Lower funding costs at top of banks' wish-list

There is a case for temporary extra sources of credit to be made available to mortgage lenders in Ireland, writes Simon Carswell

ASK ANY Irish banker what is required to ease their pain amid the global financial crisis and they would say that their own high funding costs need to fall sharply.

It is top of their wish-list, but they acknowledge there is little Minister for Finance Brian Lenihan can do in his budget on October 14th to reduce the banks' own borrowing rates from the seven-year highs at which they stand. The rising cost of credit has made the crisis a global phenomenon.

"I'm not sure there is any magic bullet out there," said one banker.

When the Irish Banking Federation called a group of senior bankers together for a brain-storming session recently, there was much head-scratching.

Banks concede this is an international problem requiring an international solution, though they add that some domestic measures, however minor, would undoubtedly help.

Banks have said higher funding costs have eaten into profits, while falling property values and tighter credit have made them wary of lending what is far more expensive money to higher-risk borrowers.

EBS building society was the latest Irish lender to blame higher funding costs for lower profits when it posted its results for the first half of the year on Monday.

The three-month Euribor rate, which sets borrowing costs between banks, fixes the cost of mortgages across Europe. The rate hit 4.97 per cent at the start of August - its highest level since December 2000 - and has remained stubbornly near this level.

The rate no longer bears any reference to the European Central Bank (ECB) base rate, which Irish lenders used to set the cost of mortgages on popular tracker rates. This means lenders are not making money on some mortgages sold at the height of the property boom.

Mr Lenihan would loathe to introduce any changes next month that may be perceived as a State bail-out for the beleaguered banking and property development sectors, which many commentators believe are just feeling the pain of excessive lending and borrowing during the boom years.

Bank chief executives such as Eugene Sheehy at AIB and Denis Casey at Irish Life Permanent have said publicly that Government intervention is not necessary and the market needs to correct itself naturally. In other words, property prices must fall to encourage buyers back into the market.

Mr Lenihan will recognise that the faltering property market needs some stimulus and that the fortunes of the banks and many cash-poor, asset-laden property developers are inextricably linked.

Davy stockbrokers has said the lack of activity in the market is an immediate problem for the economy as it is straining the financial system and limiting lending for investment in other sectors.

Bankers argue that activity in the property market starts with first-time buyers, whose purchases allow others to trade up and spark activity further up the chain. Of all the mortgage sectors, first-time buyers suffered the largest decline in new lending in the first half of this year as the value of new home loans dropped 28 per cent.

Rossa White, economist at Davy, said the tightening of credit rules has excluded new buyers.

"There is a case for the Government to increase the supply of mortgage credit in whatever way, ideally if they can keep it off their balance sheet by securitising it . Either way, there is a case for temporary extra sources of credit to be made available."

Among the measures being considered by the Department of Finance for next month's Budget is an extension of the affordable housing scheme where the State would help first-time buyers by taking an equity stake, perhaps as much as 30 per cent of the property's value, or by providing an interest-free loan. This would likely involve the State-funded Housing Finance Agency providing more loans.

The agency advanced €103 million in affordable mortgages in 2007 at a rate equal to the ECB base rate plus 1 per cent.

This represents good value for first-time buyers, given how high rates have increased due to the credit freeze in the banking sector.

Davy says the State could significantly expand new mortgage lending through local authorities by raising the income limits under the affordable housing scheme. This would encourage cautious bankers to lend more, but is unlikely to return lending to the highs of recent years when new mortgages totalled €39.7 billion in 2006 and €33.6 billion in 2007.

A first-time buyer grant of up to 10 per cent of an average house price has also been suggested as a solution for buyers struggling to raise larger cash deposits.

While Mr Lenihan may be reluctant to reform stamp duty further, a senior executive at one of the biggest mortgage lenders said any change on this tax would help. Stamp duty was 28 per cent behind the start-of-year projections for the first eight months of this year, with receipts yielding €480 million less than expected.

The argument goes that by cutting rates on stamp duty, which is essentially a tax on activity in the property market, the Government could generate more receipts, increasing the volume of deals, particularly in commercial property where the rate is 9 per cent.

Another idea floated in banking circles would be for the State to buy mortgages from the banks, which could use the money generated to lend to first-time buyers.

Richie Boucher, who runs Bank of Ireland's operations in the Republic, referred at an Oireachtas Finance Committee hearing in July to State-funded mortgage systems in other countries such as Germany and in the US, where the state-sponsored mortgage financiers Fannie Mae and Freddie Mac own or guarantee almost half the country's $12 trillion (€8.6 trillion) in home loans.

The committee later asked him to clarify his comments and, in a replying letter on August 21st, he said he had not been suggesting a possible solution but raising what was in place in other countries.

"Looking at and learning from how other people and countries address particular issues and seeing if these can be applied in Ireland would seem to me to be sensible and good practice."

Mr Boucher said in his letter that there was "a prudent desire not to become overly reliant" on ECB funding, which Irish banks can tap to fund their operations, using mortgages as collateral. ECB borrowing by Irish banks, which include foreign banks operating in Ireland, more than doubled to €44.1 billion in July from €21.1 billion a year earlier.

He said some countries recognised that "an orderly housing and mortgage market requires mechanisms for mortgages to be funded on a long-term basis, and for some of such long-term funding to be provided domestically".

Bankers admit that there may be little appetite for the State to buy mortgages to fund new lending, particularly in light of the huge cost involved in the US government's rescue of Fannie Mae and Freddie Mac last weekend.

However, one senior banker suggested that the Government could direct the National Treasury Management Agency (NTMA), which manages the exchequer's funding needs, to lodge "sticky deposits" with the Irish banks, bolstering their balance sheets and giving them greater lending power.

The NTMA has several billion euro held on deposit, mostly at the Central Bank, at any one time.

Alan McQuaid, chief economist at Bloxham Stockbrokers, agrees.

"If the banks are not going to give loans, then the Government is going to have to do something."

Most bankers would concur with Mr Boucher, however, when he told the committee in July: "I wish I had an instant solution, but unfortunately I do not."