This Irish residential mortgage-backed securities (RMBS) primer provides a comprehensive guide to the fundamentals and risks of the market, including an overview of both the Irish residential housing and home loan markets. We compare the performance of prime and reperforming RMBS transactions, and compare the market with the Irish covered bond market.

Irish Housing And Mortgage Market Overview

The Irish housing market has experienced substantial price volatility over the past 20 years. From the early 2000s, rapid economic expansion and access to cheap debt accelerated property price growth up to 2007. The six years following the global financial crisis saw property prices fall by 54.5%. Many lenders exited the market or were taken under full or partial government ownership as the market contracted and gradually recovered.

Since 2013, prices have been recovering, primarily due to limited housing supply and historically low interest rates until 2022. Housing supply is constrained due to high construction costs and a cumbersome planning process. Property developers tend to have limited development financing options available from banks. The house price index in third-quarter 2022 surpassed the previous highs of 2007.

Chart 1

Overview of main market participants

Table 1

Chart 2

Irish banks have one of the highest shares of revenue from net interest margins (NIMs) in Europe (see chart 3). This is partly due to their higher interest rates on residential mortgage lending. However, these gains counterbalance the larger proportion of nonperforming assets (NPAs) on their balance sheets (see chart 4) and associated capital charges. Consequently, recent prime Irish RMBS transactions tend to generate more excess spread than other European RMBS transactions. Legacy Irish RMBS transactions generally have less excess spread due to the higher proportion of loans in arrears and loans that were priced significantly narrower than would be the case today.

Chart 3

Chart 4

Impact of rising interest rates

Interest rate product switching has expanded in the past two years, as rates increased and borrowers roll off short-term fixed rates. In the prime Irish RMBS transactions that we rate, 59% of borrowers currently pay a fixed rate, compared to only 13% in reperforming RMBS transactions (fixed rate loans in reperforming transactions include a warehoused portion of split loans).

In our opinion, a modest negative movement in house prices would not significantly affect the credit quality of loans originated under the Central Bank of Ireland's (CBI) Macroprudential Lending Rules (MPR). Loans beyond the MPR's scope remain more susceptible to adverse economic conditions, and to date such borrowers have had limited access to alternative credit options.

Unemployment remains the most important variable affecting borrower credit quality. However, higher living costs and rising interest rates are restricting borrowers' mortgage affordability, especially vulnerable borrowers with legacy mortgages.

Chart 5

Irish RMBS Market Overview

Ireland's historical RMBS investor-placed issuance volumes have increased over the last five years amid increasing reperforming loan RMBS transactions. Furthermore, tier 2 banks and non-bank lenders have originated several new prime Irish transactions.

The collateral for these prime transactions comprises of newly originated mortgages issued under the CBI MPR guidelines. Bank of Ireland and AIB have primarily issued from their covered bond programs.

Irish banks with active covered bond programs prefer to publicly issue from them as they tend to be cheaper to fund with longer tenors. Generally, RMBS is instead used as a tool to securitize non-prime assets and/or diversify a bank's funding and investor base. However, RMBS is also used as collateral for the European Central Bank's refinancing operations, as home loans are more profitable to monetize in an RMBS structure due to covered bonds' minimum overcollateralization feature.

Chart 6

Typical Irish RMBS structures and collateral types

Irish RMBS transactions usually have static asset pools, with underlying collateral comprising primarily prime residential loans, reperforming residential loans, and nonperforming residential loans. Some transactions can include a combination of these loans.

Prime transactions—key characteristics:

• Prime category mainly applies to collateral originated under the CBI MPR and a small number of legacy portfolios.
• Strong credit characteristics and despite only recent relatively benign stress, their credit performance should be substantially better than loans originated pre-MPR.
• Mortgages in portfolios are mainly originated on fixed rates originated within a low interest rate environment (see chart 7).
• Sequential pay structures (the most senior notes paying timely interest and the subordinated notes deferring interest until they become the most senior class).
• Weighted-average 'AAA' projected losses for the portfolio at closing are 9.2%.

Reperforming transactions—key characteristics:

• Good credit performance under relatively benign conditions, with loans in underlying portfolios originated before the CBI MPR.
• Most borrowers are deemed vulnerable and have undergone the mortgage arrears resolution process (MARP) with a restructure in place.
• Although arrears can be high, most transactions' pay rates (payment received/payment due) for loans in arrears are also quite high.
• Outstanding legacy issues remain for some of the loans in most of these transactions, such as interest-only loans with no principal repayment vehicle at maturity and outstanding legal title issues.
• Mortgages in portfolios are mainly on variable rates, which can lead to new affordability issues in a rising rates scenario (see chart 7).
• Sequential pay structures.
• Weighted-average 'AAA' projected losses for the portfolio at closing are 21.0%.

Chart 7

Credit performance better for post-MPR prime transactions

Irish RMBS transactions' overall credit performance is worse than other European RMBS transactions that we rate (see chart 8). However, Irish prime RMBS transactions outperform both U.K. prime RMBS transactions and our European RMBS index (see chart 9).

Chart 8

Chart 9

Typical Irish RMBS legal risks and bankruptcy remoteness

Bankruptcy remoteness   Irish special-purpose entities (SPEs) are registered under the Companies Act 2014 (later amended on Dec. 14, 2022). To ensure bankruptcy remoteness, SPEs are usually new entities with no creditors and clear guidelines on permitted activities. They have separate books, accounts, and records, independent directors, and no employees. A true sale transfers all assets to the SPE. We assess each transaction under our "Asset Isolation And Special-Purpose Entity Methodology" criteria to ensure adequate comfort on bankruptcy remoteness.

Commingling risk

Irish RMBS transactions have declarations of trust over the collection account(s) in favour of the issuer. Therefore, the sums credited at any time to each specially dedicated bank account and arising from collections under the purchased home loans will exclusively benefit the issuer. The servicer's creditors therefore have no rights to any outstanding sums for the relevant specially dedicated bank account, even if insolvency proceedings start against the servicer.

Our assessment of the amounts at risk of commingling considers both the amounts accumulated in the servicer collection account before the servicer's insolvency (accumulation risk) and the amounts that may be paid to that account following the servicer's insolvency before the borrowers are notified to pay into the issuer account (notification risk).

Our considerations on commingling risk depend on the transaction's structural mitigants and also account for counterparty risk relating to the account bank where the servicer collections are held. Irish RMBS transactions tend to structurally mitigate this risk by using bank accounts with appropriately rated banks and rating triggers.

Setoff risk

Potential employee setoff risk and deposit setoff risk could arise if the originator becomes insolvent. Employee setoff risk could arise if borrower/originator employees offset their loan repayments with salaries due by the originator. Deposit setoff risk could arise if borrowers offset their loans repayments with deposits held with the originator when the originator is a deposit-taking entity. Generally, setoff risk is crystalized once borrowers are notified of the sale of the loan.

Treatment of hedging arrangements

The issuer can enter into hedging agreements to cover interest rate risk. In these circumstances, we analyze the hedging agreement and the issuer's priority of payment for each transaction in line with our counterparty criteria.

Claw back risk

For Irish RMBS, our consideration on claw back risk depends on the level of comfort provided in legal opinions in combination with solvency certificates provided by the seller.

Comparing Irish RMBS With Covered Bonds

Total covered bonds issuance outstanding in 2022 was €12.229 billion. Most covered bond issuances are euro-denominated between €500 million and €1 billion. The number of outstanding covered bond programs in Ireland has fallen to two from five since 2019.

Irish home loans can be either securitized or used as collateral in a covered bond. The main difference is the recourse to the issuer and the consequent lack of risk transfer. Since credit risk remains with the originator for covered bonds, it has more incentive to apply more prudent management. Table 2 summarizes the key differences (see "S&P Global Ratings' Covered Bonds Primer," published on June 20, 2019).

Table 2

Regulatory Environment And Products

The CBI regulates mortgage lending in Ireland. In 2015, it introduced the MPR, detailing specific underwriting guidelines for lenders, with an update in November 2022. The CBI introduced these rules in the aftermath of the financial crisis to restrict lending limits, given the detrimental impact the house price correction had on the banking sector and the wider economy. Table 3 compares the transition from the typical lending criteria for banks before the financial crisis, the initial MPR, and the current MPR.

Table 3

Long-term arrears on legacy mortgages originated in the years leading up to the financial crisis were a key focus for the CBI. It rolled out The Code of Conduct on Mortgage Arrears (CCMA) in February 2009 (with updates in 2011 and 2013), providing clear guidelines on how regulated lenders and credit service providers should engage with vulnerable borrowers in financial distress through MARP. The CCMA defines when a borrower is deemed non-cooperative with a lender and, if necessary, the steps to commence repossession of the property. MARP was introduced in January 2011 and provides a standard framework for lenders to deal with borrowers who are in financial difficulty (see table 4). Mortgage loan arrears peaked in 2013 and have been declining since, due to the structures implemented from the regulatory guidelines.

Table 4

Legacy loans remain outstanding within the Irish mortgage market. As outlined in table 3, these loans were originated with higher loan-to-value (LTV) ratio and loan-to-income (LTI) limits. A portion of the loans were originated as interest-only for life with limited or no repayment vehicle to repay principal at maturity. Furthermore, a large proportion of these mortgages were originated as tracker rate loans where the interest rate tracks either the European Central Bank rate or EURIBOR. The reperforming transactions that we currently rate have approximately 42.4% of tracker-linked loans.

The CBI implemented the updated Consumer Protection Code (CPC) in January 2012 (replacing the 2006 CPC) to provide clear requirements on how regulated lenders deal with customers. Typically, borrowers with an owner-occupied main residence will be regulated under the CCMA, with other borrowers--such as buy-to-let--falling under the CPC. Some of the CPC provisions are more wide-reaching and apply to all borrowers, such as regulatory disclosures to be included within mortgage documents. Multiple amendments have been made since its introduction, with the latest review ongoing and expected to be completed in 2024.

Chart 10 shows the loan restructuring options available to vulnerable borrowers. Arrears capitalization and split mortgage options have been declining in recent years. Since year-end 2022 term extensions have increased, which could be linked to mortgages reaching their maturity date with no available principal repayment vehicle.

Chart 10

Recovery process

The recovery process and receipt of proceeds tend to be very long in Ireland. Repossession is only allowed if the lender can prove that all reasonable efforts have been made under the MARP framework to agree an alternative arrangement with the borrower or that the borrower will not engage with the lender.

Repossession through legal proceedings generally takes two to five years. Given the long timeframe, the number of court-ordered repossessions remains low.

Chart 11

Chart 12

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Products

The CBI's mortgage rules cap annual lending to only 15% above the lending guidelines. Therefore, products are generally standard and low-risk, with very limited nonconforming lending within the market.

Table 5

Related Criteria

• Environmental, Social, And Governance Principles In Credit Ratings, Oct. 10, 2021
• Global Framework For Payment Structure And Cash Flow Analysis Of Structured Finance Securities, Dec. 22, 2020
• Methodology To Derive Stressed Interest Rates In Structured Finance, Oct. 18, 2019
• Counterparty Risk Framework: Methodology And Assumptions, March 8, 2019
• Incorporating Sovereign Risk In Rating Structured Finance Securities: Methodology And Assumptions, Jan. 30, 2019
• Global Methodology And Assumptions: Assessing Pools Of Residential Loans, Jan. 25, 2019
• Asset Isolation And Special-Purpose Entity Methodology, March 29, 2017
• Global Framework For Assessing Operational Risk In Structured Finance Transactions, Oct. 9, 2014
• Principles Of Credit Ratings, Feb. 16, 2011
• Methodology For Servicer Risk Assessment, May 28, 2009

Related Research

• European RMBS Index Report Q2 2023, May 15, 2023
• Landlord Exodus Sustains Higher Irish RMBS Prepayments, April 27, 2023
• Economic Outlook Eurozone Q3 2023: Short-Term Pain, Medium-Term Gain, June 26, 2023
• U.K. RMBS Audit Fees Could Heighten Tail Risk, March 16, 2023
• European RMBS Outlook 2023: Permafrost Or Thaw?, Jan. 12, 2023
• Cost Of Living Crisis: How Bad Could It Get For Irish Reperforming RMBS?, Oct. 25, 2022
• Ireland, May 23, 2022
• S&P Global Ratings' Covered Bonds Primer, June 20, 2019
• The Irish RMBS Story: Improving Market Conditions And The 'Tail' Of Long-Term Arrears, Feb. 1, 2019
• 2017 EMEA RMBS Scenario And Sensitivity Analysis, July 6, 2017
• Global Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016
• European Structured Finance Scenario And Sensitivity Analysis 2016: The Effects Of The Top Five Macroeconomic Factors, Dec. 16, 2016