Matthew Elderfield: Mortgage arrears - Central Bank of Ireland
supervisory strategy
Address by Mr Matthew Elderfield, Deputy Governor of the Central Bank of Ireland, to the
Association of Compliance Officers in Ireland, University College Cork, Cork, 14 October
2011.
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Introduction
Good afternoon ladies and gentlemen. It is good to be back in Cork again and particularly in
UCC where I am honoured to have been appointed an adjunct professor. I am looking
forward to being a regular visitor to the College and arranging a smaller student seminar at
some point in the New Year.
This afternoon I would like to focus on the very difficult issue of mortgage arrears which is a
top priority for the Central Bank. I welcome the opportunity today to outline in turn the
different elements of our supervisory strategy in this area. I will also tell you about the new
work the Central Bank is undertaking in this area which will involve setting out our
expectations on the structures and processes regulated lenders should put in place to handle
their arrears. I will also describe a planned supervisory review of how firms are handling
arrears in practice, with the threat of enforcement sanctions where appropriate.
Earlier this week I met with the Senior Management at the main mortgage lenders where the
Central Bank set out very clearly to them our expectations of them. Today I am taking this
opportunity to communicate our position publically.
The vast majority of Irish borrowers are meeting their commitments on their mortgages and
other debt, despite the more difficult economic circumstances. But it is clear too that the
sharp increase in unemployment, against a background of the heavy indebtedness built up in
previous years, has led to an exceptional increase in the number of households who have
missed payments on their mortgages. For some this will be a transitory or temporary
situation and they will in due course be in a position to resume full servicing of their
commitments. For others, however, their circumstances have deteriorated so severely that
they may not be able to recover sufficiently over time to fully repay their mortgage loans. This
is the difficult situation to which the lenders, the Government and other stakeholders must try
to find equitable solutions. Following their recapitalisation earlier this year the Irish banks
have more capacity to address individual arrears cases, but it is important to be very clear
that neither the banks nor the taxpayer have unlimited financial resources.
Data collection
Before getting into the important questions of consumer protection and bank capital, I want to
set out the data we have gathered on mortgage arrears to ensure we have a clear factual
basis for discussion. Yesterday the Central Bank hosted a conference on the mortgage
market, where invited speakers from the US and UK as well as speakers from the Bank
addressed this important topic.
Since September 2009 the Central Bank has collected and published data on mortgage
arrears and repossessions. This on-going monitoring of the mortgage arrears situation helps
to inform consumer protection and prudential policy. We collect data from 19 lending
institutions. In its final report in November 2010, the Mortgage Arrears and Personal Debt
Group (also known as the Cooney Group) recommended that the mortgage arrears and
repossessions data be extended to include mortgage restructuring. We implemented this
change in December 2010 and the data now shows the number of restructured loans, at
69,800 in June 2011, up from just over 59,000 in December 2010.
As part of our March 2011 Prudential Capital Assessment Review (also known as the PCAR)
and our work with BlackRock, the Central Bank collected detailed loan level data from each
of the banks. This has enabled us to analyse the arrears situation at a very granular level.
This kind of approach underpins much of our analytical work in this area, and I would
commend you to look at the papers presented yesterday which will be available on the
Central Bank website. Another important reference document is our publication of the results
of the PCAR, which set out the projected loan losses under a base and stress scenario
modelled by BlackRock: this is also available on the website.
The detailed data now available helps us to identify more clearly where the problems lie and
where targeted policy responses are required:
 The significant increase in arrears over time is clear - the number of primary
dwelling mortgage loans in arrears of more than 90 days past due, increased from
3.3% in September 2009 to 7.2% in June 2011. But this is only the owner-occupier
side of the market. The buy-to-let market (BTL) is also an area of concern to the
Central Bank. From a very small share of the market in the early 2000s, BTL loans
grew to account for around one quarter of outstanding balances by the end of the
decade. The data shows that the 90-day arrears rate in this category is growing at a
faster rate as well.
 It is clear that a significant degree of restructuring is taking place - in many cases
this will be sufficient to buy time for borrowers until economic circumstances
improve. But clearly this will not work for all borrowers, for example, where a
mortgage is unsustainable. I want to talk about this in some detail shortly.
 Affordability is the key factor driving arrears, not negative equity. Negative equity is
nonetheless important, particularly when considering potential mortgage losses.
Continuing house price falls are not helping on this front. It is also worth pointing out
that of those households in negative equity, we estimate that only one-tenth of these
are in deep arrears. As it stands, therefore, we do not believe that negative equity is
the key driver of mortgage arrears and it is hard to see justification for expensive
policy actions directed at negative equity alone.
I should note that we are aware that some banks are providing limited offerings of negative
equity mortgages to their customers. These clearly have risks, involving increased
indebtedness for example, but may be useful for particular types of customers who have
negative equity but need to move home and have the capacity to service the new debt. We
have asked the banks involved to assess the experience to date of this product and based
on this information we will reassess the guidance we have provided them concerning credit
standards and suitable marketing.
It is primarily for households caught in a trap of affordability because of changing
circumstances that restructuring solutions need to be put in place. We believe that the report
from the Department of Finance mortgage arrears working group confirms this.
The data show a wide variety of circumstances. Each different segment or category of
mortgage arrears requires different responses. There is no easy solution, no silver bullet.
There are the vast majority of customers who continue to make payments on time, including
many who are in negative equity. In addition to households that have fallen into arrears,
others in a fragile "pre-arrears" position need to be identified and assisted ideally before they
slip into arrears as their savings are used up. Some households have already rescheduled
mortgages to give them some temporary breathing space to get over a transitory difficulty
and can have a reasonable prospect of recovery. However, there are others whose present
rescheduling arrangements are unrealistic, and merely postponing a more intractable
problem of an unsustainable mortgage that requires different approaches. Within each
category there will be a need to assess the individual circumstances of each borrower.
Treating customers fairly
At the Central Bank we have a statutory duty to protect consumers in addition to
safeguarding the stability of the financial system. Ensuring that regulated firms treat their
customers fairly is at the heart of our consumer protection strategy. Getting it right for
consumers is at the centre of what we do and the area of mortgage arrears is an important
priority for us.
In early 2009 we added to our consumer protection arsenal by launching a new code of
conduct setting out how regulated lenders must deal with consumers who were in arrears
with their mortgage payments. While our Consumer Protection Code already required
regulated lenders to treat customers fairly, we felt we needed to strengthen the requirements
to protect consumers who were facing difficulties repaying the mortgage on their family
home. In February 2009 we launched our Code of Conduct on Mortgage Arrears which set a
moratorium of six months before a lender could commence legal action against a
homeowner who was in arrears on their mortgage. In February 2010 we amended the Code
to increase this moratorium protection to 12 months.
The CCMA now requires all regulated mortgage lenders:
 to communicate promptly and clearly with mortgage holders as soon as difficulties
arise,
 to agree with borrowers a plan for clearing their mortgage arrears that is consistent
with the interests of both the borrower and the lender, and,
 to handle all genuine cases of mortgage arrears sympathetically and positively with
the objective of assisting borrowers to meet their obligations.
We added new protections to the Code in December 2010 based on the recommendations of
the Cooney Group as I mentioned earlier. Set up by the Government in February last year
under the chairmanship of Hugh Cooney, this Group examined measures that could be put in
place to assist genuinely distressed mortgage holders.
The recommendations of the Group included specific measures to strengthen the protections
for consumers in the Code, including a proposal that lenders must not apply penalty interest
or arrears charges to borrowers who take part in a mortgage arrears resolution process. We
recommended a Deferred Interest Scheme for some borrowers and suggested that lenders
should consider facilitating borrowers in negative equity who wished to trade down to a more
affordable home. Where a mortgage is unsustainable, we recommended that the
householder should be assessed for social housing before repossession takes place and that
there should be a mechanism in place whereby repossessed borrowers could remain in their
homes for a time to allow housing authorities to find appropriate alternative accommodation.
Acting on the recommendations of the Cooney Group, the Central Bank strengthened the
Code. These new protections came into effect on 1 January this year and now include the
Mortgage Arrears Resolution Process or MARP. The MARP sets out the framework
regulated lenders must follow in handling cases of arrears and pre-arrears and adds very
important protections for consumers. Regulated lenders now must have a centralised and
dedicated arrears support unit to manage and assess arrears cases. They must use a
Standard Financial Statement or SFS to gather the information from borrowers that will allow
an assessment of possible alternative payment arrangements to help borrowers meet their
commitments. We worked with the Money Advice and Budgeting Service (MABS) to develop
a SFS that could be used by all lenders and we also worked with MABS to produce a guide
to help consumers complete an SFS.
Lenders must also set up an appeals process to examine appeals by borrowers. Pre-arrears
borrowers must also be treated under the MARP which requires specific information to be
provided to borrowers in a clear and customer friendly manner. Borrowers in arrears cannot
be changed from a tracker mortgage to another type of mortgage.
Where a borrower is cooperating with their lender, the lender must wait at least twelve
months before applying to the courts to commence enforcement of any legal action on
repossession of a primary residence. In addition, lenders may only attempt to make
unsolicited contact with arrears customers three times in a calendar month.
We are determined to ensure that we have the necessary measures in place to protect
distressed and vulnerable mortgage customers who are trying to meet their commitments.
For this reason we are monitoring the effectiveness of the Code and we will review the
measures again next year. I can assure you that we will further strengthen this Code as
required.
At this stage I would like to send a message directly to worried homeowners who feel they
are at risk of getting into arrears - we have put the measures in place to protect you, for
your part what you need to do is to come forward and engage with your lender to find
a workable arrangement to deal with your loan. The Code provides the space and the
protection to allow you to do this.
Transparency and improved communication
A key part of the Code is improving communication to consumers and this is the first step in
the MARP process. As soon as a borrower goes into arrears, a lender must communicate
promptly and clearly with the borrower to establish why the repayment schedule agreed in
the mortgage contract has not been adhered to. The lender must ensure that all
communication with the borrower about arrears and pre-arrears is timely and that all
information relating to a lender's handling of arrears and pre-arrears is presented to the
borrower in a clear and consumer friendly manner. The language used in communications by
lenders must be in plain English so that it is easily understood. A lender must prepare and
make available to the borrower, an information booklet providing details of its MARP,
including the alternative repayment measures available to borrowers and outline, in general
terms, the lender's criteria for assessing requests for alternative repayment measures. It
must also include a statement that the borrower will not be required to change from an
existing tracker mortgage to another mortgage type plus other helpful information.
There is also some very useful information on the Central Bank website for consumers facing
mortgage arrears, including our booklet - "Mortgage Arrears - A Consumer Guide to
Dealing with your Lender" and some answers to frequently asked questions.
I referred earlier to the Code requirement that lenders set up dedicated units to handle
arrears cases and lenders must also have a dedicated section on their websites. That
website section must include the information booklet I referred to earlier, information about
the charges that may be imposed on borrows who do not co-operate with the lender; and a
link to the website operated by the MABS that contains information about mortgage arrears.
Information on the website must be easily accessible from a prominent link on the lender's
home page. The Code also requires lenders to inform borrowers in writing when they have
appointed a third party to engage with the borrower about their case and must explain the
role of the third party.
The Code requires lenders to ensure that the level of contact and communications from the
lender, or any third party acting on its behalf, is proportionate and not excessive.
When a mortgage loan goes into arrears and remains in arrears for 31 days, the lender must
write to inform the borrower within 3 working days. This letter must include the date the
mortgage fell into arrears, the number and total amount of full or partial payments missed
and the monetary amount of the arrears to date. It must confirm that the lender is treating the
borrower's situation as a MARP case and let the borrower know the importance of
cooperating with the lender during the MARP process as well as notifying the borrower that if
co-operation ceases, the protections of the MARP no longer apply and the lender may start
legal proceedings for repossession.
A key element in the Code, and an important protection for mortgage holders, is the
requirement for banks to set out their different restructuring options and the criteria used for
applying these. This is designed to allow consumers to understand better the options
available and to help them to prepare for their meeting with the bank. As part of our next
phase of the Central Bank supervisory work we are going to review how the lenders' process
of determining the most suitable option for the borrower is working in practice. As I said
earlier, following this review we will decide if we need to add further protections and whether
some of the measures already in the Code need to be strengthened. Active outreach by
lenders to consumers in pre-arrears is one area not currently covered in the Code that we
want to address. While some banks are showing best practice in this regard, and while some
customers in pre-arrears are making early contact with their lenders, we will look closely at
whether lenders could communicate more proactively in this area.
We are vigorously policing this Code. As I will explain shortly we are about to undertake a
major supervisory initiative on mortgage arrears to assess the implementation of the Code. In
anticipation of this earlier this week, I advised bank chief executives to examine very
carefully their compliance with the Code and to ensure their processes and resources are up
to the task.
Providing a breathing space
As I said earlier, the CCMA provides important protections for distressed consumers who are
trying to meet their commitments. Where a borrower co-operates with their lender, the lender
must wait at least twelve months from the date the borrower is classified as a MARP case,
before applying to the courts to commence legal action for repossession of a borrower's
primary residence. Importantly, legal action is also not permitted if the borrower is complying
with the terms of any alternative repayment arrangement agreed with the lender or when an
appeal by the borrower is being processed.
A lender can commence legal action where the borrower does not co-operate, where the
borrower commits fraud, or in the event of breach of contract.
As you can see the Code is designed to buy time to allow a mortgage holder to reach
agreement with their lender. It provides a de facto moratorium which continues so long as the
mortgage holder is meeting their obligations of the new rescheduled agreement. The
strengthened Code also added in other measures to help provide some breathing space for
distressed borrowers such as prohibition on penalty interest - prohibiting lenders from
applying penalty interest or arrears charges to borrowers who take part in a mortgage arrears
resolution process. This prohibition was introduced on the basis that banks shouldn't make
matters worse and add to arrears problems.
The thinking behind the prohibition on charging penalty interest is that banks' actions should
not exacerbate the financial problems of customers in distress. There is something to be said
for looking at the treatment of standard variable rate customers from a similar perspective.
Traditionally, SVRs were understood to adjust in line with competitive market conditions.
Current conditions are unusual in several respects. When the interest rate on so much of
their mortgage portfolio is fixed at a very modest (tracker) spread over the ECB's policy rate,
some banks have found that even the performing part of their mortgage book as a whole
may be unprofitable given their increasing cost of funds in the market. The increases in
SVRs implemented by some banks may thus be going beyond the traditional
passingthrough of the cost of funds, instead seeking to make-up for what has proved to be an
inadequate spread on trackers. The Central Bank does not have the power to set standard
variable rates or other interest rates - nor does the government (although as shareholder in
many of the domestic banks it does have the opportunity to influence management actions.)
However, it may be that these actions are, on balance, self-defeating if they push more
customers into arrears, adding to the mortgage arrears problem and ultimately costing more
in terms of capital. We are looking closely at this issue, and we do have a statutory
responsibility so far as it concerns the soundness of banks. Accordingly we have decided to
require any bank that has received government capital support to provide an impact analysis
of any proposed standard variable rate increase in terms of the implications for its arrears
position and future capital requirements, and that the bank's Board of Directors be required
to review and approve this analysis to ensure that proper attention is given to the costs of
such actions. We informed lenders in February of this year to allow at least 30 days notice to
be given in advance of any SVR mortgage rate increases and we are now introducing this as
part of the revised Consumer Protection Code. These are admittedly limited actions in light of
the absence of direct powers by a public authority concerning rate setting. If the banks
continue to act in a way which is so damaging to customers and which appears to take
advantage of the current dysfunctional competitive environment, it seems they are courting
the risk of a public policy response involving powers to impose direct restrictions on their rate
setting capacity by the competition or financial regulatory authorities.
Unsustainable mortgages
Let me spend a moment to specifically address what the Cooney Group has called
"unsustainable mortgages." These might be described a number of ways. Most simply, they
are mortgages where the homeowner has such severe affordability problems that there is
very little prospect of eventually servicing the debt and retaining ownership of the home. The
Cooney Group proposed an initial simple rule of thumb according to which being in arrears
for more than, say, 18 months accumulated overdue interest, and where the property is in
significant negative equity (making it impossible to trade down and unlikely that improved
housing prices will provide a benefit in a reasonable time period) are in combination strong
indicators of an unsustainable mortgage. That can't be a definitive test, because in some
cases individuals might be able to come back into stronger earnings situations, repay the
interest arrears and start to rescue the situation. And of course a strategic decision to go into
arrears when one can afford not to is certainly not what the criterion has in mind. Bear in
mind that the longer the period of arrears, and the more missed payments the harder it will
be for the household to get back on track.
Standard mortgage rescheduling or forbearance techniques are unlikely to be successful
where a household has run up substantial arrears - this is the group where the problem is
being deferred rather than resolved. Indeed, from the perspective of treating customers fairly
it could be argued that forbearance is actually making the position for the homeowner worse
- if default or loss of ownership is pretty much inevitable every intervening month of interest
roll up and capitalisation is actually adding to the shortfall that the borrower will eventually
owe the bank. It is unclear how many mortgages might be in the unsustainable category,
and, as I said, the evaluation needs to be on case-by-case basis. However, we do know from
our analysis of the loan data that of those mortgages 90 days or more in arrears, 70% are at
least 180 days past due, and 40% are at least 360 days past due.
The unsustainable mortgage group is the portion of the overall arrears group that requires
more effort, fresh thinking and clarity about the future bankruptcy regime. Even when the
bankruptcy code has been reformed to streamline the process and remove some of the
overly burdensome elements, bankruptcy - whether judicial or non-judicial - will remain an
unpleasant and costly experience. Better in most cases for both borrower and lender if a fair
restructuring can be achieved without recourse to the bankruptcy procedures.
At the same time, unsustainable mortgages are very much in the minority. Existing
rescheduling approaches will be appropriate for many, if not the majority of arrears cases.
And it is hard to see there is a case for action to simply reduce negative equity where
customers are continuing to make their payments - this would be a prohibitively expensive
undertaking for the State, and even if it could be afforded, clear questions of horizontal equity
would arise.
The discussion on unsustainable mortgages is, to my mind, sometimes characterised by
either denial or simplicity. Some banks are only now beginning to face up to this challenge,
and re-thinking the existing menu of options for customers in distress. Where this problem is
correctly recognised, it is equally important to be wary of the simple allure of debt forgiveness
and the costs that would impose on the taxpayer. The awkward truth is that it is likely that
repossessions will increase over time. However, the challenge to the banks and policy
makers alike is to minimise that outcome while also recognising another awkward truth, that
for most in this group, ownership of the home will be lost, in whole or in part. However, there
should be solutions like mortgage to rent schemes that allow homeowners to stay in their
homes. It is in the banks' own economic interest to consider modification arrangements such
as debt for equity and shared ownership solutions. This is preferable to denial about the
severity of the problem and the hope that the ever growing shortfall of capitalised interest will
eventually be recovered in full.
It may be that uncertainty about the legal framework for dealing with shortfalls is one reason
for the denial - or perhaps the hesitation - about dealing with unsustainable mortgages. The
key question is: in the absence of rescheduling or modification, what will happen to the
shortfall when ownership of the home is surrendered and the negative equity amount is
crystallised and due to the bank. There is a logic in both bankers and borrowers holding back
from taking action on the unsustainable mortgage problem in the knowledge that the legal
framework that will govern this shortfall is due to change in the near term through bankruptcy
reform and the introduction of a non-judicial debt settlement mechanism. That points to the
importance of settling the key policy issues in this reform as a matter of some urgency and, if
you like, bringing the debate on mortgage arrears public policy more generally to a settled
conclusion so that there is certainty about the rules of the game. Until that happens it will be
difficult to make progress on the unsustainable mortgage problem, despite the additional
efforts being encouraged by the supervisory strategy I will describe today. In the meantime,
we will use our engagement with the banks to require them to focus on the unsustainable
mortgage problem.
Rescheduling options
The Code does not prescribe that a lender must agree to a rescheduling with a customer.
That decision still ultimately rests with the lender based on an individual assessment of the
borrower's particular circumstances. That assessment needs to be on an individual,
case-bycase basis, although banks will have standardised procedures to facilitate their decision
making process - and will have a suite of different rescheduling options which might be
applied, of which more in a moment. However, again, the decision on rescheduling, like that
of originally granting credit, is for the lender. That is the role that banks play in society and
despite the opprobrium that they have rightly earned from their performance in the financial
crisis, it is hard to see that the fundamental role of banks in the economy has - or should -
change in this respect.
That said, it is clear that many lenders have been slow to acknowledge the extent of this
problem and to put in place sufficient operational infrastructure to deal with it. It is a task from
which the lenders should not be relieved. Neither the lender nor the borrower is well-served
by delay in recognising the existence of an inability to service debt. Banks must put the
framework and resources in place to examine additional measures to address the individual
unsustainable cases of distressed borrowers. The sooner they do this the better.
As I will explain shortly, a major focus of our supervisory efforts in the next period will be to
encourage the banks to improve their organisational capacity to tackle this problem.
Central Bank data shows that the main restructuring options currently offered include moving
to interest-only payments, extending the loan term and interest holidays with capitalisation of
the missed interest. In some cases these measures will buy time for the mortgage holders
who can recover. However, as I have explained, in other cases they just delay addressing a
more intractable problem and could make the shortfall greater for the consumer in the event
of a later default.
Banks need to recognise the shortcomings of these measures and should work much harder
to widen their range of options for dealing with affordability to bear on this problem, in
particular in individual cases where there is little prospect of servicing the original loan terms.
At the same time, however, the banks must husband their available capital in a prudent
manner.
As explained previously, under the Code lenders are required to publish details of their
approaches and the criteria that must be met to be considered for the different options. As
part of our review we will be gathering information on the various options each lender offers.
We intend to include a summary of this information as part of our wider public feedback
following the completion of this review. In addition to this, we plan to require lenders to
conduct a review of the efficacy of the existing restructuring arrangements that they have in
place and to formally provide an assessment of whether additional rescheduling approaches
are required. We want this to be debated carefully at Board level as part of agreeing the
bank's mortgage arrears resolution strategy. We want banks to give closer attention to
whether the existing range of rescheduling approaches are adequate for the scale of the
problem and whether sufficient recognition is given to individuals who have little prospect of
servicing even the rescheduled loan terms. Requiring customers to roll up and capitalise
interest and arrears is not appropriate where those customers have unsustainable mortgages
or can only stay in their home through loan modification: the bank is likely only adding to the
size of the shortfall that the customer ultimately faces in a default. Boards of directors need
to take a direct interest in whether the rescheduling arrangements that have been put in
place are working and treat their customers fairly on this point. They need to satisfy
themselves that the banks' strategy for mortgage arrears is up to the task. More of that in a
moment.
At the heart of the MARP process is the case-by-case determination by the bank as to
whether a rescheduling is appropriate and which scheme is to be offered. Under the Code all
lenders are required to carry out formal six monthly reviews to assess the appropriateness of
each arrangement. We plan to lift the lid on this process as part of our inspections and look
very closely at how the banks are working through individual cases. We would expect banks
to develop and share with us their decision-making trees for determination of individual
cases. We want to understand the staffing arrangements for these decisions. We think that it
would be best practice for banks to establish the net present value of the alternative
rescheduling approaches (much as US lenders are doing) and we want to see whether
lenders are developing such best practice approaches.
These various efforts are designed to encourage the development of a wider menu of
rescheduling options to address the arrears problem. In introducing any of these measures to
assist distressed borrowers it is essential to ensure that people who can service their debts
are not given an opportunity to escape from their obligations. The State through its taxpayers
has already assumed too great a burden in this crisis. Careful calibration of measures and a
targeted, case-by-case, approach must be the hallmarks of current and future policy for the
resolution of arrears problems. While loan modification may be necessary in some cases,
there will be adverse consequences for the homeowner - while they may be able to stay in
their homes, there will likely be a loss of ownership. These arrangements must be targeted at
those who genuinely cannot make the normal menu of rescheduling options work.
As the Governor of the Central Bank, Patrick Honohan, recently explained, resolution will be
effective only if it is guided by