Why the rise in negative equity is more bad news for the taxpayer
FOR those who care to cast their minds back just four years, the steady drip-drip of bad news from the housing market has an eerily familiar feeling.
Way back in early 2008, the Irish banks were assuring us that the €80bn plus which they had lent to builders and property developers was secure.
The market wasn't fooled. First the share prices of the Irish banks collapsed and then depositors began to withdraw their money, forcing the government to unconditionally guarantee the deposits of Irish-owned lenders in September 2008.
The rest, as we know, is history. NAMA purchased property-related loans with an original value of €72bn from the Irish banks for just €31bn while fixing the holes in the Irish banks' balance sheets has already cost the taxpayer €63bn.
The number of mortgages more than 90 days in arrears has risen steadily over the past three years and now stands at almost 63,000.
Unfortunately that figure from the Central Bank represents only part of the problem.
A further 70,000 mortgages have been restructured by lenders and 34,000 of these have fallen into arrears for a second time.
Then there are mortgages which are less than 90 days in arrears. Last October, the Central Bank said there were almost 47,000 mortgages less than 90 days in arrears.
Add it all up and there are more than 146,000 mortgages which are either in arrears or have been restructured or both. That's almost one in five of the 773,000 private residential mortgages in the country.
Bad and all as these figures are, they may represent just the tip of the iceberg. In addition to the mortgages which have already displayed symptoms of financial distress is a much larger number that are in negative equity.
How many mortgages are in negative equity? With house prices having fallen by an average of 47pc from their 2007 peak, the number is clearly a large one.
In its most recent Quarterly Bulletin, the Central Bank published a paper on the topic by economists Gerard Kennedy and Tara McIndoe-Calder which concluded that 31pc of all mortgages were in negative equity at the end of 2010.
The figure is even worse when you calculate the value of mortgages in negative equity rather than the total.
Looking at this measure, economists calculate that mortgages totalling 47pc of the entire mortgage pot are now in negative equity.
Goodbody Stockbrokers economist Dermot O'Leary has taken the Central Bank data and projected it forward to the end of 2011.
He estimates that by the end of last year, 46pc of all mortgages were underwater. This rose as high as 65pc when weighted by value.
When loans are included which have been securitised, i.e. sold to investors, buy-to-let loans Irish-based banks had €132bn of mortgages on their books at the end of September 2011. Just under €100bn of these, about €98bn, were with Irish-owned banks.
So what does the fact that almost a fifth of mortgages are in trouble and two-thirds are in negative equity mean for the Irish banks and the taxpayer who bailed them out?
At the time of last year's stress tests, which were carried out by US investment house BlackRock, the Central Bank estimated that the Irish-owned banks would have to set aside €5.8bn to cover mortgage losses under BlackRock's "base" scenario.
Since then conditions in the property market have continued to worsen and many analysts, including Goodbody's O'Leary, now believe that BlackRock's "stress" scenario may now be more appropriate.
If this does turn out to be the case then the Irish-owned banks are looking at mortgage losses of almost €9.5bn.
This could force the Irish taxpayer to inject even more capital into the Irish-owned banks, on top of the €24bn that the banks got last year.
However, Mr O'Leary points out that, even in the event of the "stress" scenario being realised, the Irish banks would still be extremely well-capitalised by international standards and that any extra capital they received would be merely to fulfil the Government's pledge that the Irish-owned banks would remain the best-capitalised in the world.
Following last year's Prudential Capital Assessment Review (PCAR), which was carried out in conjunction with the stress tests, the Irish banks were extremely well-capitalised with capital ratios ranging from 16.1pc at Bank of Ireland, 21.9pc at AIB, 22.6pc at EBS (which has since been subsumed into AIB) and 32.4pc at Irish Life & Permanent.
Unfortunately the PCAR exercise was carried out on the basis of BlackRock's "base" scenario. This envisaged GDP growth of 1.9pc this year and 2.5pc next year, an unemployment rate of 12.7pc in 2012 and 11.5pc in 2013 along with a 14.4pc fall in house prices this year followed by a 0.5pc increase in 2013.
Eleven months later with the uncertainty caused by the euro financial crisis sapping demand for Irish exports in overseas markets, it is clear that the "base" scenario was excessively optimistic.
With the Central Bank having recently cut its 2012 GDP growth forecast to just 0.5pc, house prices still in freefall and the unemployment rate stuck at 14.2pc, Blackrock's "stress" scenario, which envisages GDP growth of just 0.3pc in 2012 and 1.4pc next year; a 2012 unemployment rate of 15.8pc followed by a 2013 unemployment rate of 15.6pc; an 18.8pc fall in house prices this year with a 0.5pc increase being recorded in 2013, suddenly looks a lot more realistic.
If this does in fact prove to be the case then the taxpayer had better look out. One little-observed fact about last year's stress tests was the obvious disagreement between the Central Bank and BlackRock on the true extent of the banks' likely mortgage losses.
While the Central Bank put the figure at either €5.8bn or €9.5bn, depending on whether one opted for the "base" or the "stress" scenario, BlackRock forecast much higher mortgage losses, €9.9bn in the case of the "base" scenario and €16.9bn in the case of the "stress" scenario.
The gap between the two sides was effectively bridged by the Central Bank agreeing to add a €3bn "contingency" to its estimate of the banks' capital requirements, bringing the total up to €24bn.
Unfortunately, with the gap between the Central Bank's "base" scenario and BlackRock's "stress" scenario running at over €11bn, the €3bn "contingency" could be gobbled up very quickly if, as now appears likely, the actual outcome will be closer to the "stress" rather than the base scenario.
So what can be done to prevent the problem of mortgage arrears and negative equity getting any worse?
The first thing to remember is that while up to two-thirds of all mortgages by value may be underwater, the vast majority of those mortgages are still fully compliant, with borrowers making their repayments in full every month.
For these compliant borrowers, about 250,000 of them, negative equity only becomes an issue if, for some reason, they have to sell their home.
While a majority of those stuck in negative equity can still service their loans there is another group of borrowers with unsustainable mortgages. Karl Deeter of Irish Mortgage Brokers puts the number of these unsustainable mortgages at about 25,000.
In practice, most of these borrowers, many of whom are buy-to-let investors, will lose their properties or homes.
The outlook is less bleak for a larger group of borrowers, of whom there may be up to 100,000, who may be able to service a reduced mortgage. The changes to personal insolvency law recently proposed by the Government will give the banks an incentive to cut a deal with such borrowers.
Mr O'Leary sees these changes as offering the most likely route out of the current morass, predicting a series of restructuring which, when combined with the gradual repayment of existing mortgages and a possible partial recovery in prices at some stage in the future, will allow the twin problems of mortgage arrears and negative equity to be "nursed" and gradually reduced to manageable proportions over a period of several years.
While such an outcome might not be an ideal "solution", it's the only one currently on offer.
The Central Bank paper explains why. The Dublin apartment market was dominated by first-time buyers and buy-to-let investors, the two groups worst hit by arrears.
Combine this with negative equity and chronic over-supply and it's difficult to disagree with Karl Deeter of Irish Mortgage Brokers who says that "apartments will be a slaughterhouse for the next decade".
Mr Deeter is more optimistic about other kinds of properties, particularly houses in well-established suburbs.
Not alone has the Government reintroduced mortgage interest relief for first-time buyers who take the plunge this year, investors who buy property before the end of 2013 and hold it for seven years will be exempted from capital gains tax.
"Houses are selling", says Mr Deeter, who points out that in many cases it now costs more to rent than to buy.
"On certain roads houses do not come for sale very often. Now may be the time to buy".