“the Central Bank is minded to require credit institutions to set the present value of future cash flows at zero other than those arising from disposing collateral for the purpose of calculating the amount of the impairment provision required, without exception, for all loans in arrears greater than 90 days which have not been subjected to restructured arrangements on a sustainable basis at the time of assessment” Central Bank of Ireland publication “Mortgage Arrears Resolution Targets 13th March 2013”
You might recall the fanfare of the announcement on 13th March 2013 when the Department of Finance announced it was finally getting serious with banks over distressed mortgages. Targets – which appear fanciful on here with the banks supposed to provide sustainable solutions to 25,000 mortgages by the end of June 2013 – have been set for the banks. And Minister for Finance Michael Noonan says that the Central Bank now has a stick with which to warn the banks, and hold them to account and that stick is that the Central Bank can force the banks to write down the value of loans to the underlying asset.
Let’s explain that.
If Bank of Ireland has loaned you €300,000 on a 25 year mortgage for a property that is now worth €200,000 and you have fallen behind on your payments and are in arrears. Then, under the Government’s targets, Bank of Ireland has to propose a sustainable solution for you. That may mean that Bank of Ireland places you on interest-only for a period of time or reduces your monthly payment in some other way, and in some instances, may give you a payment holiday. We don’t know exactly was “sustainable” means but you get the idea.
Now, if Bank of Ireland fails to provide you with a “sustainable solution” then the Central Bank is going to force Bank of Ireland to write down the value of the €300,000 loan in its books to €200,000. That means Bank of Ireland has to book a loss of €100,000 and if Bank of Ireland has big enough losses overall with other peoples’ mortgages, Bank of Ireland may become insolvent and need more capital – that’s the stick. As the borrower of the €300,000 mortgage, don’t get excited by the above, you still owe the €300,000 – unfortunately, it’s just the bank that books the €100,000 write-down.
All straight-forward so far?
Here is where it gets messy for the Government, the Central Bank and the banks.
Banks in Ireland, and in fact all businesses that produce public accounts, comply with accounting standards. At present, when Bank of Ireland produces its accounts, it is required to look at your €300,000 loan and because you are in arrears, it needs to estimate what the loan is worth. At present, Bank of Ireland estimates how much cash it will receive in future from you and also what the value of the property is. So, if Bank of Ireland thinks that you have temporary difficulties and will make reduced payments for the next five years and then get back to full payments, it will probably value the loan at €300,000 because it figures that between the repayments and the value of the property if it repossesses it, it will get back its €300,000.
This valuation of your loan by Bank of Ireland is governed by International Financial Reporting Standards and specifically International Accounting Standard 39. And that’s what banks here use when producing their accounts. But what is now envisioned is that the Central Bank can intervene to direct banks to write down the value of a mortgage to the value of its underlying security, regardless of whether or not the bank thinks it can get more money out of you.
This new approach is only to kick in from January 2014, but this represents a serious interference by the Central Bank into accounting practice and the view on here is that banks can tell the Central Bank to “sod off” and that banks will continue to prepare accounts in the old manner and those same accounts will be audited and approved by accountants. Of course the Irish banks are mostly owned by the Government, so they may yield to this arm-twisting, but Ulster Bank and KBC for example are more independent, and I don’t think the Belgian government will think too kindly on a demand for more capital for its Irish operation because the Central Bank wants to subvert international accounting standards.
Or, in other words, the main threat to the banks for failing to meet targets, is almost completely hollow.
The information reported above is in part derived from two parliamentary questions by the Sinn Fein finance spokesperson to Minister Noonan, these are the two questions.
Deputy Pearse Doherty (26th March 2013): To ask the Minister for Finance further to his announcement on mortgage arrears on 13 March 2013, if financial institutions will continue to prepare their accounts under International Financial Reporting Standards, and particularly if the requirement to write down the value of certain loans to the value of the underlying security, will lead to the necessity for banks to produce two sets of accounts.
Minister for Finance, Michael Noonan: The Central Bank has informed me that its publication on Mortgage Arrears Resolution Targets, which can be accessed on the Central Bank’s website at http://www.centralbank.ie, addresses the use of IFRS standards in the context of MARS targets and on page 16 states:
“An entity which prepares their financial statements in accordance with International Financial Reporting Standards (IFRS) is required to comply unreservedly with all of the requirements of those Standards. The Central Bank is conscious that its guidelines in respect of provisioning against impaired loans must be consistent with those standards and is satisfied that the approach to provisioning set out below meets that consistency requirement.”
Deputy Pearse Doherty (16th April 2013): To ask the Minister for Finance further to Parliamentary Question No. 193 of 26 March 2013, the way advertised threat of forcing banks to write down the value of problem loans to the value of the underlying security is any different to pre-existing requirements under International Financial Reporting Standards and particularly International Accounting Standard 39..
Minister for Finance, Michael Noonan: The Central Bank has informed me that it is minded to require credit institutions to set the present value of future cash flows at zero other than those arising from disposing collateral for the purpose of calculating the amount of the impairment provision required. This applies without exception, to all loans in arrears greater than 90 days which have not been subjected to restructured arrangements on a sustainable basis at the time of assessment.
This will force credit institutions to value assets on their books which are 90 plus days in arrears and not sustainably restructured based on the expected net proceeds of collateral disposal only. Credit institutions would not be allowed to incorporate assumed or expected future cash flows from other sources into these valuations as may be the case currently.