THE three surviving domestic banks, AIB, Bank of Ireland and Permanent TSB, have around €80bn in outstanding residential mortgages. They face inevitable write-downs, as well as further losses on non-mortgage lending. There are resources to meet loan losses available, courtesy of the taxpayer, but these are limited. If they prove inadequate, there will be another banking crisis, so there is no capacity for across-the-board debt forgiveness.
On Wednesday, the Central Bank released its detailed requirements for the resolution of mortgage arrears by six banks that account for most of the mortgage lending in the country. There are specific time-bound targets and there will be penalties for non-compliance.
The failure to address decisively the problem of mortgage arrears to date has attracted repeated criticism from official lenders, the EU and the IMF. Progress here in that regard has been notably slower than in other countries facing similar problems. In particular, there have been very few repossessions compared to other countries.
Despite widespread non-payment of mortgages, banks in Ireland have shown far greater leniency than in, for example, the United States and the United Kingdom. The rate of repossession in the UK is about four times the rate here to date. Since the problem in Ireland is greater, logically the repossession rate ought to be higher.
The Department of Finance secretary-general, John Moran, drew some ill-directed criticism the week before last for pointing out these unpleasant facts to TDs at a Dail committee hearing.
One reason for lender leniency is a court decision (the Dunne judgement), which inhibited lender repossession. Legislation is being prepared to address this issue. There are other factors which have resulted in long-fingering the mortgage-arrears crisis, including delays by banks in getting administrative capacity in place. `
The banks claim to have resolved these problems and the Central Bank has evidently decided that it is now time to put these claims to the test.
The critical issue in assessing the stance to take in dealing with mortgage arrears is the capacity of the borrower to meet loan repayments. The notion that negative equity should also be addressed through some form of debt forgiveness is untenable and financially infeasible.
Some people in negative equity appear to expect that losing bets on house prices can somehow be refunded via a banking system which collapsed (every single bank had to be rescued), and whose collapse in turn triggered the insolvency of the State.
Any mortgage taken out during the bubble years at a high loan-to-value ratio is almost certainly in negative equity. Most of the €142bn outstanding to all banks would have been borrowed during those years, much of it at 100 per cent loan to value.
The total amount of negative equity in the system is a multiple of the amounts available in the banks to handle mortgage distress and anyone expecting a refund is likely to be disappointed.
It is natural to sympathise with those who borrowed to buy homes, only to see price drops of up to 50 per cent in a few short years. But many in this position remain well able to meet mortgage repayments, particularly those fortunate enough to have tracker mortgages, on which current monthly repayments are considerably lower than they were when the mortgages were first taken out. If any funds are deployed in debt forgiveness for those able to pay, the amount remaining for those genuinely in financial distress will be curtailed.
It has been estimated that at least 35 per cent of non-performing mortgages in Ireland should be classified as cases of strategic default. Strategic defaulters are people who could meet mortgage repayments but have chosen not to do so in the hope of a debt-forgiveness deal.
If the 35 per cent minimum figure (estimated by Gregory Connor of the economics department at Maynooth) is taken, there could be €10bn or more non-performing mortgages owed by people who have the capacity to meet repayments. The provisions already made for relieving distressed borrowers need to be concentrated on the many thousands who now find themselves unable to meet mortgage commitments. Those who have lost their jobs or who have seen sharp income drops are simply unable, rather than unwilling, to meet mortgage repayments.
The Central Bank wants to see solutions proposed for 50 per cent of all arrears cases before the end of 2013 and will set further targets for implementation of the proposed solutions.
It must insist that the cost of mortgage write-downs does not absorb all of the spare capital in the banking system, leading to a new requirement for bank rescue.
There are simply no State resources available for another bank bailout and, if excessive forbearance is shown to any category of borrower, including strategic defaulters, the result will be a new fiscal crisis, further expenditure cuts, yet more tax increases and an end to hopes of economic recovery.
For each individual bank, there are pitfalls aplenty. Many households have multiple borrowings aside from their mortgage, often with several financial institutions. If a lender decides to write down the mortgage debt, it will also need to ensure that the other lenders to that household are involved.
If not, Bank A takes the hit to the benefit of Bank B, which can now expect the car loan to be repaid in full. The banks have already come together on a joint approach to unsecured debt and will need to address mortgage distress in the context of the household's overall financial position.
There will be controversy where agreement cannot be reached and lenders resort to repossession. It is clear that the banks will see repossession as undesirable, not least because it will increase the supply overhang in the housing market. But the threat of repossession cannot be abandoned if a workable resolution process is to be implemented.
Who would make mortgage loans in future if the security of the asset was removed? Politicians who object to repossession in any circumstances are, in effect, proposing that housing finance should be undertaken as unsecured lending. No country in the world, to my knowledge, has ever tried to operate such a system.
Last year, €2.6bn was advanced in mortgage loans. The lending target for this year seems to be at least €4bn and the longer-term level, if we return to a normal housing market, might be €8bn-€10bn.
At the height of the bubble in 2006, the Irish banks lent around €40bn in mortgage loans, four or five times the likely figure whenever normal times return. It is important that mortgage lending should rise. Normality in the housing market requires that transactions get completed and that a new and realistic price level is established. This is happening in the urban markets, especially in Dublin, but there are hardly any transactions in provincial areas, and there is great uncertainty about what price level will ultimately emerge.
The resolution of the mortgage-arrears problem will inevitably involve trading down through voluntary moves, as well as repossessions, and new buyers will have to be funded.
There is limited downside risk for lenders at the more realistic prices that have been reached and the Central Bank should be encouraging the banks to relax their de-leveraging targets, at least in the area of mortgage finance. It could even be argued that the fall-out from the burst bubble requires, at least temporarily, a sharp jump in new mortgage credit.
In addition to voluntary moves to trade down, lenders can agree to split the mortgage in two, with a new lower repayment schedule that can be afforded and the balance 'parked', giving the borrower the option of returning to full ownership if their financial circumstances eventually improve.
There needs to be imagination shown about borrowers renting out properties they can no longer afford and moving to less-expensive accommodation with the hope of ultimately reoccupying their original residence.
Some lenders operate restrictions on renting which can inhibit sensible outcomes. For example, an unemployed borrower offered a well-paid job abroad might prefer to take the offer and service the mortgage through renting. They should be facilitated, whatever it says in the small print of the mortgage contract.
Finally, the domestic banks will be exercising discretion in offering relief to genuine distressed borrowers, in effect using taxpayer funds. It is important that the process be as transparent as possible, with no hint of sweetheart deals for the well-connected – including bank staff who themselves borrowed excessively.