Insights from the Experts

On April 2, Matt Phillips[i] in Atlantic Weekly penned an article entitled, “Welcome to Ireland, Where Mortgage Payments Are Optional and the Banks Are a Mess”. He wonders why “Ireland's homeowners are the European and perhaps the world champions in not repaying mortgages” and concludes: “The simple answer is that Ireland is one of the hardest places in the world to drive a family from its home. Though thousands aren't paying, repossessions of Irish homes remain” negligible relative to the level of arrears.

Professor Gregory Connor of NUI Maynooth in an article[ii] entitled, “How Large Are Strategic Arrears in the Irish Mortgage Market?”, tentatively suggests “that the proportion of strategic arrears in Ireland is greater than 35%” in the PDH sector based on a comparison with research done in the US. His conclusions are based on the fact that “Ireland has experienced a greater cumulative property price fall than the USA, and its repossession laws are much stricter, which strongly influences upward the proportion of strategic arrears.” He further suggests that strategic arrears in the BTL sector “may be greater than 50%” given the larger proportion purchased near the height of the boom.

Drivers of PDH Arrears

So what is the explanation for the huge increase in arrears? And to what extent are these arrears a tragic outcome of changed circumstances or are they a conscious decision by mortgagors who choose not to pay their mortgage though they have the wherewithal to do so?

The most obvious cause of PDH arrears is loss of employment. And much of the increase in arrears in 2009 and 2010 is likely to reflect the huge jump in unemployment. Whereas the unemployment rate stood at just 4.9% in January 2008, it had increased to 13.0% within two years. While unemployment increased still further afterwards, peaking at 15.0% in January 2012, it has been on a downward trajectory since and stood at 13.9% in April 2013. The unemployment rate seems unable to explain the ongoing increase in arrears.

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The most common measure of mortgage affordability is the mortgage repayment-to-income ratio (MRTI). Even if a mortgagor remains in employment, they may experience mortgage distress if they are faced with reduced net income or higher mortgage payments since either will increase their MRTI. Most people are experiencing reduced after-tax income arising from higher taxes and, in some cases, pay cuts. However, while their income has decreased, for most mortgagors, the mortgage repayment has decreased proportionately more.

Most of those facing difficulty paying their mortgages purchased their houses in the years leading up to the property price peak. According to data from the IBF/PwC Mortgage Market Profile[i], more than €30bn of mortgages were granted by banks in each of the years 2005, 2006 and 2007.

(Figure 2)

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In particular, tracker mortgages, which account for 53.3% of all mortgages[i], were issued in a period when the ECB rate ranged from 2% to 4.25% p.a. compared to its current level of 0.50%.

A 30-year, €250,000 mortgage issued in 2006 was typically paying an interest rate of 4% at the time of issue and cost approximately €1,200 per month to service. The monthly repayments on that mortgage would be approximately the same at present if paying the standard variable rate (SVR) but would have fallen below €900 monthly if paying a tracker rate. In fact, for most PDH borrowers, despite tax increases and wage cuts, affordability has improved since the crisis began. An earlier paper by McCarthy and McQuinn also supports this conclusion. [ii]

However, when a borrower finds themselves in payment difficulties and cooperates with their lender, the Code of Conduct on Mortgage Arrears (CCMA)^[iii] requires the lender to “explore all options for alternative repayment arrangements”. Such arrangements “must include … an interest-only arrangement for a specified period” and “extending the term of the mortgage”. An interest-only payment for the SVR borrower above would approximate €800 per month while the corresponding tracker payment would be just €350 per month.

Drivers of BTL Arrears

The key determinant of ability to pay for BTL mortgagors is rental income. According to the Daft.ie rental report for Q4, 2012[iv], there are two diverging markets within the country:

• In Dublin, “rents are about 6% higher now than two years ago.” Furthermore, “there were just over 2,100 properties available to rent in the capital. In the middle of 2009, there was almost four times that amount.” They note that “there has been only one period when there were fewer properties sitting on the rental market than now – February to May in 2007 – and then rents were increasing at 13% year-on-year.”
• In Ireland’s smaller rental markets, rents fell in each of the last two years. “In Connacht and Ulster, there are five times as many properties available to rent now as there were five years ago.” The overhang of excess supply will keep rents subdued and see BTL landlords incur long void periods.

The report concludes: “The evidence from the rental market is that Dublin in particular is facing if anything a shortage of places to live, not a glut.” It further comments: “Without new supply in Ireland’s cities, though, rental inflation may be here for a while.”

BTL investors in city properties should be able to rent their property with just modest void periods. With 60% of BTL borrowers on tracker rates[v], the combination of increasing rents and the record low ECB rate should allow them service their debt. Outside the city, the situation is likely to remain challenging for some time and BTL landlords will need to supplement the rental income with their own resources to meet the mortgage repayments.

The report catalogues the average rent by postcode/region and property type. It reports an average rent of over €1,000 per month for two-bedroom apartments in Dublin while the rent for a three-bedroom house was €1,300. For most BTL owners, these rents are sufficient to meet their mortgage payments.

Conclusion

The ongoing increase in mortgage arrears levels has puzzled many researchers and worried many in banking and official circles. Increasing unemployment, declining GDP and collapsing rents seemed to explain the initial increases; however, most of these indicators have turned positive in the last two years while mortgage arrears increase inexorably.

There is no doubt that there are many caught in mortgage arrears who have lost their jobs and the income which was available to service the mortgage is gone. Similarly, some BTL investors acquired property, particularly in areas outsides the main cities, for which there is very weak rental demand. These investors may struggle to pay unless they have other resources. For these borrowers, mortgage arrears are the tragic consequence of changed circumstances. These are the circumstances which the CBI had in mind when they undertook the Prudential Capital Assessment Review (PCAR) and subsequently capitalised the banks. They assessed that lifetime losses on the covered banks’ mortgage books would amount to €9.7bn in the base case and €16.3bn in the stress case.

But those with PDH tracker mortgages are paying far less now than they were when they first took out their mortgage. In almost all urban areas, rent exceeds the cost of servicing the mortgage. The forbearance which banks are obliged to extend under the CCMA reduces the cost of servicing the mortgage still further. There are very many people in rented accommodation across the country paying rents which are higher than the mortgages which those in arrears appear unable to pay.

By the same token, those with BTL tracker mortgages on properties in urban areas are the beneficiaries of the reduction in the ECB rate and the more recent hardening in rents. Most BTL investors in urban property should find that the rent meets the cost of servicing their debt.

It is hard to escape the conclusion that there are many PDH borrowers currently in arrears whose MRTI is less than historical norms and have simply chosen not to pay. And it is hard to understand why a BTL borrower on a tracker mortgage with a property in an urban location cannot pay their mortgage. It is clear that the nature of public discourse has changed people’s attitude to mortgage debt despite its recourse nature. The Dunne judgement seems to have emboldened some to think that repossession will not occur. While the recent revision to the CCMA[vi] addresses some of the difficulties which banks experienced in dealing with customers in arrears, it’s too early to say whether it will be sufficient to prompt borrowers in arrears to engage with their lenders. Gregory Connor’s estimates of strategic defaults are, if anything, likely to under-estimate the extent of strategic default.