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New government, new competition to challenge Irish banks on mortgages

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New government, new competition to challenge Irish banks on mortgages

Ireland'snew minority government looks set to apply some pressure to the country's banksover mortgage rates and competition, but it will need to tread carefully to avoidthrowing off course its plans to attract new lenders to the sector.

Followinginconclusive elections on Feb. 26, Ireland's Fine Gael and Fianna Fáil parties reachedagreement in the week of May 2 on a so-called confidence and supply arrangementthat resulted in the re-election of Taoiseach Enda Kenny. After sharing power withthe Labour Party for five years, Fine Gael will now govern alone as a minority,and Fianna Fáil has agreed to support three Fine Gael budgets in exchange for certainconcessions.

Thesewill include measures addressing mortgages, which were a key plank of Fianna Fáil'scampaign platform. A version of the confidence and supply agreement published byThe Irish Times includes protections forholders of mortgages transferred to "nonregulated entities," commonlydubbed vulture funds, as well as the extension of mortgage interest relief and newways to deal with mortgage arrears cases. Kenny is due to outline proposals in keepingwith the arrangement over the next 100 days.

Variable-rate anger

Irishbanks have been criticized for charging significantly more on variable-rate mortgagesthan counterparts elsewhere in the eurozone, especially given declining costs offunding as even 12-month EURIBOR has dipped into negative territory in recent months.But Dan O'Brien, chief economist at Dublin's Institute of International and EuropeanAffairs, noted in an interview that banks might take some comfort from the continuityat the top of Irish government — Finance Minister Michael Noonan will also stayin post.

"Had the government wanted to do something on it, it would'vebeen pretty popular to be seen to be kicking the banks," he observed.

Highvariable-rate mortgage costs are, among other things, an aftereffect of the boomand subsequent bust in Irish real estate around the 2008 financial crisis. Thiswas fueled in large part by tracker mortgages, which were pegged to the now rock-bottomECB rate and still account for about half of outstanding Irish mortgages, accordingto Diarmaid Sheridan, a research analyst at the Irish stockbroker Davy Group.

"Thetracker loans were a form of insanity," O'Brien said. "They were neverprofitable. They were part of the mad craziness of the time [for local banks] tomaintain market share."

Now,he added, "What the banks are doing is effectively cross-subsidizing trackermortgage [holders] with the new lending they're giving out at higher rates."

Rateson new floating-rate mortgages — defined as those with variable rates or fixed termsof up to a year — amounted to 3.23% as of February, compared to 2% for the eurozoneas a whole, according to the CentralBank of Ireland. Meanwhile, the average rate on new fixed-rate householddeposits was 0.18% in March, the lowest of 18 countries surveyed by the ECB, The Irish Times wrote May 3.

AmongFianna Fáil's demands during the election campaign was for a mortgage switchingmechanism backed up in law, obliging lenders to meet certain conditions when mortgageholders change providers. Brian Hayes, a former junior finance minister who is nowa Fine Gael member of the European Parliament, cited as a model the mortgage switchingmechanism in Italy, which imposes time limits for banks to complete the processand gives borrowers the freedom to move between fixed and variable rates and tochange the term of their loan.

Hayessaid in an interview that for the most recent comparable year, 32% of all new mortgagesin Italy were to people who were switching, compared to about 6% in Ireland.

The Irishcentral bank suggested in a July 2015 economic letter that 21% of mortgage holderswould benefit from changing providers, but said that out of approximately 684,000mortgage holders, a mere 38 had switched each month on average since January 2014.One reason for the low level of switching might be that banks match any offer madeto an existing mortgage holder, the central bank said, but it also pointed out thatthe costs involved, financial and nonfinancial, may serve as a deterrent. It estimatedroughly €1,300 in average costs to switch, but pointed out that banks typicallycover €1,000.

Newentrants

Fianna Fáil also called during the campaign for the governmentto encourage European lenders to enter the Irish mortgage market, something on whichFine Gael is in agreement. Ireland has just six institutions that offer mortgages,whereas Northern Ireland has 15 to serve a population amounting to 40% of that inthe Republic, Hayes noted.

However, tempted by the high margins on offer, the Irish mortgagesector now faces the prospect of at least three new possible nonbank entrants, possiblymore.

Australia'sPepper financial services group began offering three mortgage products through asmall group of 20 brokers in February, becoming the first new entrant since the2008 financial crisis. It also is the first nonbank group offering residential loans.

A secondnonbank lender, Frank Money, was founded in 2014 by Colin Cunningham, a former executivein Danish lender Danske Bank A/S'Irish operations and is seeking Irish central bank approval to provide mortgages.Using outsourcing firm Capita to manage and administer its loans, Frank Money plansto offer rates half a point lower than AlliedIrish Banks Plc and Bankof Ireland, which have 30% apiece of Ireland's mortgage market.

Meanwhile,the U.K.'s Northview Group, formerly Kensington, is exploring entering the Irishmortgage market later in 2016.

But althoughIreland offers plum prizes to market entrants from elsewhere, an important constraintis how long it takes under the Irish system for a lender to take control of a defaultingborrower's collateral — three to four years, compared to a matter of months in theU.K. and many U.S. states.

'We wouldsee that as difficult for any new entrants in terms of sizing up the market,"said Davy's Sheridan. "If they can't get access to collateral in a meaningfultime frame, that would be a barrier to entry for them."

Pushing banks — but not too hard

Hayes also suggested that the push for greater competition inIreland's mortgage market could serve to constrain any government efforts to crackdown on issues such as variable-rate mortgages.

"I suppose [Noonan's] concern is the more intervention,the more pressure, that sends out the wrong signal to potential entries to the Irishmarket in the long term," he said, noting that Noonan has twice previouslypersuaded AIB to undertake "very little marginal rate changes." AIB onMay 9 announced another quarter-point cut in its standard variable mortgage rate,its fourth in 18 months, taking the SVR to 3.4%. It also introduced a €2,000 contributiontoward professional fees for customers switching their mortgage to the bank.

The Irishcentral bank's introduction of new mortgage lending limits has led to a drop inthe number of mortgage approvals, which fell 14.0% year over year by value duringthe three months to March. The central bank will review the rules, which includeminimum deposits and a requirement that mortgages not exceed 3.5x borrowers' incomes,during the summer. Noonan had called for such a review in September 2015, notingthat the rules made borrowing difficult for first-time buyers in Dublin, where pricesare much higher.

But Davy'sSheridan noted that "one of the big issues in the mortgage market is not necessarilyaround the availability of mortgage finance — it's the availability of properties."

Irelandbuilt just over 12,000 houses in 2015, about half the number needed given the householdformation rate. Though there is an oversupply of housing left fromthe property boom years, it is in the wrong areas — not the urban centers whereeconomic recovery has taken off. Fewer than 2,900 residential unitswere built in 2015 in Dublin, where the population is rising by 32,000 each year,O'Brien noted.

And withthe property market still bearing the scars of the 2008 crisis, some 15.7% of residentialmortgages languished in arrears at the end of 2015, according to S&P GlobalRatings. Loans more than 90 days in arrears accounted for 80% of all bad loans overthe past three years.

Bankof Ireland reduced NPLsby €3.8 billion during 2015 to €12 billion at year-end, and it a further €900 million in the firstquarter of 2016. AIB reported€13.1 billion of impaired loans at the end of 2015, a reduction of €9.1 billionfrom a year earlier.

"They have made significant progress," said Dany Castiglione,an assistant vice president at Moody's. "The question is, are these sustainablearrangements — and that might change with economic conditions."

S&PGlobal Ratings and S&P Global Market Intelligence are owned by S&P GlobalInc.