Tuesday 12 December 2017

Are greedy mortgage lenders about to see enormous margins squeezed?

A consumer watchdog has urged action on competition after bank interest margins almost doubled since 2012, writes Dan White

AIB’s HQ in Ballsbridge — a reduction in Irish mortgage interest rates to the eurozone average would cost AIB €435m a year and Bank of Ireland €360m
AIB’s HQ in Ballsbridge — a reduction in Irish mortgage interest rates to the eurozone average would cost AIB €435m a year and Bank of Ireland €360m
Dan White

Dan White

Bank of Ireland's move to cut some of its mortgage rates and the Competition and Consumer Protection Commission's call for greater competition in the mortgage market are likely to make it more difficult for the banks to keep widening their net interest margins.

On June 6 Bank of Ireland cut its fixed mortgage rates by up to 0.35 percentage points. While these new lower interest rates are hedged in by various terms and conditions, Bank of Ireland's variable mortgage rate of 4.5pc remains one of the highest in the market. However the unchanged rate cuts do signal more competition between lenders.

Then last Thursday the Competition and Consumer Protection Commission (CCPC) published a paper on the mortgage market. The CCPC paper described the Irish market as "distorted" and "dysfunctional" and "characterised by a high concentration of a small number of lenders, limited competition between these lenders and low levels of entry by new players".

For the new slimmed-down, post-crash Irish banks, mortgages are very much where it's at. Bank of Ireland has €48bn of mortgages split roughly 50:50 between Ireland and the UK, some 60pc of its total loan book. AIB has €35bn of mortgages, over half of its total loan book, of which more than four-fifths are in Ireland.

For the Irish banks it's a case of where mortgages lead, just about everything else follows. Anything that erodes the profitability of their mortgage lending will have major implications for the banks as a whole.

Do the Bank of Ireland rate cuts and the CCPC paper signal that the enormous margins enjoyed by Irish mortgage lenders in recent years are finally about to be squeezed?

The most recent figures from the ECB estimate that the average interest rate on Irish residential mortgages (including trackers) was 3.19pc compared to a eurozone average of just 1.72pc. A reduction in Irish mortgage interest rates to the eurozone average would cost AIB €435m a year and Bank of Ireland €360m.

It is largely their very high mortgage rates that have allowed the Irish banks to widen their net interest margins - the difference between what they charge their borrowers and pay their depositors - in recent years.

Bank of Ireland's pre-crash net interest margin peaked at 1.74pc in 2008 while AIB did even better with a net interest margin of 2.21pc in the same year. Then it all went horribly, terribly wrong. Bank of Ireland's net interest margin fell to just 1.25pc in 2012 while AIB bottomed out at just 1.22pc in the same year.

Since then both of the major Irish banks have been relentlessly widening their net interest margins. AIB's net interest margin hit 2.25pc in 2016 and had climbed to 2.42pc by the fourth quarter of last year. It has been a similar story at Bank of Ireland, its net interest margin climbed to 2.19pc in 2016 and reached 2.27pc in the second half of last year.

It is this combination of rapidly-rising net interest margins and falling bad debt charges that has restored the Irish banks to profitability and facilitated this month's AIB IPO.

But how much further can their net interest margins widen? Already the net interest margin enjoyed by the two main Irish banks is much wider than that of most major eurozone banks. The net interest margin of Deutsche, Germany's biggest bank, is just 1.42pc.

The Irish banks have up to now been protected from overseas competition by the toxic reputation this country's financial sector acquired during the crash. Instead several overseas banks, including Lloyds and Danske, pulled out of the Irish market altogether while another, RBS - which owns Ulster Bank in this country - significantly scaled back its Irish business.

Ironically, by drawing attention to the Irish banks' lush margins and the improved lending environment, will a successful AIB serve as a catalyst in luring overseas banks back to this country?

The CCPC paper proposes several measures aimed at attracting new entrants to the Irish mortgage market. These include the establishment of a startup unit in the Central Bank aimed at enticing new lenders into the market, speeding up repossessions where the mortgage is in arrears, easing the restrictions on lenders earning non-interest income and encouraging the development of long-term sources of finance for mortgage lending. "We want to encourage new entrants. There are good margins to be made in Ireland," says a CCPC spokesperson.

This won't happen overnight. New entrants have so far been few and far between with specialist Australian lender Pepper being one of the very few to dip its toe in the water. Pepper, which already offers residential mortgages, announced that it hoped to write up to €300m of Irish commercial property loans over the next two years.

Many of the changes urged by the CCPC to attract new entrants will require Government action. While the Commission compiled its paper at the request of the Government, it is of course conflicted in the matter of the Irish banks' high net interest margins. Even after the AIB IPO, the Government will still own 75pc of the bank. It also owns 75pc of Permanent TSB and 14pc of Bank of Ireland. At the IPO price range of €3.90-€4.90 per share, AIB is worth between €10.5bn and €13.2bn while the Bank of Ireland and Permo shareholdings are worth about €1bn each, a total of €12.5bn-€15.2bn.

Will the desire to maximise the value to the exchequer of its bank holdings, temper the Government's enthusiasm for measures that increase banking competition and thus cut net interest margins? Or will a growing clamour for lower mortgage and other interest rates force it to roll out the red carpet and welcome new entrants?

Sunday Indo Business

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