Mary O'Dea: interim financial regulator

The Financial Regulator has significantly stepped up its supervision of how banks are dealing with write-downs and provisions on their €148bn of mortgage loans as defaults surge and concerns grow that up to 350,000 people could end up negative equity by the end of next year.

The regulator, which was criticised for its failure to spot the rising threat from property development loans, is now carrying out visits to branches to specifically assess the approach of banks to mortgage defaults and arrears.

It is also reviewing the methodologies banks use for writing off mortgage loans or providing for future mortgage losses.

"While this is a continuation of existing monitoring work, we are focusing on this very closely at the moment in the context of developments within the economy. This work includes on-site reviews and random sampling and challenging the banks on their approach,'' said a statement from the regulator.

The regulator is examining what are known as "sub portfolios'' of mortgage loans, which provides more detail on underlying stresses in the loans and their potential damage to bank balance sheets.

"We challenge the institutions on the information provided and look particularly at understanding the differences between institutions. We continue to review provisioning methodology and challenging the banks to explain their models and approach. A key element of this is tracking is loan-to-value for negative equity,'' said the statement.

The Financial Regulator, it is understood, has seen a copy of the recent report on negative equity by ESRI research David Duffy.

In his study Duffy said in a worst case scenario, where house prices fell from peak by 50% at the end of next year, 349,715 homes would suffer negative equity.

Negative equity is when the value of the house is below the value of the loan.

At present the value of a mortgage loan is only written down if the "recoverable amount'' of the underlying security falls below the value of the loan. However if the borrower is still making payments this allows the bank to limit the level of impairment which shows up in its books. Researchers are keen to point out that negative equity does not translate directly into mortgage defaults.

However Duffy said negative equity "increases the likelihood of default''.

"Those who are at most risk of default are those who are in negative equity and who experience a cash flow problem. These cash-flow problems could be caused by illness, divorce or job loss,'' Duffy said in his recent paper.