State’s strange move into higher risk, high leverage mortgage lending

First Time buyers accounted for 11,896 transactions in the Irish housing market in the first eleven months of 2017, which is 1700 up on the same period in 2016 but still only around 20% of total turnover. The Government has sought to support that segment of demand via a tax rebate to help those seeking to buy or build a new home (the Help to Buy scheme) and has just announced a fresh initiative, this time in the form of State mortgage lending ( Rebuilding Ireland Home Loan) , although the scheme has a number of odd features and appears a strange step to take.

To qualify, would-be borrowers have to have been rejected by at least two lenders, which immediately implies that the State would be taking on if not sub-prime then certainly higher risk loans. The lending decision will be taken by local authorities, so someone in those authorities will be making credit risk decisions, raising the issue of the criteria that will be used to decide which applicant is successful.

Third, the State is driving a coach and horses through the Central Bank’s mortgage controls and one wonders what the Bank makes of it and whether it was consulted. Lending institutions are required to limit mortgage loans to  a maximum of 3.5 times  the borrowers income , with 20% of lending to FTB’s  per annum allowed above that. The  specific limit  for FTB’s has just been introduced and represents a de facto tightening of standards, as 24% of lending to that segment exceeded the limit in the first half of 2017. Yet the State scheme allows a LTI range from 3.8 to 5.0, which is much higher leverage than deemed acceptable  to private lenders, and therefore higher risk.

The scheme does have a loan to value limit ( 90%) and a maximum property price, so putting a cap  on a given loan, although it does differentiate by location; properties in the major cities and in the counties surrounding Dublin carry a  maximum loan of €288,000 as against €225,000 elsewhere. Over 60% of transactions are in the former areas so the €200m allocated implies that less than 800 loans could be granted in 2018. Total mortgage lending for house purchase this year is likely to be around €8.5bn so the scheme is not material in terms of the overall market.

Finally, we have the issue of funding costs. Successful borrowers will have three options, two fixed rates and one floating, all well below current market rates. For example, a 25-year mortgage would cost 2% fixed, and a fixed rate for that term is not available from Irish banks- in general, banks can’t borrow at that maturity, so 3-5 year fixed  is the most common (although some 10-year is now available). The State can and has borrowed for 25 years and longer, with a bond maturing in 2045 trading at around 1.8%, implying a very small margin if that was tapped to fund this initiative.

Successful borrowers will be getting a cheap loan with the State taking on a level of risk that the private sector is unwilling to bear, at least at that cost, and indeed  what the Central Bank is also unwilling for borrowers or lenders to countenance.