Mortgage arrears model points to further decline this year

Residential mortgage arrears in Ireland are extremely  high, both in absolute terms and relative to comparable housing markets.  At the peak of the cycle , 130k  mortgages were over 90 days in arrears , equivalent to  1 in 7 of outstanding mortgages owed to domestic lenders.  In the UK the figure peaked at a little over 1 in 100 and  in the first quarter of  2015 the total amounted to just 114k, in a market with 11.1 million mortgages. The good news is that the  Irish figure is now falling steadily, and our arrears model points to a further decline this year, in the absence of a significant shock to the economy.

Residential mortgages have been treated differently to other assets by the Irish  banks.  Real estate and commercial property loans were sold to Nama in 2010 for 43 cents in the euro, so crystallising a €42bn loss for the banks and opening up a capital hole subsequently largely filled by the Irish taxpayer.  Residential mortgages were not marked to market, in contrast, and arrears built up rapidly, reflecting , inter alia, societal pressure against large scale repossessions, the absence of foreclosure on any scale in modern Ireland,  some legal issues, political unease and a reluctance by the banks themselves in an environment of falling property prices and capital constraints.

Arrears on Private Dwelling Homes (PDH) are largely driven by three factors. The most important is unemployment, as the loss of a job and subsequent hit to income is one of the main reasons why mortgage payments cannot be met. The numbers unemployed in Ireland soared during the recession, from under 100k to a peak of 325k in late 2012, with the result that arrears  climbed rapidly. Interest rates matter too, although the impact is not as significant, and the decline in  mortgage rates since 2008 has had some offsetting impact on arrears. A third factor is house prices, perhaps surprisingly, but the relationship is clear in the data; the fall in residential values from 2007 to 2013 was a factor in pushing up arrears , with the scale of negative equity appearing to influence the decision on whether to continue to meet the monthly mortgage payment.

All three factors , with varying lags, help determine the level of PDH arrears in our model, which has performed reasonably well in tracking the 2013 peak and subsequent decline; PDH arrears in the first quarter of  2015 had fallen to 74k (9.7% of  the outstanding stock ) from a high of 99k (12.9%). House prices are now rising, so putting downward pressure on arrears , but the main driver of the fall is the improvement in the labour market and accompanying decline in the numbers out of work. As noted, these explanatory variables enter the equation with a lag so we can forecast arrears forward, given the current level of interest rates, unemployment and house prices, and that points to a figure around 50k by year-end, or well under 7% of the PDH mortgage stock. All econometric equations have a margin of error, of course, and debtor behaviour can change, particularly in response to  an economic shock or a perceived change in the attitude of lenders. The last few months has also seen a marked slowdown in the pace at which unemployment is falling, which if sustained will impact arrears into 2016.

There is less data  available on Buy to Let  (BTL) arrears and there seems to be other factors at work, making it difficult to derive a parsimonious model. Arrears in this market are proportionately much higher than private homes, although they  also appear to have peaked,  albeit a year after PDH, and are also now declining ; the q1  figure was  27k ( 19.7% of the total stock) from a  high of 32k (22.1%). The different drivers in BTL are also evident from the decision by lenders to send in rent receivers in order to recover mortgage payments, with the total rising to 6k in the first quarter.

The improvement in the economy and the recovery in the housing market have therefore resulted in a brighter picture on arrears, although these  factors have also prompted a change of tack on repossessions ( the sale of loan books, a return to bank  profitability and  a new  financial regulator in Frankfurt  have no doubt also played a part). The flow  of properties into repossession has certainly increased, rising to 557 in q1 from 354 a year earlier ( half the total is voluntary ) and that figure looks likely to rise, given the reported numbers before the courts.

Ireland’s Debt Dynamics turn more benign

Irish government debt stood at €47bn in 2007, just 24% of  GDP, one of the lowest ratios in the euro area. Debt then ballooned, rising to over €215bn by 2013, reflecting capital injections to the banking system, the impact of the recession on the underlying budgetary position, and latterly, the inclusion of IBRC’s liabilities. The impact on the debt ratio was compounded by the trend in the denominator, nominal GDP, which fell by some €32bn or 16% from 2007 to 2010, with only a modest pace of recovery evident up to 2013.  As a result the debt ratio ended  the latter year at 123.2% of GDP, one of the highest debt burdens across the single currency area, and one some felt was not sustainable. That ratio now appears to have peaked, however; the CSO  estimates that  the debt ratio fell to 109.7% in 2014, with the level of debt declining to €203.3bn, in part due to the sale of liquidation and sale of IBRC assets.

Ireland’s debt dynamics are now turning positive and , based on current expectations, the debt ratio should now fall steadily, with the caveat that events can and do throw up consequences which render previous expectations redundant. That aside, the factors which determine the debt ratio are all moving in a more benign direction for Ireland.

Take nominal GDP.  That rose by 6.1% in 2014, to over €185bn,and the Government is currently projecting a  5.3% increase this year, with a similar rate of growth forecast out to 2018. The 2015 figure is based on real growth of 3.9% , which some feel is now too low, and an upward revision is possible when the next set of official projections appear (they are due later this month).

The other key drivers in terms of debt dynamics are the average interest rate on the debt and fiscal position excluding interest payments , or primary balance. The former is projected to average 3.5% this year( which appears too high now in the light of QE) but in any case is well below the growth rate of GDP, a  reverse of the malign  dynamics operating between 2008 and 2013 and one that will now put downward pressure, albeit modest, on the debt ratio.  The official forecast envisages a marginally upward path  in the interest rate  over the next few years. although still below the projected growth in GDP, which implies a further continuation of that more benign trend.

In addition, Ireland is now running a primary surplus (i.e. revenue exceeds non-debt expenditure) which is required to ensure a more rapid decline in the debt burden. In 2015, for example, the primary surplus is currently projected at 1.1% of GDP, rising to  4% by 2018. The debt ratio is also influenced by one-off adjustments ( e.g. the NTMA  running down cash balances, revenue from asset sales)  and leaving those aside the above interaction of  nominal GDP,  the interest rate and the primary surplus results in Ireland’s debt ratio falling to 107.5% this year before declining to under 100% in 2017 and 94% by 2018.

That projection is also  based on the current forecasts for the fiscal balance, which envisages a steady decline in the overall  deficit, from 2.7 % of  GDP this year to 0.9% in 2017 and a marginal surplus in 2018. That now also looks conservative, given the strength of tax receipts in the year to date, and so a stronger primary surplus path may emerge, albeit one  that takes no account of the political cycle, although any Irish government will be constrained by EU rules on government spending, even if some leeway is given in terms of interpretation. A noted above,  economic shocks may  emerge but in their absence the Irish debt ratio does look to be on a downward path to a more sustainable level, if at a steadier pace than experienced during its upward trajectory.

Press Conferences, the ECB and the Fed

The ECB and the Fed differ at many levels, including their respective mandates (the latter is charged with  maintaining full employment as well as price stability ) and the frequency of policy-setting meetings (one a month for the ECB but only eight a year for its US counterpart). The Fed’s Open Market Committee, which sets monetary policy, has twelve voting members and releases minutes of its deliberations, including the voting pattern, whereas the ECB Governing Council’s  membership is double that, with no published minutes, at least to date. They do have one thing in common though- press conferences hosted by the Head of the institution- although the Fed has only recently adopted that practice and limits it to one a quarter, as against the ECB’s regular slot on the first Thursday of the month.

The press conferences also differ markedly however. Ben Bernanke has held court at all of the Fed’s to date, and things may change when Janet Yellen takes over, but  there is a much more open  atmosphere than in Frankfurt and it probably reflects more than the personalities involved. This may in part be due to the nature of the audience, which is smaller in number than for the ECB and made up largely of ‘Fed-watchers’, who like the Kremlinologists of old are attentive to the slightest hint of any change in policy. Few, if any, foreign journalists appear to be present and the questions are usually to the point and illicit equally straightforward responses from the Chairman. One senses that there is an implicit belief that the population have a right to know what the Fed is thinking and the questioners seek to tease out any areas where there is a lack of clarity, although of course central bankers are not omniscient and any statement of intent is always contingent on events.

The ECB conference is more formulaic ( the President opens by reading a much longer statement than that issued by the Fed ) and the atmosphere feels very different, at last as viewed on television,  with the ECB President often striking a defensive and sometimes peevish tone, with attempts to justify past policy decisions (‘ the events of the past month have vindicated our  stance’). One is always left with the impression of an audience seeking to illicit answers from a Bank reluctant to elaborate,  which leaves an unsatisfied taste. A good case in point is OMT, which is regularly raised and is met with the response that all has been explained at some earlier meeting  although if that were the case the question would not arise. The sheer numbers involved in setting ECB rates inevitably makes for differing views in the Council and that may explain the President’s  caution in response to some questions but at times the dichotomy between the Bank’s  current stance  and its stated policy aims is glaring; the ECB is  forecasting inflation in 2015 at 1.3%, for example, which does not appear consistent with its definition of price stability (‘below but close to 2%’) and implies monetary policy is too tight, even after the recent rate reduction.

Monetary policy in the euro area is  certainly more pragmatic under Draghi and the ECB has moved a long way from its Bundesbank-centred roots. The  press conference has  also ditched some of  the rituals common in President Trichet’s time, when everyone listened for some key words, like ‘strongly vigilant’, as a signaling mechanism- what’s wrong with saying  that ‘ we are likely to raise rates at the next meeting in the absence of unforeseen events’ rather than use some code?. The questions  also vary in quality and relevance it also has to be said, with some journalists seeking comments on specific country issues which are beyond the remit of the ECB (‘Draghi praises Ireland’s/ Portugal’s/ Italy’s/  stoic adherence to fiscal rectitude’). One final point. President Draghi’s pledge ‘to do whatever it takes to preserve the euro’ was queried by a (German) journalist at one press conference, with the latter pointing out that Governments and ultimately electorates would decide the single currency’s fate. An unusual intervention , highlighting that the ECB is ultimately accountable to the citizens of the  euro area, and that it is their Central Bank.