43 thoughts on “Central Bank PCAR Stress Scenarios”

  1. The commercial property prices scenarios look odd.
    -2.5% for baseline and -22% for adverse. Why such a large gap and is -2.5% realistic?

  2. The commercial property adverse scenario uses a decline of 22% in 2011 followed by a recovery of 1.5% in both 2012 and 2013.

    Remember that we have a new government which has given a pledge to allow commercial tenants to secure rent reductions in upward–only leases. On a prime property where the rent was last reviewed 5 years ago, that could lead to a 50% reduction in rent and a 50% reduction in capital values.

    Also for each of the last four quarters, JLL’s commercial index (one of two indices in the State) shows rent declines of 20%+ annualised. But prime rents here are still almost twice the level in prime Belfast.

    Also a 22% decline from the present level which is already a decline of 60% from peak would indicate a 68.8% total decline from peak (100-60-((100-60)*0.22)). The recent purchase of the Dept of Transport offices on Clare Street in Dublin show that we are already at 70% discounts to peak levels.

    22% is not an adverse scenario. Arguably it should be a base scenario.

    At this stage, there is a reluctance to throw more oil on the flames of this crisis, but this stress testing was supposed to be realistic so that we could sit back and consider our options. And not have a situation where we shovel another €35bn into the banks now only to find next year that we need return again and shovel in more funding.

  3. Anything less than a 60% drop – peak to trough – in residential property values is also rose-tinted-glasses wishful thinking. We are already there where I live – and that is just going on advertised/asked for, not what they actually go for. Anyone want to bet on it being nearer 70% by 2013? There is still an awful lot of crap to come over the next year or two.

  4. If we accept the PTSB series to be an accurate reflection of residential prices, then we were 39% off peak nationally at end Q4, 2010. The stress test base case decline for property from peak to trough is 55%, the adverse is 60%. That’s quite a narrow range. Even the base decline is beyond the ratings agencies where there has been a consensus of a 43-47% decline. Others like David McWilliams and Morgan Kelly have produced projections of 60%+ falls. Also John Moran, the MD of JLL said last November 2010 (link below) that we are already 60% off peak and still not at the bottom.

    This is very difficult but it is indeed sobering that the adverse scenario is an average national price of €125k (€313k peak * (100-60)/100) or a base of €141k (€313k * (100-55)/100)

    http://www.independent.ie/business/irish/euro31bn-in-small-loans-will-be-namas-biggest-worry-2358987.html

  5. I didn’t see anything on what default rates they’re planning to use. And what about sme loans?

  6. @DE
    @Jagdip

    You’ve beaten me to it.

    The contrast between the scenarios for residential and CRE is remarkable.

    The 2 scenarios:

    Residential: -13.4 -14.4 0.5
    Commercial: -2.5 1.5 1.5

    Residential: -17.4 -18.8 0.5
    Commercial: -22 1.5 1.5

    They seem to be essentially sticking to their strategy of assuming CRE will not follow residential at all, bu they have put a -20% approx reduction in one scenario (as a one-off) to reflect the suggestions that the FG legislation on upward only rent reviews would reduce CRE values by 20%.

  7. @Grumpy indeed the Society of Chartered Surveyors estimate that the effect of the retrospective rent reviews on upward only leases would reduce commercial prices by an average of 20%.

    But given rents have been dropping by 20%+ annualised in the last four quarters, it is hard to see how the additional decline would only be 2% in the adverse scenario.

  8. Yeah, I’m running some “stress tests” to find out what might happen if one of the White Star Line’s ships were somehow to hit an iceberg. Apparently it might sink! Gosh.

  9. @Jagdip

    If you haven’t done so already, suggest you might like to look at the Honohan interview on Vincent Browne’s programme from about October. I found his response to questions about the Nama CRE valuations quite revealing – particularly the “so I’ve been told” bit. Some of us had already bothered to check.

  10. The figures make truly abysmal reading. Even at that, I feel the personal consumption figure for 2011 (Base -1.9% ADV -3.9%) must be too high based on the other readings.

    My main objection to the PCAR stress tests is that they are the equivalent of assessing how fast a very sick patient would run 3 miles. Knowing that the result will be very poor, you then reduce the rations for the patient’s temporary and reluctant guardian, an equally sick patient. The end result of course is that both patients will end up dead. Or if one patient survives, he will not be sending flowers to his physician any time soon.

  11. @grumpy there is a transcript of the interview to which you refer here

    http://namawinelake.wordpress.com/2010/10/08/central-bank-governor-patrick-honohan-on-vincent-browne-%E2%80%93-not-excited-about-nama-overpaying-e2bn-for-loans/

    I think it’s asking too much for Patrick Honohan to be a property expert, and anyway which of us has a crystal ball? That said, he should be able to challenge an adverse scenario of a 22% drop this year when the SCS says there will be a 20% drop purely considering the retrospective rent reviews. Then bear in mind that rents have been dropping sharply (and the Q4, 2010 drop was greater than the Q3, 2010 drop) and it is hard to see how you get a decline as low as 22%. That said, maybe he did ask the questions and maybe the answers given satisfied him. Be nice to know what the answers might have been though …

  12. None of these stress scenarios can model political risk , as in for example the risk that the EU panjandrums making the decisions have no clue and are just waiting to get upcoming elections over and done with.

  13. @jagdip

    Had a look at that and it doesn’t look like a complete transcript. PH added the comment regarding the Nov 2009 valuation date, at the end I think (not verbatim) ” …and in any case commercial real estate prices are rising in the US an the UK – or so I’m told”.

    This really wasn’t true at the time – and PH didn’t have to be a real estate expert to know that – he just had to be an occasional visitor to Calculated Risk or similar. I don’t think it is unreasonable that the governor of the central bank should have gone to a bit of trouble to look this stuff up – were there many more important economic variables for him to be interested in, at least in passing?

    Here is (National Composite Monthly Indices, near the top) a graph the US for up to end 2010:

    http://www.costar.com/about/CCRSIndices.aspx?id=9557

    Everything except Investment grad was more or less tanking. The implications for the Irish market were clear IMHO.

  14. @grumpy, the transcript includes the point to which you refer : “It’s true that the NAMA property values are based on a November 2009 benchmark and prices have come down a little bit, they’ve gone up in the UK and US I’m told”

    And he was correct as to the UK which is up 10% since Nov 2009 (IPD). The US has a number of micro markets and I certainly believe commercial in the north east US is up by ref to 30th Nov 2009 and although I haven’t seen a regional breakdown of NAMA assets in the US, Anglo in particular was most active in the Boston/NY area.

  15. Never thought I would end up pointing out positives on something like this, but here goes.

    1) I imagine that the main hit from the end of upward-only reviews will be taken by commercial property where the leases were already in place at the top of the bubble. I think this isn’t a part of the market where NAMA and the banks have particularly large holdings. Even if SCS is right, the impact on the values of the properties we the people are exposed to should be a fraction of 20%.

    2) Putting the question of the credibility of the 22% decline followed by a small rebound to one side, and focusing in on the question of whether the scenario is consistent with the residential scenario, one thing to be borne in mind is that commercial property prices are much less prone to lags than residential prices. It seems fairly clear to me that residential prices are much further from equilibrium than commercial prices. So if a scenaro shows commercial bottoming out, then one would expect residential to keep on falling for at least another year or two. This is what we see in the negative CBI scenario.

  16. @BCT,

    “I think this [commercial property where the leases were already in place at the top of the bubble] isn’t a part of the market where NAMA and the banks have particularly large holdings.”

    Why do you think this?

    “It seems fairly clear to me that residential prices are much further from equilibrium than commercial prices.”

    Why do you think this?

  17. @Jagdip

    Missed that in your transcript.

    On the link to costar, the US regional indices are the 5th chart down. Even this appears lower than Nov ’09 at Oct ’10. The other regions are significantly lower.

    My – and I know others’ – take from these comments was that the reference was being used as as an indicator for valuations within Ireland. As such we considered the ex-investment grade indices nationally would be most relevant, given he speculative nature of a lot of the Irish CRE. Given that these were sliding consistently – and were lower than Nov ’09 plus the economic situation was in any case much worse than in the US – it seemed an either naive or contrived point to make.

    The take away from the interview as “maybe not clued into what the reality is”.

  18. 1) Because they seem to be heavy in the really crappy, undeveloped, half developed, and recently completed end of the market.

    2) The commercial property indices moved like lightning in comparison with the residential property indices when the downturn came, which I interpret as meaning they are less lagged. I may be wrong, but that’s my impression.

  19. I think you’re all kinda missing the point with the big shiny numbers. On the residential mortgages, the foreclosure model, rather than the house price drop, will be far more importnant in determing losses.

  20. @Eoin

    Yes we are all waiting with bated breath for the microeconomic assumptions – let’s hope they don’t use the Nevada market as a comparison to Ireland (similar population, property bubble, unemployment, negative equity) which had 180,000 foreclosures in one year compared to the ~500 here.

    @ BCT

    (1) The banks were moving the “undeveloped, half developed, and recently completed end of the market” [land and development] stuff to NAMA so these bank stress tests will examine what is left.

    (2) I see where you’re coming from with commercial falling 60% from peak already and residential only falling 39% but residential is now comparable with Northern Ireland, commercial has some way to decline yet and ongoing poor domestic demand across the economy and a general oversupply of commercial property would tend to depress prices further even before the retro rent reviews.

  21. Following Cearbhall O’Dalaigh’s link took me (via another Lisa O’Carroll article) to a paper by Keith Walsh on the MNCs. Well worth a look.

  22. the irish times reports

    http://www.irishtimes.com/newspaper/frontpage/2011/0317/1224292406625.html

    “GDP is expected to grow 0.9 per cent in 2011 and 1.9 per cent in 2012 under the base case and to shrink 1.6 per cent in 2011 before rising 0.3 per cent in 2012 under the worst-case scenario.”

    What sort of austerity package would the worst case scenario envisage? A Suds type €10-15 bn for the little people would presumably do a lot more damage than +0.3 % in 2012.

    they also report :
    “Central Bank governor Patrick Honohan has warned the stress tests would likely uncover larger losses beyond current estimates.”

    Aren’t stress tests about scenarios that might happen rather than those which have already happened? Can someone explain?

    The moral of the story seems to be that house price crashes are worse than natural disasters. I read somewhere that the 1755 lisbon earthquake that destroyed the city cost 30-50% of GDP. A bargain compared to Ireland’s bust.

  23. Lets look on the bright side. Its now becoming clear that the number will be so big that it will be completely beyond the ability of the Irish Govt to even try to fix it with borrowed money.
    So fold the banks. It should have been done in Sept 2008.

  24. @ Joseph Ryan

    If FF had given up earlier would it have made any difference ? Or did everything need to collapse completely to get the country into your bright side scenario?

  25. @Jagdip

    In your post above you state: “On a prime property where the rent was last reviewed 5 years ago, that could lead to a 50% reduction in rent and a 50% reduction in capital values.” With long-term financial assets like equities etc. a 50% decline in immediate cash flows need not be tied to a 50% decline in capital values. Wouldn’t the capital decline be somewhat moderated? I have limited knowledge of commercial real estate but curious about your reasoning.

    Also, I am skeptical of Irish-US mortgage default rates unless bankruptcy law unless there is a sudden and spectacular change in Irish bankruptcy law and practice to mimic the US bankruptcy environment which is very different.

  26. @Eoin
    “I think you’re all kinda missing the point with the big shiny numbers. On the residential mortgages, the foreclosure model, rather than the house price drop, will be far more importnant in determing losses.”

    As the saying goes, garbage in, garbage out, regardless of how good the model is.

    The fall in commercial property prices just isn’t credible, even the adverse scenario looks slightly optimistic.

  27. @Gregory,

    Taking Nevada as an example because it seems to have similar economic/property problems to Ireland and mortgages there are recourse (like our own), the key reason for the differing foreclosure rates must surely be differences in the bankruptcy arrangements. We have 10 bankrupts here per year, even Northern Ireland has a bankruptcy rate/1000 that is 350 times ours and the US’s is 1000x. But Ireland has committed to reforming its bankruptcy laws as part of the bailout deal and bring the laws into line with “international norms” for “honest bankrupts” if I could borrow the language in the programme for government. Will that mean our foreclosure rates rocket? Surely a stress test would take all of this into account.

    As regards commercial real estate, the estimate by the SCS/IPD is that on the IPD portfolio of properties which informs one of the two commercial indices in the State, allowing downward rent reviews in upward-only leases would reduce the capital values by 20%. I understand where you’re coming from with say discounted cash flows on investments but a 50% permanent reduction in a property’s rent will lead to a capital decline in that order.

  28. @Dreaded_Estate

    Are you still sticking to your claim that residential fell by 10 per cent last year? You maintained this claim throughout last year, even when both the CSO and Daft showed otherwise. You claimed to have your own database that differed from the other two. Back in September, you claimed that your database showed a big fall in residential rents after July. At that time, the CSO and Daft figures weren’t out. But, when they came out, they did not show the fall you claimed your database showed.

    Now, both the CSO and Daft figures for residential rents are available for the whole of 2010. They are remarkably consistent with each other. Both show residential rents levelling off in 2010, with virtually no change between the end of 2009 and the end of 2010. The most recent CSO figures published last week showed them rising slightly in January and February 2011.

    As Lady Bracknell said, for your figures to differ from those of one of the established databases is unfortunate, but to differ from both is careless.

  29. @Seafoid

    If FF had given up earlier would it have made any difference ? Or did everything need to collapse completely to get the country into your bright side scenario?

    Regime change is never easy. People that hold power rarely give up power and privilage voluntarily. Hopefully FF are gone forever but there are still a vast numbers of people still feasting while others have been consigned to misery and despair. But it is the banks and their professional supporters that are bringing the country down. In their final years FF was just a suitable mudguard for them.

    Only a stake through the heart of the banks that are still bleeding the country to death will allow us to live free again.

    Happy St Patrick’s Day!

  30. Strange how reality evades some folk.

    Current res property market prices have a significant way to decline. The rough-rule-of-thumb is that for every year of increase (during a bubble) you should allow at least two years of a decline to revert to ‘mean’, plus a drop below the ‘mean’, then a slow recovery to the ‘mean’.

    The property bubble (+200% -> +300%) was 7 years in the making, so that would put the decline at 14 years – from end of 2006. Hence we have some ways to go yet. Decline is Sigmoidal in character. Cert Par as they say, but economic fundamentals are anything but Cert Par at the moment. And prognosis is poor. Incomes are declining, interest rates may increase, credit availability is tight: ergo, property prices decline.

    The political predicament will arise when ‘something has to be done’ to alleviate personal debt burdens which have become unsustainable.

    BpW

  31. The off-peak property price estimates assume that there is or would be a market for such property. Call me a skeptic on that scenario. Mortgage approvals are on the floor and the country is awash with vacant property. Anyone who has been out trying to sell property or knows the state of indebtedness of any sizable property company would, I suspect, agree.

    60%+ does not seem at all far fetched based on my experience (which is all I can go on). I gave an example some months back of a development property bought for €1.1million at peak, and sold last July for €200K. Similarly a piece of land in South Dublin bought for €17 million was disposed of last summer for slightly north of €2 million. The CFO of a major development company told me last weekend that just one of their clients owes them €80 million. More mundanely, I relation of mine has been trying to sell a small house in a rural town. It was valued at €180k in the boom, and at the moment he has no concrete offer over €36k.

  32. Given that residential property prices became divorced from intrinsic value during the bubble, it’s tough for me to conclude much by looking at the % up/down to/from the peak so I’ve tried to anchor prices to some level of affordability. Using the average Irish wage as a comparative basis, the Central Bank adverse case looks to me to finally be a reasonable level for where the market might bottom out.

    According to the Permanent/ESRI house price index, the average national price in Q1 1996 (the first available period) was €75k. If you take the average industrial wage in 1996 of €348 per week x 52 weeks (hat tip to Finfacts Guinness Pint Index http://www.finfacts.ie/Private/bestprice/guinnessindex.htm) you’d get to an average house price that’s 4.1x the average industrial wage. That’s a little higher than the UK and US post-war averages of about 3.5x, but interest rates are broadly lower (average mortgage rate was 7% in 1996) and there is more female labor market participation/two-income families today than prior to the early 1990s, so it’s not unreasonable. If you look at older indices for Irish house prices then the beginning of 1996 is also a reasonable proxy for the long-term affordability trend over the prior 12 years.

    The primary reason why house prices are normally stable around these levels is because a sane bank will only normally lend someone about 3x their annual salary.

    Affordability obviously collapsed post 1996 and applying the same logic to Q4 2006, when the average price was €311k and average wage was €598 per week, gives a nosebleed ratio of 10.0x. The ratio stands at 6.2x as at Q4 2010 (using €192k and the 2009 wage of €595 per week).

    If you deflate the Q4 2010 property price by the Central Bank adverse case of 17.4%/18.8% in 2011/12 and inflate earnings by their CPI, then you’d get to a 2012 house price of €129k and a weekly wage of €606 which would put us right back to Q1 1996 affordability of 4.1x. Leaving aside the observation that markets typically overcorrect to the downside before finding equilibrium, I think this would be a fair base case assumption, which is better than we’ve seen in the past.

  33. @Edward, there are a number of ways to justify prices of residential property – multiples of gross salary as you suggest, percentage of net salary or affordability, multiples of rent, supply:demand price:quantity equilibrium and replacement/build costs would be five such ways which are all perfectly reasonable in themselves.

    But property will fetch what buyers and sellers will agree which might take account of the above or other “hard” methods. But price levels can also take account of perception – that’s why we had prices at 10x average salary in the boom. You would tend to expect prices to overshoot the “hard” valuation methods on the way down just as they did on the way up.

    Personally I was shocked at the official assessment for future prices of residential which represent a 30% decline from present levels in the base case. The decline is significantly more than last year’s CEBS’s stress test
    and what the ratings agencies have been saying.

    If you’re buying a property today, yesterday’s release practically gives you the right to demand a further 30% discount.

  34. @ Jagdip

    I’ve looked at rental yields and mortgage cost as % of post-tax income also, which both arrive at very similar conclusions. I agree that one should expect to see an overshoot on the way down, but I’m starting to get pessimism fatigue!

    I also completely agree with your point on buyers demanding a 30% discount – it has the potential to be a self-fulling prophecy to tell buyers/sellers that the price is likely to change at some time in the not-too-distant future… kind of like telling bond holders they may need to take a haircut after 2013…

  35. @Gregory Connor

    On bankruptcy law – I .. er .. agree! Is this a first? (-;

    It is an absolute essential to clean-up operations – present set is Dickensian in the extreme … and impediment to recoveries ………

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