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.