Slow progress in mortgage debt crisis

It used to be the case that analysis of the banking system was only of interest to a small number of professional market participants and academics.

Now, warnings about the banking system are the concern of everyone because we know to our cost that it can lead to cuts in public services and a squeeze on our living standards.

We are all invested in the safety and soundness of the system.

Last week, when Phillip Lane, the governor of the Central Bank, issued a pre-budget letter he warned that Ireland is “especially exposed” due to the legacy of high public and private sector debt levels.

He also noted that the results of the recent stress tests on banks confirm that the financial system remains vulnerable in the event of a downturn and/or a deterioration in the international financial environment.

The key word used by the governor was “legacy”. In other words, these are not new issues but rather involve risks from the abnormal sluggishness in resolving legacy issues from the 2008 crisis.

This failure has left Ireland at the bottom of the European class.

The governor’s remarks presaged the stock-take published by the ECB which reported that more than €50bn worth of non-performing loans (NPLs) remained on the banks’ balance sheets in Ireland at the end of 2015.

The fact that Irish banks have a NPL ratio of 19% compared to a European average of 7% should be a red flag. The benchmark US figure is under 3%.

Having non-performing loans at this level over such a protracted period is not the hallmark of a conservative and prudential approach.

The ECB reported that the five Irish financial institutions have a non-performing loan ratio of 38% for SMEs and 44% for commercial real estate.

Having the SME sector lending burdened by bad loans to this extent is unsustainable and should be a cause of concern for the Government’s economic agenda.

In this context, the latest residential mortgage arrears and repossession statistics published yesterday by the Central Bank follow the continuing pattern of marginal improvement.

The figures do not indicate any breakthrough change in approach that would mean a resolution to the mortgage arrears problem within the two- to three-year timeframe indicated as necessary by the ECB study.

The headline numbers appear to give the impression of good progress.

However, the detailed statistics reveal that accounts in arrears more than 720 days represent 87% of arrears outstanding and this category is still proving to be the most intractable when it comes to reaching long-term sustainable solutions.

It is also concerning that the report suggests where solutions have involved recapitalisation of arrears, close to 22% of accounts have defaulted again. That means the arrears balance has increased since the arrangement was put in place.

Having survived the visceral experience of a banking crash, it would be reasonable to expect that Government policy in the intervening eight years would have placed Ireland at the most prudential end of the European spectrum.

It would be reasonable to expect that the regulator would have made sure that Ireland was not “especially exposed” and have normalised the system to something approaching the NPL levels prevailing in the US.

It would be reasonable to expect that we could see the end of the mortgage arrears problem on the horizon.

The Programme for Government indicated that a new more conservative approach was being adopted.

However there is little evidence in the latest figures of this approach making any difference or improving the rate of sustainable long-term resolutions particularly in the case of accounts in arrears for more than 720 days.

The ECB’s response is to issue a consultation process on guidance to banks on non-performing loans, which at least has the benefit of an implicit recognition that the current process is not working and that a different approach with a more realistic timeframe needs to be adopted.

Perhaps the publication of the ECB’s consultation guidance may act as an overdue catalyst for the application of a more prudential approach.

Eugene McErlean in an expert on the banking industry and corporate governance.

He has recently advised the Independent Alliance on mortgage arrears.


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