End to falling mortgage rates hard to stomach

It was good while it lasted, but on Monday, one of the State’s pillar banks looked to draw a line under the recent downward trend in mortgage rates, which have helped ease the burden on homeowners. But is the move justified?

Andrew Keating, chief financial officer of Bank of Ireland, told homeowners – or at least those who are customers of the bank – that the good times are going to come to an end, and they shouldn’t expect any more reductions in the cost of their mortgage. “My expectation is that the price of mortgages, particularly those longer-duration mortgages, will increase,” he said at the publication of the bank’s annual results, putting a dampener on anyone hoping for a bit of a lift to their household finances. A 50 basis-point (half a percentage point) drop in mortgage rates would save a homeowner with a €200,000 mortgage about €53 a month – or almost €20,000 over the life of a 30-year mortgage.

So the declaration from the bank is bad news indeed. Particularly when you consider that just last week the bank made another move on the deposit front, when it cut rates across a host of products.

But why, one might reasonably ask? After all, European interest rates remain at zero and, while there had been expectations of a rate increase later this year, this appears to have dissolved on sluggish growth in key economies like Germany.

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So why should Irish customers, who will feel they have already being paying too much for their home loans given the European zero interest rate environment, have to pay more yet again?

Yes, rates have fallen in recent years. Bank of Ireland recently dropped its one- and two-year fixed rates to 2.9 per cent for example, while Ulster Bank now offers a rate of as low as 2.3 per cent over two years but mortgage rates remain someway north of our European peers.

In France for example, Vousfinancer, a network of property loan brokers, offers rates of between 1.35 per cent for 15 years and 1.75 per cent for 25 years. And those rates are fixed. Or how about Germany, where Deutsche Bank offers a rate of 2.87 per cent – fixed over 25 years – with a down payment of 20 per cent required, or where Comdirect offers a rate of just 1.81 per cent fixed for 20 years, again based on a loan to value of 80 per cent.

Cost of funds

Of course, the bank has its reasons. One of those cited by Keating are the rising long-term funding costs in the international capital markets, hence the need to bring medium- and long-term rates in line with these. Already Bank of Ireland has pushed up its five and 10-year rates, by 20 basis points, to 3.2 per cent and 3.5 per cent respectively.

But the bank has a loan to deposit ratio of 97 per cent – down significantly from about 175 per cent back in 2010 – which means that for every euro it loans out, it has more than that on deposit. And these deposits cost the bank a negligible amount; according to the bank’s latest annual report, the gross rate paid on its Irish deposits was just 0.08 per cent in the second half of 2018, which means that someone with €10,000 on deposit could earn as little as just €8 a year.

Not only that, but this cheap source of funding keeps growing. Last December, the bank held some €78.9 billion on deposit, up 4 per cent on the previous year. This compares with total loans of some €77 billion.

At the same time, its dependence on funding in the more expensive wholesale markets has shrunk, down from €20 billion in 2014 to just €11 billion last year. As noted by Keating, it has got more expensive – at an average rate of 0.94 per cent in 2018, up from 0.58 per cent in 2017 – but it’s also evident that a growing deposit book means it needs to fund less from these markets.

Wholesale markets

Analysts say that, despite being able to fund its lending from deposits, the bank needs to cover itself against market rates, in the event that it sees an outflow of deposits and has to cover these loans in the wholesale markets. But don’t our aforementioned French and German banks have to do the same thing? Well, different funding models might be a factor here – such banks could have cheaper funding alternatives for example – but nonetheless the difference in long-term rates is striking.

Another factor cited by Keating in the upward pressure on mortgage rates is the amount of capital Irish banks need to hold in reserve against mortgages. In a hangover from the crisis, Irish banks have to hold more capital because of the continuing scale of their non-performing loans.

Bank of Ireland’s risk-weighted assets on mortgages for example, equate to 38 per cent of its residential loans portfolio – far in excess of norms in Italy (19.9 per cent) and the UK (10.3 per cent). So Irish borrowers continue to bear the brunt of the bank’s inability to address non-performing loans.

In signalling that rates could be set to rise from here, the bank might also need to be mindful of competition law. After all, Keating wasn’t just telling shareholders or customers of the bank that mortgage rates will either plateau or increase. He was also telling the banks’ competitors that it has effectively gone as low as it’s going to go on rates.

And price signalling, when followed up by similar comments from other players in the industry, can be seen as an anti-competitive practice. Back in 2016, the Competition and Consumer Protection Commission (CCPC) launched an investigation into price signalling in the insurance market, after it became concerned about insurers forecasting that motor insurance premiums would rise.

And the CCPC said on Tuesday that it is aware of the comments made by Keating and is “monitoring developments”.