ECONOMICS:The US subprime lending crisis does not pose a material challenge to the stability of the Irish banking system. The exceptionally rapid growth in residential mortgages in the home market does not weigh heavily on Irish credit institutions. The principal threat to the stability of the Irish financial system in the period ahead stems from its excessive lending to the construction and real estate sectors.
In the years after 2003, the second stage of the Irish boom was financed by flooding the economy with credit. The rising tide of domestic credit creation has percolated every corner of the economy. However, it has reached its high water mark in the pool of property-related lending. The extent of the private sector lending boom is shown in the table. Advances by all credit institutions increased by almost €208 billion or by 155 per cent in the five years to June 2007, rising from €133.6 billion to €341.3 billion in the process.
Over these five years, the ratio of private sector credit to gross national product has risen 124 per cent to 213 per cent. The growth in lending has been concentrated in the business sphere. Advances to businesses have increased by €102 billion or by 248 per cent in the five years to June 2007. However, within the business arena, there has been an extraordinary emphasis on advancing cash to construction and property development.
Between June 2002 and June 2007, loan advances to finance real estate activities increased from €10.7 billion to €71.8 billion, an increase of €61.1 billion or 571 per cent over the five-year span. In the same period, the amount of credit extended to the construction sector rose by almost €20 billion or 422 per cent. Thus, taken together, the property development and construction sectors have accounted for €81 billion or almost 80 per cent of the €102 billion growth in loan advances to Irish business over the past five years.
Moreover, Irish financial institutions continued to pour credit into property-related businesses in the year to June 2007. Total advances to all businesses over this period grew by €33.6 billion or 30.7 per cent. However, real estate and construction took up €28.4 billion or 85 per cent of the additional credit on offer during the year.
As a result, the business loan book of the Irish financial system now has a lopsided look. Of the €143 billion stock of loans advanced by credit institutions to the business sector at June 2007, €96.2 billion or 67 per cent had been lent to just two sectors - construction and real estate activities. This represented a marked shift on the position five years earlier when lending to the construction and real estate sectors comprised just 37 per cent of the total business loan book. In short, over the past five years, the Irish financial system has placed large and increasing bets on the property sector. To date, the property play has paid off handsomely in scintillating profits with trivial default rates.
But, as a cumulative result of their lending policies over the past five years, Irish financial institutions are now heavily exposed to the domestic property sector. As house building activity stalls and property transactions stutter, this increased exposure to property carries rising risks for Irish financial institutions.
In the 2007 Financial Stability Report, Rory McElligott and Rebecca Stuart survey the lending performance of 13 Irish banks which account for 93 per cent of advances to non-financial corporates (NFCs).
They find that, for most of the banks surveyed, loan concentration in property-related areas has increased since 1999. A concentration of loans in a specific area increases the chances that if one loan goes bad, others can quickly follow.
"Thus, in the event of a shock to the construction and real estate sectors, banks may find that the performance of these loans might be correlated and asset quality could deteriorate in many loans. An additional risk is that the rates of increase in prices across different segments of the Irish property market have tended to move upwards and downwards over the past 30 years, particularly during periods of slower economic growth," McElligott and Stuart write.
They point to some mitigating factors: there may be within-sector dispersion that reduces the correlation of loan performance; property-related loans may be collateralised or securitised to a greater extent than other loans; and lending to business accounts for only a portion of total bank lending.
The key question then centres on whether a shock to the property sector is a prospect. The auguries are not good. For a start, the 2008 Budget anticipates that housing completions will fall to about 55,000 next year compared to 88,000 in 2006. As a result, the volume of gross fixed investment is forecast to fall by 1.6 per cent in 2008.
With investment subtracting from national economic performance next year, the real growth rate in gross national product is projected to decline to 2.8 per cent.
Transactions in the market are stalling. In domestic housing, home buyers are sitting on the sidelines, while buy-to-let investors are staying their hands. The global credit crunch is starving commercial markets of both funds and investors.
The old joke says that if you owe the bank €10,000, then you have a problem, but if you owe the bank €10 million, then the bank has a problem.
Somehow, it doesn't seem so funny anymore.
