IMF Post-Program Monitoring Report on Ireland notes the unusual risk profile of the Irish banking sector

The IMF has released its latest post-program monitoring report for Ireland. What is notable in the report is how it highlights the still very-high-risk profile of the Irish banking sector, and the policy quandary regarding encouraging housing construction without endangering another Irish banking sector crash over the medium term. Despite a strong, three-year-long domestic economic expansion, Irish mortgage loans remain an unusually risky asset class.

Due to demographic pressures, Ireland needs a sharp increase in housing construction, but the very-high-risk nature of Irish mortgage loan assets pushes against any such increase. This is a quandary for the banking sector, the construction sector, and especially for the Irish Central Bank, attempting to calibrate its macroprudential regulation of the mortgage lending market.

Irish mortgage loans have very limited, almost negligible, realizable collateral value. That is a big risk factor for the banking sector and the domestic economy, although obviously in the midst of an economic boom it is not a short-term problem. At the same time, there is a demographic bulge of young Irish adults needing more and better housing.

 

Some selected quotes from the report (see the link for the full report):

“Staff cautioned that, as banks may resort to more risky assets to improve returns, supervisors must ensure that banks’ business models appropriately balance profit seeking and risk management, and that loan pricing adequately reflects credit risk and barriers to collateral realization. “
………………………
“In the mortgage segment, NPL [non performing loan] resolution is complicated by weak cooperation between borrowers and lenders, lengthy legal proceedings, and limited (but increasing) utilization of personal insolvency arrangements. As a result, the stock of mortgage accounts in deep arrears (over 720 days) continues to increase, reaching 55 percent of past-due loans (over 90 days) in mid-2015 from 49 percent at end-2014. About half of the CRE [Commercial Real Estate] loans are still nonperforming, despite promising trends in restructurings and write downs. “
………………………….

“Provision coverage declined slightly as collateral values rose, although these values often remain untested by foreclosures and sales. Nonetheless, loan books continue to contract, profitability remains low and partly driven by provision write backs, and nonperforming loans (NPLs) are still high at about one-fifth of gross loans.”
………………………

“With banks continuing to release provisions as property market conditions improve, staff cautioned that write backs should be based on conservative assumptions and collateral reappraisals. “

28 replies on “IMF Post-Program Monitoring Report on Ireland notes the unusual risk profile of the Irish banking sector”

Wouldn’t it be gas if the IMF recommended a programme of social housing to bypass the risk of the banks tearing the arse out of it again? What is an economy for anyway if it cannot serve the people?

Ireland still has very high public and private debt levels. CBS can’t generate 2% inflation and QE is a joke. If they just say fu#k it and let markets find an equilibrium for rates Ireland would be in serious trouble. There is no easy way out of this debt crisis.

Seafoid,
The current guidelines from the CB will prevent the banks from lending money at too low a rate to people who have a low propensity to service the debt and where the security cannot be recovered. Irish mortgage lending is effectively unsecured zero coupon lending so is highly reckless.

Which leaves with a dilemma. Who will pay for the construction of houses? I look forward to a political party expressly advocating higher taxes for social housing. Such a policy will have to consist of the provision of houses on a rent free basis for indefinite leases paid for by the taxpayer.

Where are the 350k empty houses that were supposed to exist a few years ago? If these houses actually existed, there wouldn’t be any urgent need to ramp up the construction of new houses.

I don’t buy the argument that these empties are in locations where no one wants to live. Ireland is a tiny country. Most of its towns and villages are tiny. The idea that in the typical Irish village of Ballygomuckamore (pop 768) there are scores of empty houses going abegging in the north end of the village, while in the south end people are unable to find a house to buy, is fairly ludicrous.

Might I suggest that Morgan Kelly and NIRSA be called in to find these 350k empty houses, and so alleviate the homelessness problem. Failure to find them would, of course, confirm that it was all a hoax (similar to the 70k net emigration hoax just prior to the last election).

Hoping to see something a little more subtle to boost supply and hold prices down. Immediate introduction of the proposed levy on development land to tilt the balance in favour of developing now, instead of waiting, looks like a winner. Shifting the taxation mix away from development levies looks like a winner too.

Over a longer period, it’s worth doing a fundamental re-examination of Irish building and planning standards to see what can be done to cut costs. There was a big improvement in residential construction productivity over the 10 or 15 years to 2007, but Irish construction is still shockingly expensive.

It is clear from the recent turmoil that deflation is coming. Also most of Irelands export markets will be either close to or in recession. This means that all the exaggerated claims of Irish growth will be slashed this year and we will be lucky to get out level. Because of the high level of debt inherent in Ireland, government, personal and corporate (in fact we are second to Japan in the GDP/debt ratio) it is clear that a deflationary spiral will be lethal. Capital flight from Ireland will be huge as the ultra-rich try to meet margin calls as asset prices are deflated. What this means for housing is unclear at the moment as house prices, particularly in Dublin will fall. However most of the marginal renters will probably be stuck in a sort of upwards only rent review aided by our rentier government which has done nothing but financial damage to this group as demonstrated by the major upswing in homelessness caused by the failure of the government to effectively legislate the stop rent gorging by private landlords. Rents will lag price falls and the government will do nothing. Basically when they come up against a powerful rich lobby or individual they always back down against the common good. Witness the recent crumbling of attempts to introduce meaningful competition in the legal sector which is leading directly to enhanced insurance claims and premiums for all. The neo-liberal approach will definitely not work but is hard to see another government formed which will not pander to this outdated economic theory. Witness what happened to Syriza when they had the affrontry to tackle the western status quo.

We also need to look at the cultural aspect.

In recent years builders and developers have been vilified and demonised by the left-liberal media and cultural elites. A housing shortage is the result. Builders and developers have become hate figures. They have been branded as crooks and gangsters. Recently, the Minister for Housing Shortage, Alan Kelly, told them they shouldn’t expect to make profits from house-building. That belonged to the bad old days of FF, when builders were incentivised to build houses in the numbers needed by the prospect of handsome profits in doing so. Its hardly surprising that builders and developers aren’t rushing to build houses at present, even though there is an obvious demand. To compound the problem, no political party will touch them with a bargepole or even consider tax or other incentives to get house-construction moving, as to do so will mean being branded as corrupt by the twitteratti.

The reality is that for Ireland to build houses in the numbers needed in coming years, builders and developers need to be brought in from the cold and recognised as having a key role to play in Ireland’s economic growth. As a start, I suggest bringing back the Galway Tent. There were never any housing shortages while it was up and running. The left-liberal commentariat will fume, of course, but they aren’t going to build any houses.

There has been much recent commentary on how the Central Bank rules on first time buyer lending have impacted on the financial viability of construction of houses for this segment of the housing market. I looked at the actual makeup of the components of house price, the price target that must be met to enable purchasers buy the houses (given the lending constraints) and the feasibility of constructing houses for sale to this target market at this price level. The results of the my study are:
• A price target of €290K must not be exceeded to allow an average first time buyer household purchase a 3 bed semi-detached starter type house – this assumes 2 in the household earning a total household income of €70K.
• To achieve this price houses must be sized at 1,100 sq. ft. and site cost not exceed €50K per house;
• Sites priced above the €50K per unit may not be suitable to build first time buyer starter houses;
• At this house price level the financial viability of housing development is at best marginal and there is significant risk in starting projects for a housebuilder/developer – a 10% increase in construction costs will eliminate projected profit – cost control is key in constructing for this segment of the housing market;
• The public sector take from housing development is c. 30% of the house price – a reduction in this charge could improve the affordability of this type of house – this is tricky as the development levies etc. pays for ‘stuff’ that has to be funded somehow.

The full article is downloadable here (http://www.kmcs.ie/HousingStudy.pdf ) – I am sure that some of the assumptions are challengeable –

We need to be able to provide houses for key workers and it seems questionable when the monthly cost of the loan is €1,265 and below the rental cost of an average 3 bed unit that some mechanism cannot be found to facilitate buying and building

Seafoid,
Given the budget constraint, the money for social housing has to come from cutting other expenditure measures or by raising taxes somewhere else. Please don’t argue that it is capex as the stock of public housing generates a negative rent. Let’s see the first political party put that in their manifesto and win support.

” …. it seems questionable when the monthly cost of the loan is €1,265 and below the rental cost of an average 3 bed unit that some mechanism cannot be found to facilitate buying and building.”

Barry, thanks for the article. But two quick comments re- the above.

You need to include ALL costs which directly relate to house – mandatory insurance cover, maintenance, security, taxes and charges. These will increase the monthly ‘bill’ significantly – and that bill must not exceed 28% of your after-tax income! Otherwise the borrower is perched out on a very shaky limb indeed.

Also: ” A price target of €290K must not be exceeded to allow an average first time buyer household purchase a 3 bed semi-detached starter type house – this assumes 2 in the household earning a total household income of €70K.”

Relying on the incomes of 2 borrowers is something that should be expressly prohibited. Its a recipe for a financial disaster: 140,000 is the (sustainable) total cost (property + transaction) charges of a so-called starter home – we have a 20%+ residential mortgage default rate!!!

Barry, thanks again for the paper – v-interesting! Revenue (not Gov) ‘captures’ 30% of the cost. WTF!

To paraphrase estate agents – the key characteristic of home purchase is “Income, income and income.” The really vulnerable individual is the borrower – and they have about as much financial protection as that provided by a shrivelled fig-leaf.

“Affordability is driven by the AVERAGE (my emphasis) household income(s) …”

This is economic and financial madness. Affordability must be assessed on the basis of only one actual (real), rather than an estimated income. Its trivally easy for the lender to check a real income. P60???

“Based on CSO data an average first-time buyer household (of 2 earners!) earns 72,500 and an affordability target of 290,000 need to be reached.”

Just treat the CSO data with a pinch of salt – and accept their Means as essentially meaningless – unless you have independent, confirmatory evidence. Again, I re-iterate, there are NO average home buyers and the affordability target is totally meaningless absent an independently confirmed, real income status,of the real individual person who is borrowing that 80% mortgage.

A build cost of 126 euro/sq ft appears a tad excessive – but ….

The challenge is to provide purchasers with incomes which are sufficeint and adequate so as ensure that the probability of failure of a long-term residential mortgage is less than 1%. As I wrote in my first comment – the current failure rate is 20%. So what might be the causal factor for that then? Dodgy borrowers? Dodgy lending practices? I’d bet on the latter.

The revenue capture is quite staggering. I would argue that this is a stealth(y) additional tax imposed on the after-tax waged-labour income of the purchaser, in much the same way as debt re-payments are imposed on after-tax waged-labour incomes. Or to state it more correctly, the future, after-tax income stream of the individual.

And then you have the privilege of paying your Property Tax – as well! Do we really have the ‘lowest’ tax-take in the EU?

We’ll be back at this issue. Thanks again for the paper.

@Tull

“Please don’t argue that it is capex as the stock of public housing generates a negative rent.”
What an fallacious comment.
Even taking a narrow definition of rent, one can safely assume that it is more economical to house people in public housing that rather with private landlords or hotels; and the State still has, to my knowledge, a legal obligation to house its citizens, no matter how much that legal obligation is ignored or frustrated.

There was no problem finding 64 billion for the banks- it took a few hours. Why the big deal about spending money on housing?

Two points regarding the subject of the thread.

The IMF criticism of the Irish banks for recording ‘profits’, by means of writing back reserves, is spot on. Not only the IMF, but the Central Bank should simply have told the banks where to get off, and forced them to rewrite their financials.
One can understand, however, the reluctance of the central bank, to start forcing a proper recording of bank profits and bank reserves in Ireland, while Irish banks have almost twice the capital levels of the the major European banks, yet large European banks seem immune from criticism from the powers that be.

The weakness of European banking is to the fore again this week.

Two European banks in the news are Deutsche Bank and Banca Monte dei Paschi di Siena; Deutsche losing more of its meagre capital and in Italy, what is starting to look like a bank run.

The IMF (and Draghi) will have more to concern themselves with than Irish banks, if the EZ economy does not improve quickly.

text from Blind Biddy in Davos:

On a mild razz here with old pals Axel Weber and Joe Stiglitz …

Joe: ‘
Ireland’s economy would have fared better if it had been permitted by the European Central Bank to burn private debt holders, Nobel Prize-winning economist Joseph Stiglitz has said.
Speaking at a panel debate alongside Taoiseach Enda Kenny in Davos today, the Columbia professor conceded that Ireland had performed better than other euro zone economies who were forced to undertake austerity programmes.

“The question I always ask is, was there an alternative better policy and would you have been better off if the ECB had not forced you to take on some of the debt from the private onto the public. My answer to that is you would have been better off if you didn’t have that debt, you would have been better off if you had had the assistance for a growth policy rather than an austerity policy.”

Axel: That’s what I strongly suggested at the time … right Biddy?

Blind Biddy: You did indeed Axel.

aside … Enda: Best little country to do business … we are insulated.

Joe, Axel – Who’s yer man.

Biddy: I have .. er .. no idea! Wan_of_18 maybe. But we could sure build sufficient social housing with 40 Billion or so …. fully insulated of course!

http://www.irishtimes.com/business/economy/stiglitz-ireland-would-have-fared-better-by-burning-bondholders-1.2505276

Tull

Deflation is on the way anyway. The Govt should open the taps and build as many houses as it can and PFO the ECB because with that debt load and deflation the country is f#d anyway. Building would generate its own economic momentum and put money in ordinary peoples’ pockets. Now is not the time to follow rules built for a world of 2% inflation imo. Solvency 2 and Basel 3 are worthless under deflation. JPM and its fortress balance sheet could go to the wall. This is senior hurling squared.

Jules

I agree on the deflation. I think France or Italy will leave the Euro because the pain will just not be worth it and the Germans can have their DM back and share Switzerland’s problem. The memes of neoliberalism are all falling apart . Expanding the money supply and inflation is near zero. The ECB’s inability to hit 2% inflation means debt is running amok. The difference over 10 years between 2% inflation and 1% deflation is 35%. Apply that to Italy’s 2.2 tn debt and how much of it will never ever be repaid ? It must be a bit like the Nazis in 1944. Who is thinking post Hitler ? Surely some people right at the top can see what is happening.

@Seafood

My take is that there will come a time when the ECB will want to starting sending cheques directly to citizens. To get inflation going. QE for the people, as Jeremy Corbin is calling it. At which point the extremely leveraged will be saved and will inherit the earth from the prudent.

The only question is, what will the Germans do?

@jto

If developers hadn’t tore the arse out of it they wouldn’t be any need for bad press

Priory Hall, Fire safety cert issues in any apartment block that’s inspected.

I mean gouging for a properly built property is one thing but gouging for apartments that are a fire hazard is quit another. Not to mention the very real risk thst your roof might blow away while you’re watching telly.

I take your point on the missing houses though. The doom port reached 11 out-of 10 there for a while. To be fair you were in a small minority, if not alone, in your fight against the doom pornographers.

@Seafoid Yes I think a lot of the reason we have not seen much more deflation to date is because of lags in system, consumer facing businesses are much slower to reduce prices than increase in inflationary times. Also the dollar strength which has been appreciating against all currencies is another factor. However I do expect this to last as China, Saudi and Russia are selling their dollars to prop up their budgets. Of course there still are vast amount of dollars hiding in computer digits in the tax havens owned by the ultra-rich and multinationals, you can bet a lot of this has been recirculated by the tax haven banks in “safe” government bonds US, Germany and even Italy and Brazil on the margins and some of this will disappear when Government debt starts to look shaky in a deflationary environment. Also any sign of sustained dollar weakness will cause the ultra-rich and multinational treasuries to start pulling in these dollars to meet margin calls and so CEOs can prop up their share price and hence inflated salaries by share buy-backs. In many ways the rise of the dollar has been mirrored historically by the yens rise a couple of decades ago. In this case asset prices in Japan also went through the roof with a park in Tokyo having a higher “value” than all the real estate in California. Meanwhile production moved to Tiawan and China and Japan ate its own tail as relative production costs escalate. These trends must be obvious to the FED so I expect any continued long term dollar strength to be frozen by a return to QE and the slowing of the US economy. Where does all this leave Ireland, IBRC bonds which were in effect a transfer of wealth from the standard tax-payers to the ultra-rich with the tax-payers paying by USC, water and property taxes for these bonds which are adding to our debt and increasing our risk profile and the ultra-rich gaining by having their risky deposits and bank bonds made good by the government. The weight of these bonds on the government budget will gradually increase in time as we are forced to sell more and more of them cancelling promissory notes, which are basically a bit a bit and replacing them by real debt reducing the amount the government has to spend on housing, education and health. In a deflationary environment the weight of debt increases in time and eventually Ireland too will reach breaking point. What to do?. The process of QE although initially successful in stabilising the market is now failing as it had little or no effect in raising aggregate demand as the cash basically went to underwriting a large amount of mal-investments that would have been liquidated in normal cycle and basically ended up causing inflation in luxury penthouses and art. Not the stuff of recovery. Across the west, with the exception of Ireland, real wages have been falling or stagnant requiring population growth to cause Economic growth. Jobs created tend to be concentrated in low wage service type minimum wage and there has been a large amount of erosion from the work force as a result, with both continuing education for younger demographic were you now need a degree or masters to work as nurse or in a crèche and drop-out by shear exhaustion or lack of wages in older demographics or by government hounding or unemployment benefit claimants as is happening the U.K.. All this makes the unemployment rate, once a good gauge of economic health, get increasingly divergent from real economic health. This can be seen in the US where an unemployment rate of 5% is leading to little or low wage pressure. What can a government do;

Jules, Real US unemployment is more than 10% if you count those who have given up. The labour participation rate is down 500 nps since 2007. The U6 measure of unemployment captures this. The Fed uses U3. All numbers are political.

I think deflation is independent of currencies and comes down to capital v labour , debt vs payrises. Wall St can’t see the danger of wage Stagnation

@Jules

‘IBRC bonds which were in effect a transfer of wealth from the standard tax-payers to the ultra-rich with the tax-payers paying by USC, water and property taxes for these bonds which are adding to our debt and increasing our risk profile and the ultra-rich gaining by having their risky deposits and bank bonds made good by the government. The weight of these bonds on the government budget will gradually increase in time as we are forced to sell more and more of them cancelling promissory notes, which are basically a bit a bit and replacing them by real debt reducing the amount the government has to spend on housing, education and health.’

Precisely! Yet this Fine Gael/labourAdmin has not even requested a ‘write down’ on the odious from its EZ masters.

@seafoid

neolib strategy is to crush labour and the state; once the latter is in its pocket [by loading with debt, reducing its revenue, and privatizing all] it can basically do what it likes to the former …

Gregory,

(i) Irish insistence on having probably the developed world’s most difficult residential property loan security to realise, by a distance, and

(ii) Lack of competition in the mortgage market.

Might these two be in any way connected?

Perhaps you might try this on your first year students.

Without being overly specific, not much seems to have changed wrt realisation of loan security since a couple of years ago when the arrears figures were regularly commented on on this blog. Curious stuff has been going on – highly rent-able properties left empty for several years (no rent, no repayments) without being marketed, ‘flash’ marketing with connected parties purchasing, properties connected with both bank negotiations ‘for sale’ with the occasional ‘sale agreed’ status for a couple of years.

Maybe its the right policy, Dublin is very small, a lot of people know a lot of people, but it is out of line internationally.

The BTL stuff looks very odd.

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