Ex-Bank of Scotland mortgage filings reveal extent of risky interest-only loans

Most of the €3.46 billion of former Bank of Scotland (Ireland) mortgages currently being refinanced in international bond markets are interest-only loans, which carry "greater" risks than typical home loans, according to documents relating to the transactions.

Lloyds Banking Group, which inherited BoSI's €32 billion Irish loan book as part of its rescue of HBOS in 2008, sold its remaining €5 billion of Irish mortgages to fellow UK banking giant Barclays in May.

Barclays has repackaged €3.46 billion of these loans into two so-called residential mortgage-backed securities (RMBS) transactions, where investors can buy bonds backed by interest income from the loans.

Prospectus documents for the transactions – known as Roundstone Securities No.1 and Dublin Bay Securities 2018-1 – show that more than 56 per cent of the outstanding loans are made up of interest-only mortgages, where borrowers are contracted to pay the principal at the end of the term of the loan.

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“Because of the greater risk relating to refinancing of interest-only mortgage loans, a significant downturn in the property markets or the economy could lead to a greater increase in defaults,” the documents said.

Industry sources say that BoSI, best known for introducing European Central Bank tracker mortgages to the Irish market in 2001, was the most enthusiastic promoter of interest-only mortgages to owner-occupier professionals and buy-to-let borrowers during the boom.

Borrowers

Since last year, borrowers on interest-only loans have typically been allowed a term extension of up to two years as they approached maturity, according to the prospectuses. This would give people more time to refinance their loans with banks that remained open for business in Ireland, or afforded them a chance to sell the property.

While the prospectuses said that interest-only borrowers are “generally” advised to have some repayment mechanism, such as an investment policy, in place to ensure they have money to repay the principal at the end of the loan term, this was not required by the mortgage documents.

Meanwhile, the documents disclose that a “significant number” of loans in the two RMBS portfolios comprised borrowers who fell behind in mortgage repayments and had their arrears automatically added to monthly repayments. The issue usually came about when the bank recalculated monthly repayments after an interest-rate change.

Lloyds ceased this practice on BoSI loans last November and the documents say that “the overall impact of remediation [for customers] is not expected to be material”.

Central Bank director of consumer protection Gráinne McEvoy told the Oireachtas finance committee in a letter in June that a review by the regulator into automatic arrears capitalisation had found that the practice, which originated in the UK, was "not widespread in Ireland". Some 5,400 cases were identified at that stage.

“We do not have concerns that borrowers were overcharged, rather we are not satisfied that borrowers’ arrears were presented in a fully transparent manner,” Ms McEvoy said. “Where the practice was identified, we intervened to ensure that the practice ceased.”