is not a “new way of paying a mortgage” in which everyone wins.  It’s just debt forgiveness.  Ken gets €80,000 or 25% of his mortgage written down right from the start.

If this is a representative case and the same reduction was applied to 80% of the €17.5 billion of mortgages which are in arrears or have already been restructured then the upfront cost would be nearly €3.5 billion.  If the other 20% of loans see half the mortgage written off through debt resolution the bill would be a further €1.8 billion.  This €5.3 billion might be lower than some other debt forgiveness schemes, but it is still debt forgiveness.

The New Beginning plan can only work if each borrower’s mortgage is reduced so that the interest-only payment is equal to 35% of their net disposable income and the balance written off.  It then depends on the borrower’s net disposable income rising by 3% per year.  Finally, it needs an interest rate that does not rise above the initial level.  If any of these is absent the plan cannot work and the mortgage cannot be repaid.

New Beginning deserve great praise for the work they are doing in providing legal services and support to borrowers facing legal proceedings.  The benefits of this are huge and easy to see.  The benefits of the mortgage solution they propose are much harder to find.

‘New Beginning’ Mortgage Proposal

Ireland’s mortgage crisis rumbles slowly on.  Last week the Keane Report was published but it merely presented a list of possible measures that could be introduced rather than detail how an actual solution will be implemented.

On the Monday of that week The Frontline on RTE devoted an entire episode to the issue of property prices, mortgage debt, negative equity and arrears.  In this show a proposal was made by the New Beginning group that aimed to be a way out of the crisis for “80% of those in difficulty”.  This was also raised in a discussion on Primetime later in the week and formed the basis of an article in yesterday’s Sunday Business Post: A modest proposal to ease the pain of mortgage debt. 

In all three cases the proposed plan appears to be the same but it is very hard to determine exactly what the proposal is with the details provided.  There are always some key elements missing. 

The best example appears to be on The Frontline when Pat Kenny asks Ross McGuire of New Beginning "what did you have in mind?” about 27 minutes into the show.  This is what he said.

“We think this applies to about 80% of distressed mortgages.  There is a 20% group that it won’t apply to, but it applies to the vast majority.  What we would do is we would begin with a figure.  [..] People should be asked to pay about 35% of their net disposable income. [..] If your disposable income is €1,000, €350 is the most you are going to pay on mortgage repayments.”

“We take that figure and they we can work out the kind of mortgage that you can pay over whatever term it is.  And using our maths and our systems it is possible in fact with a restructuring of the mortgage to pay the full amount over the term of the mortgage as originally set out.”

“How could that possibly be? And it’s just quite simple.  Initially, in the current style mortgage your first payment is the most expensive because you pay capital and you pay the interest in the whole lot and your last payment is the cheapest because you have got very little interest to pay.  And we simply flatline that.”

“So if someone is able to pay interest only, or even less, we can say to that person “pay that; be willing to grow that a little bit as years go by; and you can pay your entire mortgage off”.

Whoa. We better stop there.  What he is on about? Mortgage payments don’t go down during the lifetime of a mortgage.  Baring interest rate changes they stay exactly the same.  There is nothing to “flatline” using “maths and systems”. 

A mortgage is designed so that the same amount is repaid each month.  In the show an example used of someone who has a €315,000 mortgage to be repaid over 35 years.  The monthly payment is €1,450 so this implies an interest rate of 4.29%. (Calculated using this excellent mortgage calculator.) 

Anyway, if the interest rate is 4.29% the monthly payment will be €1,450.  It doesn’t matter whether it is the first month or the last month, the payment will be €1,450 (as long as the interest rate is 4.29%).   I have no idea what is going on when New Beginning talk about flatlining.  Mortgage payments are flat.

What does change is the amount of each repayment that goes on capital and interest.  At the start, most of the repayment goes on interest, but as the capital is paid down, the interest portion of the repayment gets smaller and smaller.  But again note that the repayment stays exactly the same.  I am saying that a lot because if someone who is running a group to help mortgage holders in arrears does not know it, there may be a lot of people who do not know it.

Anyway, of the first payment of €1,450 about €1,126 goes to pay interest and €324 goes to pay down the capital.  By the start of the tenth year, the repayment is still €1,450 but the interest bill has fallen to €953 with €497 now going against the capital.  By the 20th year the interest has fallen to €687 and the capital payment is now greater at €763.  By the 30th year the interest is €280 and the capital is €1,170.  This continues until the very last payment which is €10 interest and €1,440 capital.  At all times the payment is €1,450.  Here it is graphically.

For each of the 420 months of the mortgage the payment is exactly the same, but every month the interest/capital composition is different with the interest amount always declining and the capital amount always increasing.  Interest rate changes may provide occasional resets and lower or higher payments but the principle of falling interest and rising capital amounts then continues.

Here are two screenshots which gives the details provided for the example used in the show.  You can listen to the description from about 28:40 in the show.

 

Here is how Pat Kenny (rather than New Beginning) described the proposal using figures based on the current situation of a member of the audience .

“He borrowed €315,000 [..] Currently his full payment is €1,450 but if it was interest only and he did a deal with the bank that would be €917.  If some of the interest was deferred, which the banks will do, to 66.66%, that would bring it down to €605.”

“But under the New Beginnings (sic) solution Ken would pay 35% of his monthly net income.  That would be €840, which is more than the deferred interest payment. But that would be equivalent of paying a mortgage worth €235,000.  Now the payment would then gradually increase by 3% a year over ten years.”

“In the meantime, the balance, that is €80,000.  That is placed on the shelf.  No payment on that shelf money for ten years at all, and it doesn’t accrue interest.”

“After ten years it comes into play and his repayment would have increased to, a maximum, a maximum ever, of €1,572.  And the whole mortgage would be paid off in 31 years which is already the agreed term of the mortgage.”

Now there are three winners in all of this.  The lender would stand to lose €225,000 today if he just walked away and handed back the keys.  This way it’s all paid except the interest on €80,000 for ten years.  He has the satisfaction of paying out his mortgage. And thirdly, the State would not have to house Ken if he had nowhere to go and he becomes a functioning spender in the economy.”

“So it’s win, win, win.”

This example is missing some details and we have to make some assumptions.  First it is assumed that the €315,000 loan will be paid off over 31 years.  The interest rate used in the calculations is not provided which is disappointing but again appears to be 4.29%.

Anyway in a typical mortgage of €315,000 at 4.29% over 31 years the borrower would repay about €570,000 (€315,000 capital and €255,000 interest). 

Under the New Beginning proposal it seems that the borrower will pay €840 for the first year and this will “increase by 3% a year for ten years”.   A payment of €840 is not the “equivalent of paying a mortgage worth €235,000”.  €840 is the interest-only payment on a mortgage of €235,000.  The person is not repaying the mortgage at all!

It is suggested that the payment would rise above the interest-only level by 3% a year for ten years.  This would put the monthly payment at €1,096 by year ten.  Thus over the first ten years €115,556 of mortgage payments would have been made.

After ten years the payment increases to “a maximum of” €1,572 for the next 21 years.   I’m not sure what the phrase “a maximum of” implies but if the €1,572 was paid each month for 21 years then €396,144 of payments would be made. 

In total, over the 31 years of the mortgage there would be payments of just under €512,000 made under the New Beginning plan.   The New Beginning plan is at least €58,000 short in order for the mortgage to be fully repaid.  

It is likely that it is short by much more as the capital owed is decreasing by much less in the reduced payment period of the New Beginning proposal so the amount of interest that should be charged is greater than would be charged on a traditional mortgage.  In fact, in the early years when the payment begins at €840 the balance on the mortgage (and hence the interest to be charged) is actually increasing.  The interest-only payment on €315,000 at 4.29% is €1,126 so when paying €840 a month the balance on the mortgage will be increasing and the interest to be paid will be rising not falling as under a typical mortgage.

I am not necessarily against this plan of reducing the mortgage payment to €840 and then slowly increasing it to €1,096 over ten years and moving it to €1,572 from year 11 like in this example, but let’s accept it for what it is.  The mortgage holder is being let off the hook for at least €58,000 of repayments.  The Sunday Piece Post article says:

Does that involve debt forgiveness? By any rational standard, it does not. All it involves is the bank forgoing some income and profit. There is no capital implication for the lender’s balance sheet and no negative consequence for the taxpayer. The bank is repaid in full and the borrower owns his home.

Of course it is debt forgiveness.  The Frontline and the article go off on a tangent about some sort of “shelved balance” which is “warehoused” on which no interest accrues.  This is just a deflection. 

If someone borrows €315,000 at 4.29% over 31 years the total amount that must be repaid to the bank under a typical mortgage is €570,000.  Under the New Beginning plan the borrower repays €512,000 on the same loan, and as they are making reduced capital payments (and in the early years none at all) they should actually be paying more the  €570,000.  The bank is likely to be losing out on €80,000 of payments under this plan.

Here are the two repayment schedules compared.  It is not difficult to see that the area under the red line for the first ten years is greater than the area above the red line for the next 21 years.  This difference is the cost of granting this proposal to a mortgage holder.

I am not necessarily against this type of plan and something like it will have a role to play in resolving our mortgage crisis.  There are four types of borrowers who are in arrears.

1. Borrowers who are in temporary difficulty but will be able to get back on track pretty quickly without any assistance.
2. Borrowers who are in temporary difficulty but will need some forbearance for a limited period in order to see them through such as term extensions or interest-only periods.
3. Borrowers who are in difficulty but will be able to get back on track at some point in the future but need more assistance than that offered by a term extension or interest-only period.
4. Borrowers who are in difficulty and will never be able to get back on track.  These unsustainable mortgages need to be terminated.

The Central Bank have shown that 44% of mortgages that go into arrears of 90 days or more return to performing mortgages over time (slide 24).   These will not have benefitted from anything like the New Beginning proposal.

The New Beginning proposal may be appropriate for the third category above which could be about one-half of those who get into difficulty.  A proposal like this is unlikely to be of any benefit for those in the fourth category who have unsustainable mortgages. 

There may be 20,000 unsustainable mortgages in Ireland.  These mortgages need to be ended and if the size of the mortgage exceeds the value of the house by an average of 150,000 then there is a €3 billion shortfall that needs to be addressed.  In my view these mortgages should be ended with the borrower ceding ownership of the house while at the same time getting any shortfall written off after making nominal payments for a period of three to five years so they truly can make a new beginning.  The €3 billion lost on these mortgages will never be repaid and must be faced up to.

There may be around 50,000 households who need assistance like that offered by the New Beginning proposal.  This will allow them to maintain ownership of the home and eventually get back to making repayments on their mortgage.  This scheme is not free and will have a cost.  If the average cost per household is €80,000 then the cost of implementing this scheme for 50,000 households will be €4 billion.  This is not cheap and this proposal should not be viewed as a “win, win, win”.

A full proposal will outline how entry to the scheme is to be assessed.  It may also be possible to modify the scheme so that some of the costs incurred in the ten years of subsidised repayments can be recouped later in the life of the mortgage.  A suggestion that might be able to achieve this was previously outlined here.