My colleague Tom Flavin and I are preparing a paper for the Dublin Economic Workshop on the financial characteristics of Irish Mortgage defaults. The analysis relies on a donation of anonymized data on mortgage arrears from Permanent TSB and we are grateful to them for their assistance. Tom will give a fuller account of our data analysis at the conference; this blog entry highlights some of the strong evidence for a very substantial proportion of strategic arrears in Irish mortgage arrears.
In US-based research (e.g., Guiso, Sapienza and Zingales, 2011) strategic arrears behaviour has been shown to be significantly affected by the current loan-to-value ratio of a mortgage. Current loan-to-value has no effect on a household’s ability to pay the mortgage, but it has a big potential impact on willingness to pay the mortgage. Current loan-to-value has no short-term cash flow implications (unless the householder is currently selling the property) but it tells the mortgage holder his/her paper gain or loss on the leveraged property investment.
For strategic mortgage delinquents, mortgage payments on a property deep in negative equity (high loan-to-value) is “wasted money” over the medium term since the capital loss is too big to be reversed by random price changes. Strategic arrears are very sensitive to current loan-to-value whereas distressed arrears (legitimate can’t-pays) are completely insensitive to current loan-to-value.
Table 1 shows mortgage defaults sorted by columns into high (greater than 1.4) and low (less than 1.1) current loan-to-value. The data covers all PTSB mortgages in default which have submitted a Standard Financial Statement. Although all principal private residence mortgages in default are required to submit this statement, many ignore this requirement, so the sample is censored. A default is defined as greater than 90 days of accumulated arrears. The sample is sorted by rows into unstressed affordability (ratio of required mortgage payment to net after-tax income less than 20%), stressed affordability (payment to net income ratio less than 30%) and nonaffordability (payment to net income ratio greater than 40%). The proportion of mortgage defaults falling into the affordable and nonaffordable categories is strongly dependent upon the current loan-to-value ratio. Only 4.6% of defaulted mortgages with low loan-to-value have an affordability ratio in the unstressed affordability category. These are likely to be households where the affordability ratio is mismeasuring some feature of their financial circumstances. The proportion more than doubles (11%) for defaulted mortgages with high current loan-to-value ratios (negative equity mortgages). The same pattern is evident across all the categories.
Table 1: Affordability Categories of Loans in Default
Mortgage Payment to Net Income
Low Loan-to-Value
High Loan-to-Value
<20%
4.6%
11.0%
<30%
12.2%
25.5%
<40%
25.9%
42.6%
>=40%
74.1%
57.4%
Figure 1 shows nonparametric, kernel-based estimates of the proportion of mortgages in default among all mortgages with a Standard Financial Statement, as a function of current loan-to-value. In the absence of strategic default, this graph should be flat. It is in fact sharply upward sloping, particularly above current loan-to-value of 1 (that is, mortgages with negative equity).
figure 1
Table 2 shows logit and probit models of the probability of default based on loan characteristics. The logit model has technical statistical advantages, but the probit model is preferable here since it is more easily interpreted (the empirical findings are virtually identical for the two models). The evidence indicates that one of the strongest predictors of Irish mortgage default is current loan-to-value, as in US research on strategic mortgage defaults. Consider a mortgage which is perturbed from an affordability ratio of 0.2 to 0.4 (from unstressed to unaffordable). The probability of default for such a mortgage increases by 10.84%. Consider a mortgage which is perturbed from a current loan-to-value ratio of 1.5 to 2.0 (such as from a 30% fall in property value). The probability of default for such a mortgage increases by 19.92%. More details at the DEW conference on October 11th – 12th in beautiful downtown Limerick.
Table 2: Logit and Probit Estimates of the Probability of Mortgage Default Based on Loan Characteristics
DDV(dist=logit) default
# ppr nonppr nets ltv appnets
Binary Logit - Estimation by Newton-Raphson
Convergence in 4 Iterations. Final criterion was 0.0000000 <= 0.0000100
Dependent Variable DEFAULT
Usable Observations 31422
Degrees of Freedom 31417
Skipped/Missing (from 37124) 5702
Log Likelihood -20515.8092
Average Likelihood 0.5205277
Pseudo-R^2 0.0626346
Log Likelihood(Base) -21508.3958
LR Test of Coefficients(4) 1985.1731
Significance Level of LR 0.0000000
Variable Coeff Std Error T-Stat Signif
***************************************************************************
1. PPR -1.298293660 0.046655174 -27.82743 0.00000000
2. NONPPR -1.485035539 0.045404048 -32.70712 0.00000000
3. NETS 0.883894644 0.032694867 27.03466 0.00000000
4. LTV 0.645248662 0.023445407 27.52132 0.00000000
5. APPNETS -0.345663177 0.102147798 -3.38395 0.00071451
DDV(dist=probit) default
# ppr nonppr nets ltv appnets
Binary Probit - Estimation by Newton-Raphson
Convergence in 4 Iterations. Final criterion was 0.0000000 <= 0.0000100
Dependent Variable DEFAULT
Usable Observations 31422
Degrees of Freedom 31417
Skipped/Missing (from 37124) 5702
Log Likelihood -20516.2121
Average Likelihood 0.5205210
Pseudo-R^2 0.0626094
Log Likelihood(Base) -21508.3958
LR Test of Coefficients(4) 1984.3673
Significance Level of LR 0.0000000
Variable Coeff Std Error T-Stat Signif
**************************************************************************
1. PPR -0.802575009 0.028265540 -28.39412 0.00000000
2. NONPPR -0.919901178 0.027459850 -33.49986 0.00000000
3. NETS 0.542310980 0.019652259 27.59535 0.00000000
4. LTV 0.398303919 0.014320162 27.81420 0.00000000
5. APPNETS -0.206773145 0.061545719 -3.35967 0.00078036
Notes: Default = 0/1 default dummy, PPR = 0/1 dummy for principal private residence mortgage, NONPPR = 0/1 dummy for not principal private residence mortgage, NETS = current affordability ratio, LTV = current loan-to-value, APPNETS = affordability ratio at time of mortgage application.