OREANDA-NEWS. July 13, 2015 Potential legislation giving Irish courts the power to cap the standard variable rates (SVR) which banks charge on residential mortgage loans could be credit negative for Irish banks, says Fitch Ratings. Margin compression could make it difficult for banks to sustain profitability and build up capital through retained earnings. A strain on profitability, which has made a fragile improvement over the past two years, could affect the standalone strength of Bank of Ireland (BOI), Allied Irish Banks (AIB) and Ulster Bank Ireland (UBL), whose Viability Ratings were upgraded by Fitch in May.

SVRs are charged on around 40% of the stock of mortgages extended by Irish banks and for new mortgages, the proportion, at 58%, is far higher. The main reason for this is that it is difficult for borrowers to refinance their loans and secure a more attractive rate if loan to value ratios are in excess of 100%. This is not uncommon on Irish mortgage loans.

Political pressure has been mounting for banks to adjust their SVRs. Research published by the Central Bank of Ireland in May and June identifies Irish SVRs as the highest in Europe. The research highlights that overall rates charged on new mortgages in Ireland are, at around 3.6%, well in excess of the EU 2.5% median. SVRs on new mortgages charged by Irish banks are even higher, averaging 4.13% in 1Q15. The cost of funding for Ireland's banks is still higher than peers in more highly rated EU countries but the research suggests that Irish banks comfortably pass on these additional costs to consumers. Margins earned on retail mortgages in Ireland are, at around 3.5%, well in excess of the EU 2% median.

The high SVR rates charged by banks go some way toward making up for the large, very low yielding, tracker mortgage books which account for around half of total mortgage loans provided by Irish banks. Banks are heavily reliant on net interest income, which generates around 80% of total recurring income. Mortgages are an important product, representing around 50%-60% of gross loans.

Risks associated with mortgage lending in Ireland are still high and this provides some explanation for charging higher margins. Within the EU, only Greece reports higher mortgage arrears and default rates. At end-2014, nearly 15% of all mortgage loans in Ireland were in 90 days arrears or more (EU average: 2.8%). Years of restructuring means that Irish banks are beginning to reduce impaired loan volumes but the problem remains considerable and it will take a number of years of sustained improvement before the stock of loan impairments is adequately cleared.

The potential for political intervention to cap SVRs appears to be mounting. Irish Prime Minister Enda Kenny said earlier this week that, in the absence of banks moving voluntarily towards a rate cut, government intervention could follow and proposals could be discussed in the October budget. Irish Finance Minister Michael Noonan has been urging banks to offer better rates for consumers. To date, BOI and AIB have cut their fixed rates but no significant change to the SVRs has been announced.