Thursday 14 November 2019

No fairytale ending for tracker mortgages

Number-crunchers: Jean-Claude Trichet, ECB president, right, chats to German Finance Minister Wolfgang Schaueble
Number-crunchers: Jean-Claude Trichet, ECB president, right, chats to German Finance Minister Wolfgang Schaueble

Last week's decision by the ECB to raise its official interest rate, with the prospect of several more rate rises to come, comes at the worst possible moment for the Irish banks.

With a 10th of all loans already in arrears, a series of interest-rate increases will quickly show if last month's stress-test results were realistic.

Last Thursday the ECB, having flagged its intentions well in advance, increased its official interest rate by 0.25pc to 1.25pc. This rate increase is set to be the first of many with most analysts reckoning that ECB rates will hit at least 2.5pc by the second half of 2012.

What will dearer money mean for Ireland's beleaguered banks, into which the taxpayer is committed to pumping a further €24bn of fresh capital?

Will this week's rate rises derail the Government's plans to revive the banks? Speaking to the Dail last Wednesday, a day before the ECB made its decision, Finance Minister Michael Noonan said that withdrawals from the pillar banks, AIB and Bank of Ireland, "has been very significantly reduced".

The minister also pointed to the rise in the share prices of both the main banks since the recapitalisation announcement and declared that "confidence is being restored".

Unfortunately, the minister's declaration of victory seems to have been a tad premature. The rise in the AIB and Bank of Ireland share prices, which was in any case from a very low base, was reversed after the ECB interest rate increase. There also seems to have been less than meets the eye to what Noonan had to say about deposit withdrawals. Surely a "significant reduction" in withdrawals means that money is still flowing out of the banks, albeit at a somewhat slower pace.

Despite these objections, it would be churlish to be too cynical about the minister's statement. Last Monday, Wall Street investment bank Morgan Stanley pronounced Irish government bonds a "buy" while the cost of insuring Irish government debt against the risk of default also fell sharply this week. Noonan can hardly be faulted if he declares that the glass is half full rather than half empty.

However, while there may be some rays of spring sun shining on the banks, there are also some very dark clouds on the horizon. Chief among these must be the state of the banks' mortgage books.

Last week's ECB rate rise, and the four of five further increases that seem certain to follow over the next 18 months, will hit homeowners with tracker mortgages, about 55pc of all mortgages, for the first time. As tracker interest rates are explicitly linked to ECB rates, the banks have not been able to increase the rates they charge on tracker mortgages.

Up to now. That all changed last week. Which of course begs the obvious question, if with most homeowners having been spared higher interest rates until this week, a 10th of all mortgages are either in arrears and/or restructured, what sort of havoc will higher rates wreak?

Unfortunately, the much-trumpeted stress tests, which were conducted by US consultancy BlackRock Solutions, don't provide much room for comfort on the likely future behaviour of tracker mortgages as interest rates rise. The 88-page report published by the Central Bank on the stress-test results, which revealed that the Irish banks stand to lose up to €16.3bn on their Irish mortgage books in a worst-case scenario, doesn't mention tracker mortgages once.

That is an absolutely incredible omission. It's almost as if the Department of Finance and the Central Bank were hoping that the problem of tracker mortgages might somehow resolve itself over the next few years without any need for intervention on their part.

That's the sort of thing that often happens in fairytales but, sadly, rarely if ever in real life.

One can only conclude that BlackRock's estimates of likely mortgage losses make no provision for any write-down of tracker mortgages. That's hardly sensible. Before last week's interest rate increase someone switching from a tracker mortgage charging 1pc over the official ECB rate to a standard variable rate 30-year homeloan with either AIB or Bank of Ireland would need a 17.75pc reduction in the amount which they owed to keep their monthly repayments unchanged. For a 35-year mortgage the write-down necessary to keep monthly repayments unchanged rises to 20pc.

With the Irish banks having at least €55bn of trackers on their books, that translates into losses of €10bn-€11bn on their tracker mortgages alone before any allowance is made for arrears, negative equity or defaults.

In practice higher interest rates are likely to result in a significant increase in mortgage arrears as already financially stressed homeowners who were previously shielded by tracker mortgages see their monthly repayments rise for the first time.

Will even BlackRock's worst-case scenario prove to be an adequate provision for the losses which will inevitably result?

Taxpayers and bank shareholders will be desperately hoping that it will be but it might not be a good idea to bet on it.

Sunday Indo Business

Also in Business