Mortgages in Irish Banks (and their interest rates)

A previous post looked at loans in Irish banks.  Here will we confine ourselves to mortgages and will start from this graph in the earlier post.

The Central Bank report Private Household Credit and Deposits Statistics which allow us to look at this in a little more detail.  Here is the same graph (going back to 2003) from the Household Credit series.  The data is quarterly and runs to Q3 2011 so does not include the shifts that occurred in October 2011 that guided the previous post.

In general, the series from the two graphs are similar though the securitised series in the latter graph shows a ‘jump’ in the second quarter of 2009 that is not evident in the first graph.  As there is no corresponding decrease in “on balance sheet” loans it is not clear what was securitised (if anything).

It can be seen that banks in Ireland began securitising mortgages in the middle of 2006 and stopped by the end of 2009 (apart from €17 billion that was “derecognised” in October 2011 of course!)

The benefit of the household statistics is that we can look a little deeper into this although most of the data series only start from the fourth quarter of 2010.  We can, however, get the breakdown of the “on balance sheet” loans for house purchase back to 2003.

Most of the significant step decreases can be explained by increases in securitised loans although the drop that can be seen at the end of 2010 is as a result of Bank of Scotland (Ireland) leaving the Irish market.

The more detailed series are only available for four quarters.  There has been little movement in the series over this period so there is little value in graphing the series.  Here is the most recent data for September 2011 in tabular form. 

First, the total amount of loans for house purchases.

The €102 billion total of residential mortgages in September 2011 is significantly lower than the €114 billion reported in the Financial Regulator’s Residential Mortgage Arrears Statistics for the same time.  The primary reason for the difference is the absence of Bank Scotland (Ireland)’s mortgage loan book from the above figures.  

We are also provided with a breakdown of the €132 billion of mortgages by interest rate type: standard variable, tracker and fixed for different periods.

More than half of mortgages in Ireland are tracker-rate loans linked directly to the ECB base rate.  With the ECB rate now back to 1% the repayments on these loans are now much lower than when these loans were taken out in the 2006 to 2008 period.  Finally, we can get a breakdown by interest type for residential, buy-to-let and holiday home mortgages.

Here is a breakdown of the €102 billion of residential mortgages by interest rate type.

Just over half of residential mortgages on are on tracker rates.  If the €10 billion or so of mortgages in the former Bank of Scotland (Ireland) were included this proportion would be even higher as most of its mortgage book comprised tracker-rate loans. 

The proportion of buy-to-let mortgages that are on tracker rates is even higher.

Although they make up a very minor part of the overall market here is the same data for holiday home and second home mortgages.

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Loans in Irish Banks

Here we will give a look at the asset side of the balance sheets of Irish banks, looking specifically at loans and in particular at some large changes that seemed to have occurred in October based on the most recent release of the Central Bank’s Money, Credit and Banking Statistics.

First up, is the total amount of loans on the balance sheets of the domestic banks, broken into the covered group (AIB, BOI, IBRC and PTSB) and the non-covered group (Ulster Bank, National Irish Bank, etc. and also credit unions).

There has been a fall in the amount of loans on the balance sheets of the covered banks.  Some of this is due to repayments on existing loans exceeding the amount of new loans issued but most of the drop from a peak of €513 billion in July 2009 can be explained by the transfer of over €70 billion of developer loans to the National Asset Management Agency (NAMA) and the sale of loans to other banks.

The total amount of loans the covered banks had was steady at around €400 billion from May of this year but there was another sharp drop to €377 billion in October.  It would be possible to explain this drop in a chart or two but we will use the drop as a reason to have a fuller look at the loans on the balance sheets of the banks.

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Investment, Depreciation and the Capital Stock

Last Friday’s release of the Q3 Quarterly National Accounts contained some interesting figures but the standout one was the 20% drop in Investment that occurred in the quarter.  Investment is now down more than two thirds on its peak and is the main reason for the fall in the Irish economy over the past four years.

In fact, if we do an unusual dichotomy for the national accounts and break it into expenditure on “Goods and Services” and expenditure on “Capital Formation” we see that the former has held up while the latter is down nearly 70%.

The distinction is a little crude but “Goods and Services” is made up of C + G + NX:

• C – Personal Consumption of Goods and Services
• G – Net Expenditure by Central and Local Government on Current Goods and Services
• NX – Net Exports of Goods and Service (Exports minus Imports)

In the third quarter of 2007 these summed to:

€22.8 billion + €7.5 billion + (€37.9 billion – €33.4 billion) = €34.7 billion

The most recent figures for the third quarter of 2011 the figures were:

€20.0 billion + €6.4 billion + (€40.5 billion - €29.7 billion) = €37.3 billion

There have been reductions in expenditure by households (-12%) and government (-15%) but these have been offset by an increase in net exports (+70%).  For the period 2007 to 2009 this was as a result of falling imports rather than rising exports but for the past 18 months or so the improvement in net exports has been as a result of increased demand abroad for goods and services produced in Ireland.  Overall demand for goods and services is up €2.6 billion over the four years.

“Capital Formation” is just I from the National Accounts: Gross Domestic Fixed Capital Formation.  Over the period used above quarterly investment fell €5.6 billion from €9.1 billion to €3.5 billion. 

Quarterly GDP fell 7.6% from €43.5 billion in the third quarter of 2007 to €40.2 billion in the third quarter of 2011.  Using the dichotomy we have applied here this is largely explained by the collapse in capital expenditure.  To explore further the nature of the fall in investment see this post on patterns of investment over on irisheconomy.ie.  The general idea is fairly clear  - it is mainly a story of households and housing.

Two weeks ago the CSO released the 2010 update of the Estimates of the Capital Stock of Fixed Assets.  Here is a graph of the value of the stock of fixed capital (excluding land) in 2009 prices.

The capital stock increased consistently from 1995 to 2008 and this is true for the overall capital stock and the capital stock excluding dwellings (other buildings, roads, transport equipment, other machinery and equipment, cultivated assets, computer software).

Of course, it is not that there was no investment in 2009 and 2010.  There was €25.3 billion of gross capital formation in 2009 and €19.0 billion in 2010, but this was just enough to cover the amount the consumption of the existing stock of fixed capital (depreciation) so the increase in the net capital stock was much less.

[The investment figure here is form the National Income and Expenditure Accounts and the depreciation figure is from the Estimates of the Capital Stock of Fixed Assets.  There may be some non-overlapping between the definition of fixed capital/assets used in each but it is unlikely to change the overall conclusion.]

The fall in investment has continued and in real terms 2011 is 15% behind 2010 so it is clear that investment this year will not be sufficient to cover depreciation.  For the first time since the series began the real value of the capital stock in Ireland will fall.  The picture is equally bleak if we exclude dwellings (with land excluded in all of the analysis here).

For most categories investment in 2010 exceeded the level of depreciation estimated by the CSO, but the gap has gotten substantially narrower and for 2011 will be negative in many cases.

The depreciation for Dwellings and Other buildings includes the costs associated with the transfer of land and buildings but a breakdown under gross investment or depreciation is not included.  The Net Investment under Dwellings and Other Buildings could be larger if conveyancing costs were included in the gross investment figure (as they are in the depreciation figure).  It should also be noted that the gross investment figure for Other Buildings and Construction includes land rehabilitation but land is not included in the depreciation figure.

The negative net investment figure for other machinery and equipment is large but a lot of this could be explained by the almost stalling of activity in the construction sector.  It be argued that a lot of the machinery and equipment here is out of use rather than depreciating and will never be replaced.

For 2011, it is likely that gross fixed capital investment will struggle to get much over €16 billion (in 2009 prices).  It is €12.6 billion for the first three quarter of the year.  The 2010 depreciation figure of €16.2 billion is unlikely to the much changed for 2011.   An increase in the capital stock for 2011 is unlikely and the prospects are that a similar outcome will occur in 2012.

Finally here’s net investment as a percent of GDP.

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Wealth (and Taxing Wealth) in Ireland

Wealth has been getting a lot of attention in Ireland recently particularly in relation to the claim that it would be possible to raise €10 billion per annum from a 5% wealth tax on the wealthiest 5% of the population as detailed in the Budget Submission of the United Left Alliance and repeated on an almost nightly basis on television and radio.

The adult population of Ireland is around 3,400,000 so the 5% that are liable for this tax would be 170,000 people.  In order for the €10 billion total to be achieved these people would have to be pay an average of an additional €60,000 in tax every year.

The ULA’s budget submission also envisages an additional €5 billion of income tax to be raised from those earning in excess of €100,000.  According to data from the Revenue Commissioners in 2009 there were 110,000 tax cases reporting an income in excess of €100,000.  The average income in this category is €180,000, but two-thirds of those who earned more than €100,000 earned less than €150,000.  In order for the €5 billion target to be achieved those earning more than €100,000 will be required to pay an average of an additional €45,000 of income tax. 

This is an addition to the €60,000 average income tax that this group paid.  In 2009, this excludes payments made because of the Health Levy and also PRSI contributions.  Anyway, the focus here is on the potential to raise €10 billion from a wealth tax.

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Do we want miss the budgetary targets?

The measures put together for last week’s budget(s) has the stated aim of getting the General Government Deficit down to 8.6% of GDP.  Although we know neither the final deficit nor the nominal GDP figure it is currently forecast that the deficit will be around 10.1% of GDP this year. 

The original Four-Year Plan published last November targeted a 2012 deficit of 7.0% of GDP but this was based on very optimistic assumptions which had the deficit falling to below 3% of GDP by 2014.  When the EU/IMF deal was brokered a few weeks later the timeframe for getting the deficit under 3% was pushed out to 2015 and at the ECOFIN meeting of 7 December 2010 a deficit limit of 8.6% of GDP for 2012 was set.

The 2011 Budget was announced the same day and still forecast a deficit for 2012 of 7.3% of GDP.  It wasn’t until the Stability Programme Update in April of this year that the 8.6% deficit figure for 2012 made an appearance in Irish documents.

Much has been made of the fact that at 10.1% of GDP the deficit for this year has come in “below target”.  This was not so much below target as below the 10.6% limit set by the ECOFIN meeting last December.  The target from last year’s budget was that this year’s deficit would be 9.4% of GDP.  The deficit is very much larger than the target.

This year the deficit limit was 10.6% of GDP, the target was 9.4% of GDP and the outcome will likely be somewhere in the middle.  Next year the limit is 8.6% of GDP and the target is also 8.6% of GDP.  While there was room for significant slippage this year (and the GGD is almost €800 million larger than forecast in last year’s Budget) there is absolutely no room for slippage next year.

If growth is slightly lower than expected or the measures introduced don’t have the anticipated impact than it is very likely that the deficit will come in above 8.6% of GDP.  This year we had the capacity to absorb such downward developments; next year we have none.

The reduction in the EU interest rates agreed last July will make reaching the 8.6% target a little easier.  These are estimated to save around €900 million in 2012.  If these were applied statically to the projections from the April SPU then the deficit target for 2012 would be around 8.0% of GDP.  This would have been a better target for 2012 but slippages elsewhere have fully absorbed the interest rate gains. Even with €900 million of savings announced in July the deficit target for 2012 is still at the 8.6% of GDP it was last April.

As a result of the interest rate savings we might be able to get fairly close to the 8.6% of GDP limit set by the EC.  How we will fare on the IMF targets are less clear.  The IMF does not make targets based on the overall general government balance and does not make them very far in advance.

The IMF budgetary targets are in terms of the primary exchequer deficit.  This is the deficit on the Exchequer Account excluding interest payments.  The IMF’s Third Quarterly Review (table 2, page 54) sets an indicative target for the end-June 2012 primary exchequer balance of €7.4 billion.  Up the the end of June 2011 the primary exchequer balance was €8.4 billion (exchequer deficit of €10.8 billion less €2.4 billion of exchequer interest payments).

The IMF targets are not affected by the interest rate reductions announced last July.  The primary exchequer deficit has to improve by €1 billion in June 2012 relative to its performance 12 months previously.

In last December’s budget tax revenue was forecast to be €34.9 billion for 2011.  It is now clear that tax revenue of around €34.2 billion will be achieved. And this was only possible with the addition of €0.5 billion from the private sector pension levy announced in the May Jobs Initiative.  On a ‘like-for-like’ basis, tax revenue for 2011 is around €1.2 billion behind last December’s target.

Just like the EC limit there was significant room for slippage when it came to the IMF target.  Last June when the primary exchequer balance was €8.4 billion, the limit set by the IMF was €10.1 billion.  We were well within the limit and had enough room to absorb the deterioration seen in tax revenues in the final quarter.  Once again we have decided to eliminate this capacity and made the limit our target.  The margin for error on the downside is zero.

Some of the numbers in last week’s budget do not stack up.  The Minister for Finance admitted that the 2% VAT increase would not bring in €670 million over a full year because the estimate did not account for a fall in demand.  The is an extra €160 million forecast to be brought in as a result of changes to CGT and CAT.  This is equally unlikely.  The €200 million gain from increases in Excise Duty also seems optimistic.  These make up the bulk of the €1,000 million of new tax measures announced last week.  

Many of the expenditure measures are equally woolly.  Here is a list of “savings” included in the €1,400 million of current expenditure cuts from the Summary of Budget Measures.

• Enhance fraud and control activity.
• Continued focus on delivering reductions in the price and volume of goods and services procured by the health services.
• Savings from anticipated lower disease incidence and operational changes.
• Miscellaneous Savings on the Vote
• Achieve a reduction in non-pay administration costs through increased efficiencies.
• Reduce costs associated with operation of the Mahon Tribunal.
• Efficiencies and changes to business processes.
• Streamlining the State’s employment rights bodies.
• Rigorously review of every area of expenditure.
• Introduce new efficiencies mainly through the use of IT.
• Programme savings through efficiencies.
• A range of measures to improve programme efficiency are being considered.
• Introduction of efficiencies.
• Efficiency measures in Revenue, Office of Public Works and savings in legal fees in Law Offices.
• General savings in Departments of Arts, Heritage & the Gaeltacht and Communications, Energy & Natural Resources.

The arithmetic might add up to a budget with €3.8 billion of “adjustments” but the reality is likely to be somewhat different.

After a year of being “the best in the bailout class” are we actually looking to exceed the deficit limits set down by our external funding partners?  Is there political capital to be gained from missing these targets?

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Inflation edges higher

Today’s CPI release from the CSO reports that the headline rate of annual inflation rose from 2.8% in October to 2.9% in November.  As has been the case since inflation returned to positive territory in the middle of 2010 this continues to be mainly driven by just two categories; energy products and mortgage interest. 

The price of energy products are up 13.7% in the year, while the price of mortgage interest is up 17.8% in the year.  These make up 15% of the index and removing them gives a measure of ‘core’ inflation.  Core annual inflation in November was 0.66%, up from 0.55% in October.

On mortgage interest, it is important to realise that the CPI measures the price of mortgage interest and not necessarily the cost.  The price of mortgage interest change but the cost to most households may not change if this change is not also applied to existing mortgages.  This has happened in Ireland for the past 18 months or so.  Mortgage variable rates have been increasing far more than tracker rates and these form most of the mortgage interest price in the CPI. 

The mortgage inflation rate in the CPI overstates the average increase in mortgage rates as it reflects mainly the rates that have been rising by more(standard variable rates) and largely omits the rates which rose only slightly (tracker rates).  Almost half of all mortgages are on tracker rates.  This is explained in a Information Note to the CPI release.

In line with normal practice for a fixed base price index, the current approach to measuring mortgage interest in the CPI reflects the situation in the base reference period December 2006 when the standard variable rate was dominant. Subsequently, tracker mortgages have become more popular. This did not give rise to any difficulties while the standard variable and tracker mortgage interest rates moved broadly in line with one another, which would be the normal expectation. However, the decoupling that has taken place since August 2009 has resulted in dramatically different trends emerging. For example, between September 2009 and September 2010 the standard variable rate increased from 2.93% to 3.66% whereas the tracker rate did not change. The Mortgage Interest component of the CPI, which is largely determined by the trend in the standard variable rate, increased by 25.1% as a result and contributed +1.25% to the overall change in the All Items index. It is crudely estimated that the latter impact would have been reduced by between 0.2% and 0.5% had the Mortgage Interest component been calculated on a current weighting basis. Users should take this “weighting effect” into account in interpreting the mortgage interest related movements in the index.

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Social welfare expenditure to fall by €88 million

Today seems like an appropriate time to update this.  The 2012 expenditure of the Department of Social Protection was subjected to €475 million of “savings measures” today.  It is projected that the full effect of the measures announced today but which will come into effect over the next three years will be €811 million.

In 2011 it is estimated that expenditure on social welfare payments from either the Department of Social Protection or the Social Insurance Fund will be €20,030 million.  With the measures announced today the forecast for 2012 is €19,942 million – a fall of €88 million. 

Here are the expenditures by six main headings for 2011 and 2012.

The actual payments under each heading were detailed in the previous post on this issue.  It can be seen that most of the expenditure increases are for pensions and in particular the contributory pensions paid from the Social Insurance Fund.

Around €45 million of the 2012 savings announced today are as a result of reduction in Child Benefit for third and subsequent children.  Even with this the aggregate amount of Child Benefit is forecast to increase (albeit by just €8 million) from €2,067 million to €2,075 million.

The large drop is income support payments from the Social Insurance Fund is evenly split between a fall in Jobseeker’s Benefit and Redundancy and Insolvency Payments.  The fall in Jobseeker’s Benefit is because entitlements expire after 12 months. Recipients can switch to the means tested Jobseeker’s Allowance paid by the Department of Social Protection where expenditure is forecast to increase by more than €150 million.

In 2009, the outturn for social welfare payments was €19,959 million.  As shown above it is forecast to be €19,942 million in 2012.  This is a drop of 0.08%.  Next year, social welfare payments will be 99.92% of what they were in 2009. 

It is clear there have been significant adjustments to social welfare expenditure and these cuts continued today.  However, there has been no reduction in overall expenditure.  Rather, the same amount of money is being spent but it is going to more people (more children, more pensioners, more unemployed) so, on average, people are getting less.

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