Tepid recommendations do little for real poblems

This mortgage arrears report was cynically spun, writes Bill Hobbs

Recommendations of this Government’s “expert group on mortgage arrears and personal debt” will be about as effective as a foot pump on the Titanic. Published last week, the group’s interim report leans far too much in favour of the lender and fails to address the core issue of a massive consumer debt problem.

Written by a group dominated by government, banking and regulatory interests, the report is a banker’s and not a consumer arrears charter. Its tepid series of recommendations will do little to tackle the underlying problem. Dealing with just one symptom of the debt crisis, it lists forbearance recommendations on tackling mortgage arrears.

Critically the group’s core recommendation to standardise an approach to arrears management does not address a lenders influential power over a borrower. Called the mortgage arrears resolution process (MARP) it is nothing more than a voluntary scheme in which the borrower has no rights and remains exposed to losing their home. Forebearance, modifying loan repayments to make them affordable, won’t work in dealing with the sheer scale of the consumer debt crisis.

First quarter data on mortgage arrears from the banking regulator sketched the outline of this quite appalling mess. Over six months in arrears, 32,000 homeowners owe an average of €172,000 each plus €19,000 in arrears. Assuming an original loan to value of 80% this equates to an unrecoverable loss of 32% per loan for the banks. Householders in this category owe €61,000 more than their house in worth. The figures get worse with peak boom time 100% mortgages, losses per loan rise to 45% or €86,000 per household.

They are quite shocking figures and as averages hide the true scale of the problem. Undoubtedly the numbers for the second half of this year will have worsened and trends indicate well over 40,000 will be in the highest risk category with thousands more joining another 30,000 who have modified their loans using forbearance sweeteners offered by banks.

It is obvious that the banks still do not want to admit to the true figures. For example the group’s report uses an estimate on modified loans as none of the banks have published actual loan experience. They are of course anxious no to come too clean on their consumer loan losses as they deal with their NAMA enforced write downs and recapitalisation worries. The group’s report failed to produce a scintilla of new data save to cite sparse information already published by the banking regulator.

Its figures do not account for other troubled personal loans or personally guaranteed business loans. The vast majority of people in mortgage arrears are also hopelessly in arrears on other loans from car finance companies, credit cards providers, credit unions and others.

When speaking of his groups report, Minister Eamonn Ryan sought to talk down the mortgage arrears problem. His line was that only 32,000 of over 750,000 mortgages were in difficulty. Apart from being the entire home owning population of quite a large town, this type of political huff and guff all too conveniently ignores the fact that the majority of people who are in trouble are under age 40, married with young children having borrowed to buy grossly overpriced and now massively devalued homes. Many have no prospect of ever repaying what they owe in full.

The problem is not about arrears, it’s about the social costs to this society and its families. A recent article in this paper wrote of a worrying escalation in male suicides in 24 to 44 year olds. A 2006 report of the British Economic and Social Research Institute found that males experience significant adverse psychological effects from living in fear of losing their homes and dealing with their loan arrears. Our court lists are full of creditors ruthlessly pursuing hopelessly insolvent debtors. Our lenders are using high pressure tactics to grab their share of dwindling homeowner incomes. Government’s response has been a list of recommendations that should have been implemented years ago and commentary on the need to do modernise Dickensian debt laws.

As Government kicks the consumer debt can down the road to buy the banks more time, the report was cynically spun as benefitting homeowners in trouble. It seems government hopes to muffle the blast and limit collateral damage to banks. But decommissioning the consumer debt landmine will take far more that the measures taken so far. And reducing loan repayments only makes the eventual debt larger, creating a form of debt serfdom from which people cannot escape.

Banks lent billions to ordinary people based on unsustainable boom time incomes, overpriced homes, low interest rates and tax rates. They recklessly assumed incomes would continue to rise, people would continue to be employed and property prices could only rise. Consequently Irish households are now the most financially vulnerable in Europe and will continue to be for some considerable time to come.

It’s a perverse scenario. A €250m loan transferring to NAMA is being written down by 50% to €125m but a homeowner is expected to able to repay 100% of their €250,000 mortgage or else “voluntarily surrender” their home. Government’s message to ordinary people is at least €65bn will be forgiven of the property development sector but you are on you own if you are an indebted homeowner. Could it be that people will revolt en-masse and default on their debts?

A version of this article appeared in the Irish Examiner Monday July 12th 2010, Business Section

NAMA: A TRAGIC FARCE

The sceptics have been proved right, as NAMA is on course to becoming one of the largest debt forgiveness programmes ever devised, writes Bill Hobbs

When first told, the NAMA story was of a benign fairy godmother that would sprinkle pixy dust on banks and get them working again. In its second telling, the story was the tax payer stood to make a profit. In its third telling this week, what began as a fairy tale ending is morphing into a tragic farce.

It is clear the pixy dust has not worked and the naïve belief that banks had come clean on their losses was mere wishful thinking. Sceptics who considered NAMA’s Hollywood “feel good” ending grossly optimistic have been proved right. NAMA is on course to becoming one of the largest debt forgiveness programmes ever devised. Politician’s assurances of pursuing people to the ends of the earth to recover debt flies in the face of one brutal post-boom fact, most borrowers are bust – their wealth was tied up in property. Unless NAMA can miraculously squeeze blood from stones, it is almost certainly going to have to agree to writing off debt.

Some say the combination of NAMA and bank recapitalisation programme will cost the state over €30bn in today’s money, which will have to be borrowed and repaid from future tax revenues. Most of this borrowed money will be burnt on the funeral pyres of two rogue banks, Anglo Irish and INBS. A new Anglo plans to rise phoenix-like from the ashes and fly again as a good bank. Flying pigs may be more apt, as its first plan for becoming a banking phoenix was shot down by the EU. Its plan, like NAMA’s first version, appears to have been full of optimistic, woolly assumptions.

NAMA believes it may pay 50c in the euro for €81bn in loans it plans to buy from the banks. So far it has bought €15bn of the top 100 borrower’s loans who owe €50bn. The balance of €31bn is owed by 1400 others. Some of the loans are worthless or near worthless, some barely ticking over and others fully functioning. The problem for NAMA is there are a lot less good ones then it planned for. Only one in four are good, the rest are a heady mix of loans financing fallow fields, partially complete buildings and thousands of unsold or untenanted finished properties. The fear is the smaller loans will present any even worse profile than the bigger ones.

NAMA says in its best case scenario it will turn a “profit” of €3.9bn. Its worst case projection shows it making a loss of €800m after cashing in €2bn through its soft landing loan loss insurance -a claw-back from the banks of money paid by it for their loans. Unfortunately worst case scenarios have a nasty habit of becoming far too optimistic as real outcomes in Irish banking illustrate. One leading economist estimates NAMA losses of over €14bn.

Long on hope and short on experience NAMA’s trying to project profits in 2019. In business, predicting anything beyond two or three years is a bit like trying to hit a moving target in the fog while blindfolded.

Imagine borrowing €500,000 to buy a house worth €450,000 whose tenants haven’t paid rent in years in the hope that in nine years time you will be able to sell the house for a sum equal to everything you will pay over the nine years, including legal costs in evicting the tenants, finding new ones, maintaining the property and covering all fees, insurance and other costs.

This is how NAMA will work with completed occupied buildings. As it deals with the unfinished stuff, it might demolish it, mothball it, sell it off or pay someone to finish it off. Farmers who made millions selling land at boom time prices will be able to it buy back at agricultural prices.

It might possible to fool all of the people some of the time, but we are beyond fooling. The cleverly spun story that launched NAMA as a costless way to get away with having to pay for one of the largest bouts of wealth destruction ever, has ended.

Most developers are quite simply broke. They will not be able to repay what they owe no matter how inventive NAMA’s predictive arithmetic is. The sums do not match up and no amount of wishing will make them do so.

The fact is banks recklessly lent money at levels that could only have been repaid in boom time economic conditions, which will not be repeated. They lent money on a borrowers’ net equity, their personal wealth, which in most cases was based on inflated property values. Once values collapsed so too did people’s ability to repay. Negative equity is not solely a homeowner malaise, many of NAMA’s clients are hopelessly insolvent.

One reality is the only people to profit from NAMA’s day to day operations will be its host of professional advisors. Instead of letting the banks pay for cleaning up the mess they created, NAMA will pay, at least €1.6bn.

Nearly two years into the banking crisis we have one bad bank, NAMA, two failed banks, Anglo and INBS and four zombies. The final story will not be just be about NAMA’s debt recovery loses or the billions burnt on two rogue banks’ funeral pyres. It will include the profits made by those who pick up cheap property assets.

A new form of carpetbagger/investor will emerge. They will kick the tyres in NAMA’s forecourt and select the best – many will undoubtedly partner with experienced professional developers. There will be many phoenix-like property developer resurrections. Debt forgiveness is always the first step on the path to recovery. But there won’t be bodies swinging on NAMA’s gibbet. Instead its people and advisors will get on with the business of doing deals and publishing annual accounts demonstrating value for the tax payer.

Predictions based on optimism almost always disappoint. There is no point saying the glass is half full when there is still a hole in the bottom as property values that underpin NAMA’s loan values continue to decline.

A version of this article appeared in the Irish Examiner Saturday July 10th 2010, Analysis Section

Banks weighing up risks of lending

The line between careful borrowing and unscrupulous lending is very fine, writes Bill Hobbs

In over two decades lending to ordinary people, I never once had someone tell me they couldn’t afford the loan they were looking for and not to give it to them.

Most people genuinely believe they can afford their use of credit. But they also have an exaggerated sense of personal safety – bad things only ever happen to other people. Guarding against this myopia is the stuff of good lending whether it’s banking, building society or the credit union type.

Can a person afford the repayments, what’s the risk of them not being able to and have they used credit wisely in the past are the key considerations.

Lenders rely on information provided by borrowers, who may decide not to reveal their true financial circumstances. Lenders get over this problem by using two mechanisms. The first is internal credit scoring, using statistical decision trees to rate borrowers as good risk or otherwise.

The second is using external credit reference agents to better understand a persons historic behaviour in using credit and predictive use of credit. At one time these agencies recorded previous behaviours. Today they also provide predictive information on how a person may behave in the future. Do these systems really work?

Only if the data used is reliable and provides a full a picture as possible of a persons credit profile. The outcome is said to lead to better lending decisions, more efficient cheaper processes and lower costs of credit. The good borrower is not forced to subsidise the bad borrower. There are also aspects of social engineering, getting people to behave as more rational borrowers. This is unfortunately the stuff of text book theory rather than human and social reality.

Central to the operation of a proper functioning consumer credit market is the ability of banks to be able to tell good risks from bad risks. Where they can’t tell the good from the bad they carefully ration credit. Where they can, they can charge less for good risks and more for bad risks. The Central Banks’ proposal for a national central credit reference agency illustrates the importance of ensuring banks can lend safely and people can access credit on affordable terms.

In future it’s likely that personal credit ratings will become a passport to living life as the citizen consumer. Those with poor or bad ratings will find themselves financially excluded, marginalised from accessing credit on affordable terms and forced to pay high rates to those willing to lend to them.

More intrusive central bank supervision of lenders and improved sharing of financial information may well create a shift back to the debt ethic of the past. A new form of citizen consumer who uses debt more carefully may emerge.

We once lived and worked our entire lives within tight knit local communities and lived as our neighbours did. Owing money was frowned on. Personal savings augmented with occasional small loans was how people funded larger purchases.

The twenty year mortgage, invented during the Great Depression in the US, was a means to make owning a home affordable to the masses. It took until the 80’s here before home ownership for everyone became possible. At about the same time the modern citizen consumer evolved. It was a consumerism that relied on borrowing to buy today rather than saving to buy tomorrow.

The consumer citizens’ behavioural use of credit shifted, driven by mass marketing that enticed people to live not as their neighbours did but to borrow to live like the rich do.

The better off were sold as the role model to emulate. The tight knit local community debt ethic became the global community credit ethic through mass media marketing. Once paid by cash or cheque, people’s salaries were paid electronically to bank accounts providing access to cash 24 hours a day. Money became bytes of data stored and transmitted across computer networks.

The physical value of the pound note became the click value of the online euro. As people needed bank accounts to pay for their consumption, banks cross sold credit cards, car loans, homeloans, holiday loans and anything that would generate fee income.

As disposable income improved, the consumer debt to income ratio expanded. More disposable income meant ever higher levels of borrowings which in turn drove incomes higher again.

Since the 80’s lenders invested little in understanding consumer credit risk. Instead vast sums were spent on driving down costs and increasing sales revenues. Counter staff were given sales targets. Lenders became relationship managers. The culture shifted from prudent lending to one that prized the successful salesman as a generation of traditional bankers were retired off. Banks are now busy getting back to the knitting of proper prudent lending and building the capacity to better understand and manage credit risk.

The perversity is to get the economy moving again, people have to start spending which means they have to start borrowing and behaving as boom time consumers. But banks won’t lend as they do not believe the risks are bankable. For the immediate future, credit will continue to be rationed and priced up, as banks cannot risk lending into a damaged economy.

Will there be a return to the pre-80’s debt ethic? Will most people once again save to spend later rather than borrow to consume today? It wouldn’t be such a bad thing. Modifying consumer behaviour sometimes takes extreme shock treatment – a credit crisis. But could it be, that having witnessed the car wreck and slowed down for a while, people will speed up again?

All the more reason then, for the Central Bank’s proposal for a national credit rating agency to be taken seriously. It may put manners on banker’s provision of credit and borrowers behavioural use of debt.

A version of this article appeared in the Irish Examiner Monday 5th July 2010, Business Section