NBLs are likely to play an increasingly vital role in the Irish mortgage market, despite recent headwinds that are testing borrowers and lenders alike. NBLs have established themselves as prime lenders and gained significant market share in recent years, and S&P Global Ratings is optimistic about their future.

NBLs Are Back

In the years following the global financial crisis of 2008-2009, NBLs all but disappeared from the Irish market, and new mortgage lending was dominated by the so-called pillar banks, such as Allied Irish Banks PLC, Bank of Ireland (Governor and Company of the Bank of Ireland), Permanent TSB PLC, Ulster Bank Ireland PLC, and KBC Bank Ireland PLC. However, in recent years, NBLs have returned, albeit in a different guise. Previously, NBLs typically focused on specialist lending and were generally considered nonconforming lenders. This is not the case for the newer NBLs. They are regulated entities, and so cannot differentiate themselves from the pillar banks on core underwriting standards. Instead, they compete on price, product, and service.

While rising interest rates affect all lenders, NBLs have less capacity than pillar banks to absorb the rises and avoid passing them on to borrowers. This could erode NBLs' ability to compete with the pillar banks on price. At the same time, the imminent departure of two pillar banks--KBC and Ulster Bank--from the Irish mortgage market presents NBLs with an opportunity to help fill the gap in supply and gain additional market share.

What Is An NBL?

An NBL is a financial institution that lends money without having a full banking license. Institutions practicing nonbank mortgage origination and securitization are active in the U.K., the Netherlands, Ireland, Portugal, Sweden, and Spain, with the U.K. dominating origination volumes, followed by the Netherlands and Ireland. The U.K. and Netherlands have long-established nonbank lending markets, which tend to focus on more specialist lending--to borrowers with complex incomes, or those seeking buy-to-let and second-lien loans, for example. However, not all NBLs have the same business model. There are three main types of NBL: warehousing, forward flow, and white-labelling.

Warehousing:   A third party provides funding to an originator for mortgage lending. The funding is structured as a securitization. Typically, once a critical mass of mortgage lending is reached, the originator will issue a securitization and use the cash it receives to repay the warehouse provider, and the process begins again.

Forward flow:   Rather than assuming credit risk directly, the lender originates loans to a predetermined specification for a purchaser. The purchaser assumes the credit risk, and the originator receives fee income for originating the loan. In such arrangements, it is common for the branding of the loan and the name of the legal title holder to be the same as that of the originator.

White labelling:   The loan branding reflects and retains the purchaser's branding and image, but ultimately is sourced and underwritten by an originator who may be acting for a number of different end purchasers. This model is more common in the Netherlands.

In Ireland, the NBLs most closely align with the warehousing type. Generally, all are backed by a warehouse facility, and, as well as adhering to Central Bank of Ireland mortgage rules, they operate within the parameters outlined by their warehouse funding provider.

The Credit Quality Of NBLs' Borrowers Has Improved

The growth of NBLs in Ireland in recent years was largely facilitated by the return of brokers to the Irish mortgage market (see chart 1). As with NBLs, to gain a foothold and competitive advantage in the market in the era before the global financial crisis, brokers tended to focus more on newer and untested products than more established lenders such as the pillar banks. As a result, loans originated at this time through a broker or by an NBL tended to be of lower credit quality than those originated through more direct methods. Nowadays, as a result of the strict macroprudential rules implemented by the regulator, the credit quality of borrowers introduced via a broker or underwritten by an NBL is of equal quality to those originated directly by the pillar banks.

Chart 1

NBLs Have More Exposure To Higher Rates Than Pillar Banks

Following years of low and even negative interest rates, we are starting to see rates increase again, and this is beginning to impinge on the Irish mortgage market. Not only are borrowers on variable rates seeing the cost of their mortgage repayments increase, but lenders themselves are being affected. All financial institutions rely to some extent on funding from the wholesale market, but this is particularly true of NBLs, which do not have access to the same alternative funding sources as pillar banks, for example, deposits. Those funding NBLs are demanding higher interest rates, and ultimately, the NBLs are passing the higher costs on to borrowers, thereby potentially eroding their ability to compete on price with the more established retail banks. Pillar banks have a greater capacity to absorb such rate rises and can resist passing such costs on to borrowers. Despite this serious challenge to NBLs and their business model, we remain relatively optimistic about their role in the Irish mortgage market.

Opportunities Abound For NBLs To Cement Their Presence In The Irish Mortgage Market

The market is in a period of flux due to the upcoming departure of both KBC and Ulster Bank. Existing players will need to fill the resulting void in the supply of mortgages, and this presents NBLs with an opportunity to increase their market share without reducing the credit quality of the mortgages they underwrite. This opportunity is further enhanced by the recent changes to the Central Bank of Ireland's mortgage measures, which include a relaxation of the loan-to-income limitation to 4.0x from 3.5x for first-time buyers. While market conditions have limited the appetite of some NBLs to take advantage of these opportunities, we expect the recent tightening of lending criteria to be a temporary measure.

Moreover, a combination of borrowers becoming savvier and pillar banks looking to reduce their branch footprint nationally could boost the roles of both brokers and NBLs even further. In the past, borrowers would typically apply for mortgages in person with the institution they banked on a day-to-day basis with, whereas today they can complete the entire application process online with any financial institution. This allows for greater competition and opportunities for both brokers and NBLs alike.

Although NBLs and retail banks are subject to the same regulation from a consumer and macroprudential perspective, NBLs are not subject to the same regulatory capital requirements as retail banks. This may offset some of the increased costs associated with being funded solely through the wholesale market, as NBLs are. In addition, the tightly regulated mortgage market in Ireland could offer some comfort to potential new NBL entrants, as it ensures a degree of stability. Moreover, historically, Ireland has had some of the highest mortgage rates in Europe, although the past 12 months have seen rates in other markets increase significantly (see chart 2). In our view, this will safeguard the market's attractiveness to both existing NBLs and potential new entrants.

Chart 2

NBLs Are Nimbler Than Pillar Banks

One area where NBLs stand apart from pillar banks is their ability to respond quickly to market trends. In many European mortgage markets (for example, France, Belgium, the Netherlands, and Germany), longer-term fixed-rate products are quite typical, but in Ireland the only products on offer until relatively recently were two- to five-year fixed-rate mortgages with a mandatory switch to a variable-rate product at the end of that fixed period. In 2021, however, NBLs in the Irish market began to introduce fixed-rate products with terms of up to 30 years. So far, take-up has been limited, but the popularity of these products is growing in response to rising interest rates as borrowers seek certainty on future repayments. As of now, the longest-term fixed-rate product on offer from the pillar banks is a 10-year mortgage from the Bank of Ireland and AIB, with rates varying from 3.5% to 3.7%.

The introduction of longer-term fixed-rate products is just one example of NBLs' flexibility to respond quickly to market trends and innovate. Indeed, innovation is something that the Central Bank of Ireland wants to encourage. As part of the Bank of Ireland's recent acquisition of €5 billion of KBC-originated mortgage loans, the Competition and Consumer Protection Commission (CCPC) stipulated that €1 million be provided for a fund to encourage innovation across the mortgage market more generally. Generally, pillar banks have legacy IT systems that can hinder the application process, whereas NBLs are specifically established for mortgage lending and have modern, bespoke IT systems to complement their product offerings. This allows for faster decision-making and execution that can, for some borrowers, outweigh more expensive funding costs, especially in a housing market with supply issues.

Mortgage Switching Will Benefit NBLs

Another source of optimism for NBLs is mortgage switching. According to Central Bank of Ireland data, as of May 2022, 83% of all new mortgages were originated as fixed-rate loans with a mandatory switch to the borrower's standard variable rate (SVR) upon expiry of the initial fixed term. This term is typically two-to-five years, although longer-term products are now becoming more common. Given where rates are now, this switch to paying interest based on an SVR will result in a significant increase in a borrower's monthly repayments, and therefore borrowers have an incentive to refinance at a more competitive rate.

In some mortgage markets, such as the U.K., there is long-established culture of borrowers switching mortgage providers to avail themselves of better terms and rates, whereas in Ireland this has not been the case. However, recent data published by the Banking & Payments Federation Ireland suggests a shift in borrower behavior, as remortgaging and switching in the Irish market grew by 129.3% year on year from May 2021 to May 2022. The increase in switching could in large part be attributable to a 2019 directive from the CCPC requiring all lenders to actively communicate with borrowers who are reaching the end of their fixed-rate period to share information on the cheaper options available in the market and the steps required to switch. This increased churn, coupled with the long-term fixed products on offer by NBLs, will ensure they remain attractive to borrowers.

Chart 3

NBLs Are An Important Part Of The Competitive Landscape

As part of the Bank of Ireland's acquisition of KBC-originated mortgage loans, the CCPC included a requirement that the Bank of Ireland purchase up to €1 billion of 'AAA' rated RMBS securities originated by Finance Ireland and Dilosk, subject to a maximum investment of €500 million in securities backed by the collateral originated by one entity. In light of the funding model that NBLs use and their reliance on securitization, this offers a degree of certainty in challenging market conditions. Overall, the CCPC's requirement points toward a recognition of the role that NBLs play, and their importance in ensuring sufficient competition in the market. In our view, this role is only set to increase in the coming years.