The Irish non-performing loan (NPL) market was the second most active in Europe last year, with EUR 9.3bn worth of loan sales by the third quarter. Since the peak of the crisis in 2013, Irish banks have undergone drastic deleveraging through portfolio sales and more recently, securitisations, bringing the non-performing exposures ratio down to 4.6% by June 2019.

These positive trends have been driven by strong economic growth, which has pushed up house prices by a staggering 85% since 2013 and made mortgage portfolios more attractive to credit investors, allowing banks to reduce reserves.

“Against the positives, the drivers of Ireland’s economic growth do expose the country to global macroeconomic developments, however, and this could have a knock-on effect on cyclically-sensitive credit, such as SME non-performing loans remaining on banks’ balance sheets,” said Florent Albert, associate director in the structured finance team of Scope Ratings and co-author of a report on Irish NPLs out today. “As most major global economies enter later phases of their economic cycles, downside risks are increasingly relevant.”

Around 11% of SME balances originated by three major Irish banks were non-performing in 2018, and this is likely to grow substantially in a stressed economic climate. Also, re-performing loans may slip back into the non-performing bucket in a downturn. Secondly, Irish banks may not be as well prepared for a downturn as some of their European counterparts: while CET1 capital ratios remain above the EU average, Irish banks’ lower loss reserves warrant caution.

Future economic factors notwithstanding, the banks have been successful in significantly reducing their non-performing exposures (NPE) to the extent that for the first time since the central bank started publishing quarterly data in 2016, the majority of non-performing mortgage balances are now on non-bank balance sheets.

The non-performing share of mortgage balances held by banks decreased to 6% in Q2 2019 from 11.5% in Q1 2016. As of Q2 2019, mortgages for principal dwelling houses (PDH) have grown to roughly 74% of all non-performing mortgage balances held by banks as banks have prioritised sales of buy-to-let (BTL) NPL portfolios. Disposal of PDH mortgages is key to a continuation of the recovery, but a political backlash is gaining traction.

A controversial bill (“No Consent, No Sale”) under consideration in the lower house of parliament intends to address the perceived mishandling of distressed borrowers by special credit servicing agents by preventing banks from selling credit rights to these loans.

“The likelihood of this becoming law is relatively low, but if it does it could prove damaging for the resolution of existing NPL stock and for the availability and cost of new mortgage credit,” said Chirag Shekhar, associate analyst in the structured finance team of Scope Ratings and co-author of today’s report. “It poses a risk of contagion to the housing market. It will require originators to obtain consent from distressed borrowers before any sale. The most controversial aspect is the potential for retrospective action, which could undo much of the progress made by Irish banks over the last years.”

Download the full report here.