Having gotten rid of €3.4 billion of distressed loans from its balance sheet over the past 18 months, Permanent TSB's (PTSB) soon-to-depart chief executive Jeremy Masding has turned his focus to a bunch of loans that threaten to give problems in the future.
The State’s former top mortgage lender highlighted this week, as it reported its full-year results, that 17 per cent of its performing mortgage book – equating to about €2.6 billion – is made up of loans doled out during the boom years where borrowers only have to meet interest payments until the loan period comes to an end. At that point, the principal falls due at once.
The bank has begun to ask borrowers how they plan to make these end-of-term payments so it can assess what level of defaults can be expected from the portfolio.
And even though borrowers may continue to meet their loan arrangements, the bank, under rules brought in following the financial crisis, may have to start classifying interest-only mortgages as non-performing loans (NPLs) if borrowers don’t come back with credible capital repayment plans.
"There's no doubt that interest-only mortgages have a higher risk profile, because they have a bullet payment attached to them," PTSB chief financial officer Eamonn Crowley told reporters, noting that most of the portfolio is made up of cheap buy-to-let loans priced off the European Central Bank's main interest rate.
Analysts reckon PTSB may turn to international financial markets to shift the riskier element of the portfolio off its books by selling bonds where interest - or coupon - payments are funded by interest income from the underlying mortgages. This is known as a residential mortgaged-backed securitisation (RMBS) transaction.
With Bank of Ireland, PTSB, Ulster Bank and KBC Bank Ireland having reported in recent weeks that their underlying earnings declined last year as ultra-low central bank and market interest rates and muted loan book growth squeezed incomes, management teams are focused on controlling the controllables.
The focus in recent times has been on moving on problem loan portfolios through loan sales, as years of restructurings loan had left lenders with their trickiest cases. Banks are turning increasingly to the RMBS market, seen as less politically controversial than selling loans to overseas investment groups, or what are dubbed vulture funds.
"While banks' incomes are being hit by the lower-for-longer interests rates environment, they can benefit in another way as this is also pushing investors to seek out assets with any type of yield, making RMBS transactions more attractive," said Stephen Lyons, an analyst with Davy. "We do anticipate further loan securitisations or sales at PTSB."
PTSB has been here before. The bank turned in November 2018 to the securitisation market to shift €1.3 billion of restructured loans – mainly split mortgages where a portion of payments are warehoused until a future date.
Political uproar
The issue with these loans from a regulatory point of view was that they continued to be classified as NPLs. PTSB abandoned plans for an outright sale of the portfolio in early 2018 following political uproar.
In order for loans in a residential mortgage-backed securitisation transaction to be moved off a lenders’ balance sheet, ultimate control of the mortgages must be handed over.
PTSB lined up US investment powerhouse Pimco to buy most of the notes in the 2018 securitisation vehicle, called Glenbeigh Securities 2018-1 DAC, with the bank retaining, as required by post-crisis rules, 5 per cent of the notes.
Elsewhere, Bank of Ireland removed €375 million of non-performing, but mainly restructured, buy-to-let loans through an RMBS deal last April. The bank continues to manage the loans for the bondholders, resulting in no change in the day-to-day interaction with borrowers.
Bank of Ireland’s chief executive, Francesca McDonagh, signalled last Monday – as she reported a 19 per cent slump in its pre-tax profit and dropped a key profitability target that had been set for 2021 – that she is planning the bank’s first sale of soured Irish owner-occupier loans this year.
Sources said the group is working towards an RMBS deal. This would be less contentious than a loan sale at a time of uncertainty about the shape of the next government following the inconclusive outcome of the February 8th general election.
Sinn Féin finance spokesman Pearse Doherty, whose party won the popular vote and secured the second highest number of Dáil seats, had been promoting a bill in the last parliament aimed at preventing banks from selling distressed mortgages without a borrower's consent. However, he had stressed that the draft laws would not hamper securitisation deals.
"Over the past 10 years, Irish banks have dramatically reduced their NPL ratios primarily through portfolio sales or restructures," said Darrell Purcell, a Dublin-based associate director of structured finance at credit ratings firm Standard & Poor's. "Subject to global investment conditions, we would expect [them] to continue to consider RMBS transactions in meeting their capital, funding, regulatory or strategic objectives."
The first Irish NPL bond deals were carried out not by banks – but investment firms that had aggressively snapped up loan books from failed Irish banks or overseas lenders that retrenched from the market following the property market crash.
Dallas-based private equity giant Lone Star paved the way in November 2016, selling bonds attached to €564 million of former Irish Nationwide Building Society mortgages it had acquired under the liquidation of the lender's assets. This process has allowed investment firms to take money off the table in one deal, rather than going down the lengthy road of repossessing swathes of properties or selling on the loans to other firms.
Transactions
“In recent years we have rated a number of different types of RMBS transactions including transactions secured by performing, re-performing and non-performing loans,” Purcell said.
“Improved market conditions, in particular the house price recovery and rising employment figures, have supported the sustainability of restructures and a number of years of performance history – plus better visibility on the likely cash flows – has allowed issuers to contemplate RMBS transactions.”
Still, straightforward loan sales continue. Ulster Bank agreed last October to sell €800 million of mortgages, mainly issued on family homes, to US distressed debt specialist CarVal Investors. A month earlier, PTSB reached a similar accord with Lone Star on about €500 million of home loans.
AIB, the biggest mortgage lender in the market, is currently promoting its first owner-occupier book to potential buyers. The portfolio, known as Project Oak, is understood to contain loans that were originally valued at well over €1 billion but that are now expected to achieve a discounted rate of €700 million to €800 million.
Analysts, however, see RMBS transactions becoming more popular as long as global financial market conditions remain favourable.
“There is also a market for banks to use RMBS deals for re-performing loans,” said Lyons, noting that while these may have borrows sticking to revised terms, banks continue to be required to hold very high levels of costly capital against them.
As lenders continue to grapple with pressure on margins, depressed share prices, and rising regulatory demands over the near term, they’ll look increasingly to pull whatever levers they can to boost returns.
