In 2011 Blackrock undertook an analysis of the Irish banks’ mortgage books. A respected global financial services company, Blackrock was given access to the inner details of the banking sector.
They looked at the capital needs of the banks under a variety of scenarios, and in effect looked at how much additional capital would be needed. Under the ‘adverse’ scenario identified by Blackrock, the banks were expected to lose an additional €43bn; under the ‘base’ scenario, they would lose another €29.5bn. The ‘base’ scenario was the one that was and is used.
Deviation from this towards or through the ‘adverse’ or ‘stressed’ scenario raises the spectre of future capital calls from the banks. To this must be added the new normal — that deposits are to be seen as potentially in play where the banks’ capital needs emerge.
We are in many respects at or beyond this adverse scenario. The recent IMF report should put paid to the rosy notion of corners being turned on a carpet of green shoots. Although the headline unemployment rate, at 14.5% or so, is below the stress scenario, the reality, as highlighted by the IMF, is that this is being masked by involuntary part-time and discouraged workers, and the real rate is closer to 23%.
The stress tests assumed rates of 15.6% or so, so it is clear that we are breaching this, as the effect of unemployment is to make mortgages more stressed. IMF forecasts do not expect the unemployment rate to fall to single digit figures till after 2018.
Similarly, the reductions in government consumption and in non-government investment have also breached the levels anticipated by the stress tests. Although residential property prices have not fallen as fast as the stress tests assumed, these same tests also suggested that we would be seeing a modest upturn in prices by now.
While this may be the case for selected urban markets, for the broader economy it is highly improbable we will see the overall residential market picking up any time soon. Falling income, house taxes and ever growing mortgage arrears combine to weigh down the market.
Thus, we are close to or over the adverse scenario of the Blackrock capital tests in many of the key areas. While exports have performed remarkably well, these do not translate, except in the loosest terms, into either jobs or revenue.
With banks on average losing money and with capital buffers declining (although still high) we face into a possible crunch scenario. There is an extraordinary high level of non-performing loans in the Irish banks’ property loan book. Some estimates suggest that these are strategic defaulters.
This terminology is technically accurate — people facing falling income make decisions to allocate income and, absent widespread repossession, there is relativity little incentive to prioritise mortgages.
It is, however, misleading in a social or political perspective, and makes little distinction between buy-to-let and private residences. Buy-to-let investments which are underwater should be treated as any other investment and foreclosed on.
Of the €31bn in buy-to-let mortgages, some 24,000 cases with €7bn in debt are in arrears of more than 180 days. These are the hopeless cases, with arrears of €1bn. The problem for the banks is that this €7bn is probably now worth at most €3bn and perhaps far less.
A hit of €4bn to the banking sector would deeply damage their capital base. But that is what the capital base is there for. When we look at principal private residences we see €14bn worth of mortgages in arrears of over 180 days.
The reality is that 23,000 people are in arrears for more than two years and these also are hopeless cases. If the banks repossess the homes they will not realise the €4.7bn in mortgage debt and under the new insolvency regime the greater part will be lost.
Thus, the banks are looking at losses of €6bn and more. What is the plan for this? Where will this leave the capital bases?
A series of clear statements on what, if any, joined-up thinking exists — on the desire to clean the banks’ balance sheets, the new insolvency regime, the growing mortgage arrears problem and the lack of desire to see mass repossessions — would be nice.
Brian Lucey is professor of finance at Trinity College Dublin
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