FEATURE-Mortgages threaten new front in Irish debt battle

* Well-paid mortgage holders struggling after price falls

* Some fear default in coming months as ECB rates rise

* Bank stress tests may underestimate mortgage losses

By Conor Humphries

DUBLIN, March 30 (Reuters) – With a steady income of 88,000
euros ($124,000) per year and a flawless record in making his
mortgage payments, Rory should offer hope to an Irish economy
ravaged by unemployment and bad debt.

But like a growing number of Ireland’s middle class, his
finances are a ticking time bomb — one that could undermine the
government’s efforts to convince investors it can deal with a
banking crisis that risks destabilising markets across Europe.

Rory’s ill-timed decision to buy a second apartment as a
retirement investment at the height of a property bubble has
left his family with 400,000 euros in negative equity. One of
his apartments is on the outskirts of Dublin, the other in a
trendy area near the centre.

The end of an interest-only teaser period on one apartment’s
mortgage and expectations for euro zone interest rate hikes this
year — the European Central Bank looks likely to start raising
rates next week — could soon make the burden unbearable.

“We have already retrenched our spending to the tune that we
feel like we are on the dole,” said Rory, a 35-year-old
accountant. He declined to give his surname out of fear this
would complicate his efforts to find a better paid job abroad.

“There is a tsunami of debt payments coming,” he said.

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Ireland’s new government has pledged to put a final price on
the banking crisis on Thursday, when authorities will release
results of “stress tests” of banks’ health. These are expected
to show how much capital banks need to return to health.

But some analysts fear the stress tests may not take full
account of Rory and thousands of others who have so far kept
their jobs and continue paying huge mortgages, but could present
the banks with a new wave of losses down the road.

“The mortgage problem is not going away and it is not being
dealt with,” said Ray Kinsella, a professor of banking and
financial services at University College, Dublin.

For the past three years, the government has been focusing
on the economic damage from rotten commercial property loans; to
help it deal with this, it obtained late last year an 85 billion
euro international bailout. But bad mortgage debt, Kinsella
said, has become the “second front” in Ireland’s crisis.

The number of residential mortgages in arrears jumped by
over half in 2010 and one in ten mortgages was either in arrears
or restructured because of financial distress, the central bank
said last month. It did not break out separate figures for more
risky buy-to-let mortgages.

LIKE A CANCER

Historically, unemployment has been the trigger for a major
jump in arrears in Ireland, but even households with high
incomes are struggling to make ends meet after a vicious cycle
of tax increases and cutbacks in state benefits. More cutbacks
are on the way as part of the international bailout.

“We are getting more and more calls from middle-class
families asking for help,” said David Hall, head of NGO New
Beginnings, which provides legal aid in repossession cases.

“The government is spinning this as just a subprime problem,
but it’s like a cancer, it doesn’t discriminate.”

The options for indebted mortgage holders are stark, and
none bode well for the Irish economy.

In a bid to reduce the 400,000 euro shortfall, Rory plans to
emigrate with his wife and two children to a low-tax country in
the hope that he can raise his income enough to start paying
back the capital on his loans.

If he rents out both apartments, he will have to absorb a
shortfall estimated at 3,000 euros per month once the
interest-only holiday on one of the loans expires and the ECB
raises interest rates.

“I hope to drag ourselves out of the gutter of debt in maybe
four to six years, rather than wait here and spiral into
bankruptcy.”

Others see no hope unless the banks offer debt forgiveness
— but while there is anecdotal evidence of mortgage holders
renegotiating their exposure with banks, the ability of
struggling banks to provide relief seems very limited.

“The message I will be giving to the bank is you can give me
some kind of deal or I’ll file for bankruptcy,” said a
42-year-old sales executive, who declined to give his name.

He sees little chance of bringing down his 850,000 euros of
mortgage debt, despite an annual income of 135,000 euros.

Like other well-educated professionals, he believed he was
relatively conservative when he invested in three properties
with a 55 percent loan-to-value ratio. He now plans to save at
least 100,000 euros to offer to the bank as leverage when he
sits down to negotiate.

“I don’t know what’s in store,” he said. “I have three
children and we are going to be out on the street if the whole
thing goes pear-shaped.”

STRESS TESTS

The central bank’s stress tests, conducted in conjunction
with the European Union and the International Monetary Fund,
have been criticised by some analysts as overly optimistic.

Under their adverse scenario, they assume an unemployment
rate of 14.9 percent this year and 15.8 percent in 2012. Figures
out on Wednesday showed the estimated unemployment rate was 14.7
percent in March; there is no clear sign that it has peaked.

The worst-case fall in property prices of 60 percent has
already been reached in some parts of the country.

“The tests will be much more realistic compared to the last
ones, but they won’t uncover what is at risk in the economy,”
said Constantin Gurdgiev, finance lecturer at Trinity College.
“The shortfall this time around will be on the mortgage side.”

While the rotten commercial property loans are larger,
residential mortgages — which cripple the spending power of
some of the most active people in society — are far more
important to the real economy, some analysts say.

“Mortgages underwrite people’s ability to invest, save and
to consume,” Gurdgiev said. “To repair the real economy, you
first need to repair mortgages.”

(Editing by Carmel Crimmins and Andrew Torchia)

FEATURE-Mortgages threaten new front in Irish debt battle