This article was originally published by The Business Post.
The farce of the Oireachtas Finance Committee hearings over the past week has demonstrated how much in control the banks are regarding the mortgage crisis. Tomorrow, the long-awaited insolvency service opens its doors. What we witnessed last week does not give one great confidence.
There is, however, an alternative to insolvency, legal letters dressed up as solutions and continued paralysis in dealing with this crisis. A number of years ago, several commentators, including David McWilliams and Matt Cooper, suggested “debt for equity”. In fact, Fergus Murphy, now of AIB but then the chief executive of EBS, presented this as an option in 2009 to the Finance Committee. I feel our politicians need to show definitive leadership and introduce debt for equity legislation through the Oireachtas.
The Central Bank has also looked at debt for equity as an option and the new code of torture, sorry conduct, for mortgage arrears issued by the Central Bank in July contains as a solution in section 39 “debt equity”.
Debt for equity as a way forward demands serious consideration by banks, policy makers and regulators. It may require Basel III (international regulatory framework for banks) rules to be changed, to facilitate the consideration of equity a bank might hold in homes. But there are many ways to be creative around capital reporting of such issues.
Debt for equity is aimed at keeping families in their homes and preventing the expected wave of repossessions in the future. This could be used by all mortgage holders, whether in positive or negative equity.
Furthermore, as a private contractual arrangement for a reduced payment aligned with affordability, a debt for equity arrangement could exist without having your name on any public register or being bound by stringent expenditure guidelines.
So how does debt for equity work?
Joe and Ann have a mortgage of €300,000 paying €1,500 per month capital and interest. They can only afford a mortgage of €200,000 paying capital and interest of €1,000 a month. With a debt for equity arrangement, one third of the home ownership is exchanged for a writing-down of the mortgage to €200,000 in a permanent arrangement.
So Joe and Ann pay capital and interest on the affordable amount of €200,000, ie, €1,000 per month until the €200,000 is fully paid off. When fully paid off, they can stay in their home until they die, at which time a family member could buy back the bank’s equity interest from the bank at the market value of the day. Alternatively, they can sell the house and retain 66 per cent of the proceeds, with the remainder going to the bank any time after the €200,000 is paid down.
In the event that Joe and Ann decided to sell the house prior to repaying the €200,000 mortgage fully, they could do so, but they would remain liable for the balance of the €200,000 not paid. The bank would also get its 33 per cent share of the sale price
Are banks likely to go for it? They certainly should. In the US, through the Hope for Homeowners and Refinance Plan, these schemes have been proven to work. From a bank’s perspective, in the example above, it receives 66 per cent of the mortgage payment on a sustainable basis for the remainder of the mortgage. These payments equal the value of the property now, ie, what the bank would get if it repossessed, but with interest added on.
Also, upon the sale of your house, either through death or if you choose to sell it, the bank will receive a third of the sale price. Therefore, debt for equity gives the bank the certainty of two-thirds repayment with interest, and a potential upside at a future date, as house prices rise over time. Long-term, this deal is to the banks’ advantage over what they could get now for it. It is also more advantageous for a bank than a split mortgage, as the bank gets the upside on the parked/equity portion of the loan, as opposed to the amount being paid in the future being defined now.
Should a homeowner sell the property prior to the mortgage being repaid, he would receive back the remainder of the mortgage not repaid, plus his one-third share of the proceeds.
Debt for equity ensures security of tenure, certainty as to how the equity held by the bank will be dealt with, no bullet payments required in contrast to some split mortgage products, and no more standard financial statement reviews.
There is no continuing review of the borrower’s circumstances, unless the borrower wishes to do so, with a view to taking some of the equity held by the bank back by increasing payments.
Debt for equity would be a product agreed between the borrower and the bank. There would be no need to enter the insolvency service and be published on a public register. Nor would you have to review payments if you got a higher-paying job or a promotion.
It gives borrowers certainty, and allows them to spend again and plan for the future. This is not a replacement for a split mortgage, just an alternative option. It lets borrowers move forward and look after their families’ interests and contribute back into the real economy.
Given the banks’ inaction over the past five years, a political solution including legislation to make debt for equity a compulsory product to be offered by lenders with prescriptive and transparent qualifying criteria to borrowers as a sustainable solution. Legislation needs to be fast-tracked through the Oireachtas allowing for the introduction of a debt for equity product.
Two generations have now been crippled by personal debt, and are facing insolvency and a greater risk of repossession. The banks have failed to act, and the Central Bank has been silent. This now needs a political solution.
*David Hall is founder of the Irish Mortgage Holders Organisation*