IRELAND: An Introduction to Banking & Finance
CHAMBERS EUROPE 2019 PRACTICE AREA OVERVIEW - BANKING
Contributed by William Carmody
1. Overview of loan market in Ireland
The Irish economy has been performing well. Indicators show that Ireland is likely to soon reach full employment and achieve a budget surplus in 2019. Recent reports by the Central Bank of Ireland paint a positive picture of the Irish lending market. This is supported by the positive rating actions that have been taken on Irish banks over the year. Standard & Poors’ stated rationale for the positive actions it took in December 2018 is that "the Irish banking system is successfully working through its past failings [and that] its industry risk profile is now less of a negative outlier relative to other Eurozone banking systems.” The number of mortgages in arrears continues to decline and Q3 2018 witnessed the twentieth consecutive quarter during which accounts in arrears over 90 days fell.
Ireland continues to see significant activity in the portfolio loan sale market, largely due to ECB requirements to deleverage non-performing loans. In addition, a number of non-Irish lenders have decided to leave the market over the last number of years, putting their entire Irish loan books up for sale. 2018 saw the largest portfolio sale in the State to date when Permanent TSB sold a EUR3.7 billion portfolio of non-performing residential loans in July 2018 to Start Mortgages, a Lone Star entity. Other notable loan sales from 2018 include the sale by AIB of its EUR1.1 billion Project Redwood portfolio to Cerberus and the sale by KBC Bank Ireland of a EUR1.9 billion portfolio of buy-to-let and corporate loans to Goldman Sachs. 2019 will see further large-scale portfolio sales with AIB having recently put its EUR3.4 billion Project Beech portfolio on the market.
It was reported by the Central Bank that, as of December 2018, non-bank entities hold 10% of all Irish PDH mortgages. 8% of these mortgages are held by regulated retail credit firms and 2% are held by unregulated funds/investors. Goodbody Stockbrokers reports that, in their estimation, at year end 2018, AIB’s non-performing exposure is circa 10%, Permanent TSB’s is circa 8% and Bank of Ireland’s is circa 6%. They expect this to further reduce in 2019 on account of the disposals that have already been announced.In addition, there has been ample securitisation activity which has seen a rise in residential mortgage-backed securities and which will be bolstered by the new securitisation framework that is now directly applicable in Ireland. Permanent TSB recently refinanced EUR1.3 billion of its residential mortgages with Glenbeigh in the bond markets and Dilosk refinanced EUR290 million of its residential mortgages. Ireland continues to be a hospitable taxation environment for organisations in the structured finance market who are seeking to invest in ‘qualifying assets’ such as securities. Ireland is the leading European jurisdiction for Special Purpose Entities (SPEs) which can avail of favourable taxation provisions. The latest statistical release from the Central Bank on SPEs reports that total assets within Irish-resident securitisation SPEs or Financial Vehicle Corporations (FVCs) increased by EUR15.7 billion to EUR432 billion in Q3 2018.
Mortgage lending in Ireland is very strong and continues to grow. Irish mortgage rates are the highest in the Euro area; however, 2018 saw a drop in rates with variable interest rates falling to 3.15%. The Central Bank, in a profitability study on Irish banks, noted that competition, or a lack thereof, in the mortgage market has played a part in the growing profitability. The report notes that the banking sector became more concentrated during the financial crisis when international players quickly left the Irish market. Since then, the market has largely remained an oligopoly, giving domestic lenders strong market power, increased margins and greater profits. It is expected that these market conditions will attract competition in the near future, however, and increased competition will lead to downward pressure on margins.
The Central Bank has also identified some current risks to the sustainable growth of the Irish economy; in particular, Brexit and changes to international tax regimes impacting foreign direct investment. In addition, 2019 will bring some legislative changes which may have an impact on lenders, borrowers and/or the loan market in 2019, including:
• The Consumer Protection (Regulation of Credit Servicing Firms) Act 2018
• The Securitisation Regulation (Regulation (EU) 2017/2402)
• The Courts and Land and Conveyancing Law Reform Bill 2018
• The Credit Reporting Act 2013
2. Brexit
The Brexit trajectory is as yet very uncertain. In the meantime, Dublin has successfully positioned itself as an alternative hub for companies operating in the EU which were previously based in the United Kingdom. This is particularly the case for financial services companies. At the time of writing, 27 financial companies have relocated or announced their intention to relocate to Dublin since the Brexit referendum. The Central Bank has reportedly received more than 100 applications for authorisation from financial institutions which will not be able to avail of EU passporting provisions should there be a no-deal scenario or similar.
After the withdrawal of the United Kingdom, the Irish legal system will be the only English-speaking common law system in the EU. In addition, judgments of the English courts could cease to be automatically recognised by the courts of EU member states. This presents further opportunity for Ireland and the Irish Government. The Bar Council of Ireland have been promoting Ireland as a centre for legal services, dispute resolution and arbitration post-Brexit. Internationally, Ireland’s well-regarded Commercial Court has a reputation for its ability to handle complex cross-border commercial disputes in a timely and efficient manner.For the first time, the International Swaps and Derivatives Association, Inc. has published Irish and French law versions of its 2002 ISDA Master Agreement and credit support documents. To date, nearly all ISDA Master Agreements entered into between EU parties have been governed by English law and the English law Master Agreement has been the only option provided by ISDA for an EU Master Agreement. The Irish law versions of the documents are largely identical to the English law versions.
It remains to be seen whether Irish law will become a popular choice of law in wider commercial contracts. However, the Irish legal system is well placed to absorb any Brexit-related uptick in transactions or litigation and it should provide a viable option for parties looking for familiarity, consistency and legal certainty.
3. Loan Purchasers to be regulated in 2019
The substantial loan sales of the past five years have brought with them increased government, public and media scrutiny to the purchasers of these portfolios, often private equity funds that are not authorised in the State or elsewhere. Certain politicians have repeatedly sought to impose restrictions and increase supervision and accountability for these entities. Most recently, this has been manifested in the Consumer Protection (Regulation of Credit Servicing Firms) Act 2018 (CSF Regulation Act) which became effective on 21 January 2019.
The objective of the CSF Regulation Act is to regulate the purchasers of loan portfolios and it will require the holders of legal title to such portfolios to be licenced by the Central Bank of Ireland. Previously, purchasers of loan portfolios were able to avoid regulation by appointing a regulated 'credit servicer' which is subject to rules protecting borrowers.The new regime will extend the requirement to be regulated to purchasers of loans by expanding the definition of credit servicing to include:
• holding the legal title to credit granted under the credit agreement;
• determining the overall strategy for the management and administration of a portfolio of credit agreements; and
• maintenance of control over key decisions relating to such portfolio.
• applies to the Central Bank for authorisation within three months of the commencement of the CSF Regulation Act; and
• currently has a regulated credit servicing firm appointed.
The CSF Regulation Act contains a carve-out for securitisation special purpose vehicles and this will allow standard securitisations to remain outside of the authorisation requirements set out in the CSF Regulation Act.
Once a loan purchaser is authorised under the CSF Regulation Act, it will be subject to inspection, investigation and enforcement by the Central Bank.
4. Securitisation Regulation
From 1 January 2019, the Securitisation Regulation (Regulation (EU) 2017/2402) is directly applicable in EU Member States, forming part of a new framework for securitisation along with the Capital Requirements Regulation. It applies to securitisation transactions where securities are issued on or after 1 January 2019. Pre-existing securitisations are not subject to the new regime unless new securities are issued or a new position is created in that securitisation transaction.
One of the principal objectives of the EU in implementing the reformed framework is to develop "simple, transparent and standardised” securitisations (STS securitisations). It will also help to differentiate STS securitisations from "complex, opaque and risky instruments” through the revised framework. STS securitisation investors will benefit from more favourable capital requirements under the amended Capital Requirements Regulation.
For a securitisation to be designated as 'STS' it must comply with certain criteria of standardisation and transparency such as homogeneity of asset type and defined payment streams. The STS securitisation must also be notified to ESMA. Certain securitisations, including synthetic securitisations, are excluded from the scope of the STS designation.
The Securitisation Regulation establishes new due diligence, risk retention and transparency requirements for all securitisations.
In respect of due diligence, an 'institutional investor' must: (i) verify that sound and well-defined credit granting standards have been applied (unless the originator or original lender is a 'credit institution' or 'investment firm'); (ii) ensure that risk retention requirements have been fulfilled; and (iii) ensure that information about the transaction has been made available in accordance with the newly prescribed transparency rules.
The Securitisation Regulation introduces a new risk retention obligation on originators, sponsors and original lenders who must retain a material net economic interest in the securitisation of at least 5%.
In respect of transparency, originators, sponsors and securitisation special purpose entities must make certain information available to holders of a securitisation position, competent authorities and potential investors. This includes underlying documentation that is essential to understanding the transaction. Underlying exposures should also be made available on a quarterly basis, which should enable institutional investors to comply with their ongoing due diligence obligations.
5. Keeping People in their Homes in 2019
In May 2018, the Irish Government approved the drafting of a proposed bill of legislation which is expressly geared at "keeping people in their homes”: the Courts and Land and Conveyancing Law Reform Bill 2018. The proposed legislation will seek to protect borrowers who are facing repossession proceedings.
If enacted, it is understood that Irish courts will be obliged to consider certain prescribed factors when hearing an application to repossess a residential property, including:
(a) the overall proportionality of the application for a repossession order;
(b) the circumstances of the resident in the property;
(c) the details of any proposals which would enable the borrower to remain in the property; and
(d) where the loan has been sold, the amount paid for the loan or mortgage by reference to the amount of debt outstanding on the loan or mortgage.
The increased presence of non-Irish and non-bank purchasers of residential mortgages has led to a political drive to protect borrowers. Politicians are concerned that non-Irish investors, who may not have long-term plans to operate in the State, will not have the same public accountability as domestic lenders and will treat defaulting borrowers more harshly than the loan originators.
The text of the proposed legislation has not yet been published, nor has the timeframe for its legislative journey through the Houses. However, if the Reform Bill is implemented as proposed, it will have implications for investors seeking to acquire loan portfolios comprised of principal private residences.In particular:
(a) the new requirements are likely to lengthen the repossession process in Ireland, which is already slow and expensive;
(b) it is not yet clear whether the requirements will apply retrospectively to residential portfolios that have already been sold. If so, it could have a negative impact on the value of these previously acquired assets; and
(c) disclosure of the price paid may impact on future pricing of loan portfolios given the commercially sensitive nature of this information.
6. Credit Reporting
The phased implementation of the Credit Reporting Act 2013 continued through 2018 and will continue in 2019. It requires that the Central Bank maintain a credit register to centralise information on loans which will be accessible by lenders and borrowers. The initiative was agreed after the financial crisis as part of the EU/IMF Programme of Financial Support for Ireland.
Benefits are as follows:
(a) the register will promote transparency for borrowers, giving them awareness of their financial profile;
(b) lenders will have access to a borrower’s credit history; and
(c) the register will support the Central Bank in carrying out its supervisory function.
• Credit cards
• Overdrafts
• Personal loans
• Mortgages
• Business loans
• Moneylender loans
• Loans from local authorities
There is an obligation on lenders to enquire on the Register when considering consumer loans of EUR2,000 (effective since 30 September 2018) and this will extend to business loans from 31 March 2019.
7. Conclusion
Politically, we are seeing a public impetus to increase protection for borrowers whose non-performing loans have been or may be transferred to unregulated entities. It remains to be seen what the Reform Bill contains and whether it will be passed. Whether the CSF Regulation Act will have an impact on the loan sale market in the next twelve months remains to be seen as a number of structures can be implemented by investors to ensure compliance with the CSF Regulation Act while the fund itself remains outside the authorisation requirement.
Securitisations became unfashionable globally after the financial crisis but there has been steady growth in recent years, particularly in Ireland. The EU has endorsed it as a means of diversification and risk allocation across market participants. We expect to see a further uptick in securitisations in 2019 on foot of the new securitisation framework. In particular, we are likely to witness securitisation being further utilised as a deleveraging strategy for domestic banks. In this regard, it is worth noting again the securitisation carve-out in the CSF Regulation Act.
Finally, technology continues to change the financial services landscape globally through cloud computing and blockchain. In Ireland, Bank of Ireland and AIB have announced their trialling of blockchain technology. To date, neither the Irish Government nor the Central Bank has published much guidance on this fast-moving space, aside from issuing some warnings on the use of crypto currencies. In mid-2018, however, the Central Bank committed itself to engaging with the growing fintech community through a new initiative called Innovation Hub. This programme will be charged with keeping abreast of fintech developments and the regulatory landscape, particularly with respect to virtual currencies. 2019 is likely to see some developments by Central Bank and the Government in the regulation of fintech organisations through RegTech, SupTech or otherwise.