Wednesday, March 22, 2017

The same but different, somehow

Apple and Samsung have distribution operations who manage the sale of their products to independent retailers in New Zealand.  Here are the aggregate accounts for these operations (for ten years in the case of Apple and seven years for Samsung).

Apple and Samsung New Zealand

Apple’s distribution to New Zealand is through a company that is resident and operated in Australia while Samsung used a branch of an Australian company up to 2013 and since then has used a New Zealand company.  The accounts of these companies and branches are easily accessible from the New Zealand Companies Office.

Apple’s distributor is slightly more profitable but there is little between them.  The average effective tax rates for the two are also very close.  One of these made front-page news; one didn’t.  A year ago we wondered the same for this side of the world.

Monday, March 20, 2017

Why is “arrears capitalisation” so difficult to understand?

The most common mortgage restructure currently used by lenders is “arrears capitalisation”.  Of the 121,000 PDH mortgage accounts that have been restructured, 38,500 have had this restructure applied to them.  It might be the most frequently used but it is also the most misunderstood.  One report states:

Arrears capitalisation, where arrears are added to the principal of the loan, was the most common form of restructure, comprising almost 22 per cent of the total, followed by “split mortgages” at 22.4 per cent, where part of a loan is warehoused for an agreed period.

This is wrong.  Arrears should never be added to the remaining principal.  We pointed this out two years ago but it still persists.  And a large part of the blame rests with the Central Bank.  Footnote 2 of their release says:

Arrears capitalisation is an arrangement whereby some or all of the outstanding arrears are added to the remaining principal balance, to be repaid over the life of the mortgage.

The only way someone can owe more when they miss payments is because of accrued interest; the fact of missing payments or going into arrears does not have an impact on the amount owed.  Adding arrears to the amount owed should never happen.

Consider a simplified situation of a loan for €120,000 to be repaid over 10 years.  To focus on the impact of arrears we will assume that the interest rate is zero.  Adding a positive interest does not change the argument.  So in this no-interest situation 120 payments of €1,000 a month are required to repay the loan over ten years.

Let’s say the borrower makes the payments for three years but then misses payments for an entire year.  The three years of payments (€1,000 x 12 x 3) will have reduced the balance to €84,000 and the year of missed payments will result in €12,000 in arrears.

At the start of year five the borrower is in a position to resume payments and engages with the lender.  The lender tells the borrower that the remaining balance is €84,000 and that there are €12,000 of arrears.  There is no basis for saying that the amount owed is €96,000 or any number other than €84,000.  It is nonsense to suggest so.  The borrower has borrowed €120,000, has repaid €36,000 and therefore owes €84,000.  With zero interest to be added that can only be the amount owed.

What is termed “arrears capitalisation” would actually be better described as “arrears amortisation”.  When the borrower engages with the bank at the start of year five there is a outstanding balance of €84,000 and six years remaining on the life of the loan to repay it.  Resuming payments of €1,000 per month will be insufficient to repay the loan over the remaining term.  Those payments would sum to €72,000 (€1000 x 12 x 6) so the shortfall would be €12,000, i.e. the amount of the arrears.

To ensure that the €12,000 of arrears is repaid over the life of the loan the monthly repayments are recalibrated to take account of the missed payments.  So repaying €84,000 over six years with no interest requires monthly repayments of €1,167.

The monthly repayment has gone up but it is not because any arrears have been added to the balance.  The payment has gone up to ensure that the arrears are paid once, not twice.  Under no circumstances should arrears be added to the balance.  The monthly payments have gone up because the borrower has a shorter period within which to repay the loan.  If the payments weren’t increased there would be a shortfall at the end which, in our simple case with no interest, would be equal to the amount of the missed payments.

In the case of our borrower with a debt of €120,000 the payments made are:

  • 36 x €1,000 for the first three years
  • 12 x zero for the year of missed payments
  • 72 x €1,167 for the remaining six years of the term.

The total amount repaid is €120,000.  If the arrears has been added on the total amount repaid would have been €132,000.  And if the borrower has missed two years of payments the total would have been €144,000.  How can the act of missing payments increase the amount that is owed?  Only interest can do that.

With an “arrears capitalisation” the payments are changed to ensure that the balance is paid over the term of the loan.  There is nothing added to the amount owed.  But I’m guessing there will be additions to the number of times we see it being said.

Do we need another category in the mortgage arrears data?

Last week the Central Bank published the Q4 update of their mortgage arrears dataset.  In general the situation is one of steady improvement but are we missing out on some of the underlying trends?

Q4 2016 PDH Arrears

The problem is that an ever larger proportion of the arrears accounts are in the final category for those over 720 days in arrears.  By the end of 2016 there were almost 33,500 PDH mortgage accounts in arrears of more than 720 days.  These accounts had an outstanding balance of €7.5 billion and had accumulated €2.2 billion of arrears.  Here are the reported categories as a proportion of the overall arrears problem.

Q4 2016 PDH Arrears Proportions

At the end of 2016 accounts over 720 days in arrears were 43 per cent of accounts in arrears, 53 per cent of the total outstanding balance in arrears and 89 per cent of the built-up arrears.  Can we really tell what is happening to arrears when so much is reported in an open-ended category?

We can look at what has happened to this category since it was first reported in Q3 2012.

PDH Arrears more than 720 days

There has been some improvement in the number of accounts in this category.  The number peaked in Q2 2015 at just over 38,000 and has now fallen below 33,500.  However both the average balance owing and the average amount of arrears accumulated continue to rise.  There may be a compositional effect at play if it is accounts below the average that are resolved, through whatever means, and removed from the category.

Taking that aside we see that the average balance on these accounts climbs ever higher. For the full period above it rose from €203,400 to €225,800.   This is likely a reflection of no or limited repayments being made to reduce the balance and the accumulated interest being added which increases in the balance.

The average amount of arrears also continues to rise and by the end of 2016 stood at €66,000 for these accounts.  We know these accounts are at least two years in arrears but it is hard to know how deep they go.  If the average monthly payment on these accounts was €1,500 then we are looking at accounts being, on average, something around 44 months in arrears.

It is often argued that very little has been done FOR those who are more than two years in arrears.  But it is also true that little has been done TO them.  It has not been possible to find comparable data for other countries in order to assess the extent to which they have experienced mortgage accounts more than two years in arrears.  Other countries don’t report such figures because it is something which would not be tolerated; some resolution would be applied.  That is not the case in Ireland and cases come before the courts where no payments have been received in five years or even longer.     

When the “more than 720 days” category was introduced in Q3 2012 it contained 15 per cent of accounts in arrears, 17 of the outstanding balance in arrears and 48 per cent of the built-up arrears.  As shown above, those figures are now 43 per cent, 53 per cent and 89 per cent.  OK, part of this reflects the improvements that have seen the arrears figure fall for the past few years but it’s clear these improvements have not been reflected in the 720 day category to the same extent.  A final open-ended category that contains a lot of the observations means we are limited in what can be learned from the data about some of the underlying trends.

It tells a lot about the approach to the problem that it is now necessary to introduce a category for accounts more 1,440 days in arrears.

Saturday, March 18, 2017

Company gets battered for paying higher rate of tax

The New Zealand Herald has a breathless story under the headline “Apple pays zero tax in NZ despite sales of $4.2 billion”.  The story takes the usual approach of linking sales and corporation tax regardless of the well-established principle that corporation tax is paid on profit not sales.  But this piece goes further and ignores the principle that companies pay tax to the country where their activities take place, not where their customers are located.

The Apple subsidiary at the centre of the piece made a profit of $113 million from 2007 to 2016 and its accounts show an income tax expense of $34 million.  On this the New Zealand Herald says:

The accounts also show apparent income tax payments of $37 million - but a close reading shows this sum was paid to Inland Revenue but was actually sent abroad to the Australian Tax Office, an arrangement that has been in place since at least 2007.

A close reading of this paragraph reveals it to be nonsense.  Companies pay corporation tax to the tax authority it is due to.  The company did not pay tax to the New Zealand Inland Revenue because it did not have a taxable presence in New Zealand.  There are no Apple activities in New Zealand to tax.  The company doesn’t have a subsidiary operating there; the company doesn’t have retail stores there.  There is no permanent establishment to levy tax on.

The piece makes a big deal about the amount of iPhones sold to New Zealanders.  But the number of iPhones that Apple sold in shops to New Zealanders is zero.  The sales in New Zealand are through third-party retailers.  Apple has a company, Apple Sales New Zealand, which acts as the distributor of Apple products to these New Zealand retailers.  The company name reflects the market it services; the company itself is based in Australia.

So the company paid the tax directly to the Australian Tax Office because that is where the taxable activities of the company are located.  And this principle has been in place since the 1920s not just since 2007.

The New Zealand Herald piece has all the information that points to this conclusion but chooses to ignore it.  It is pretty easy to see that the company pays its tax in Australia and not New Zealand.  Here is the tax calc from the 2016 accounts which the piece reproduces:

Apple NZ Tax calc

The tax rate applied to the profits is 30 per cent.  New Zealand’s corporate tax rate is 28 per cent; Australia’s is 30 per cent.  The tax is determined using Australia’s 30 per cent rate because that is where it does its business.  Some minor adjustments resulted in an effective tax rate of 32 per cent in 2016 and 33 per cent in 2015.

Maybe something should have clicked when the newspaper had to look to Australia to find someone from Apple to comment on the story:

In a statement issued from Australia, the multinational technology giant stressed it followed the law but did not directly address questions about the structuring of its New Zealand operations and the apparent lack of payments to Inland Revenue.

And the piece then lays it out straight:

Apple's New Zealand operations are wholly owned by an Australian parent and appear to be run from there.

If Apple had operated this subsidiary out of New Zealand it would have paid tax at 28 per cent.  Instead, it choose to base the company in Australia where it is subject to tax at 30 per cent.  So even when paying a higher tax rate companies can take a battering.

Friday, March 17, 2017

Mortgage Repayments in BOI

The last post looked at the aggregate reduction in the stock of PDH mortgage debt in Ireland.  It was a bit crude and the aggregate nature of the data meant some simplifications were required.  Using figures from the annual reports of the banks we can get a deeper insight into the evolution of mortgage balances.  So let’s have a look at Bank of Ireland (which we have done previously here).

First, let’s look at the total amount outstanding by year of origination.

BOI Mortgages Outstanding

In the five years from the end of 2011 the stock of mortgages BOI has in Ireland declined from €27.9 billion to €24.3 billion.  Of these €19.8 billion were PDH mortgages and €4.5 billion were BTL mortgages. 

This 13 per cent reduction since 2011 masks what actually happened to the stock of loans the bank had at the end of 2011 because the bank has, of course, being issuing mortgages since then. 

If we just look at loans issued up to 2011 we again start with a total of €27.9 billion. But ignoring loans issued since then shows that these have reduced to  €18.8 billion, a fall of 32 per cent.  This falls varies by year of origination and unsurprisingly older loans show the greatest falls.

The stock of loans issued before the year 2000 fell by 63 per cent between the end of 2011 and the end of 2016.  For loans issued during the peak of the lending bubble we see that there were 29 per cent reductions in the over the same five year period for loans issued in 2006 and 2007.

The reduction in the outstanding balance could be due to:

  • repayments on the existing loan
  • re-mortgages to a new loan or new provider
  • write-downs on the existing loan

Due to re-mortgages it is probable better to look at the average balance rather than the total stock of debt.  Here are the number of accounts for each years of origination.

BOI Mortgages Number

And using these numbers we can get the average balance outstanding by year of origination.

BOI Mortgages Average Balance

This probably gives a better insight into the capital reduction on mortgages being repaid on a typical or regular basis.  For mortgages issued during the lending bubble we can see that the average balance fell by about one-sixth in the five years from the end of 2011 to the end of 2016.

So for loans originating from 2005-2008 we have a 30 per cent drop in the stock of debt in the past five years and an 18 per cent drop in the average balance for loans that remain extant at the end of 2016.  Of course, we don’t know what happened to the 12 per cent of loans originating from 2005-2008 that were discharged/ended in the past five years.  They may have been replaced by new debt or just simply repaid.  But whatever way we look at it the overall stock of debt from the credit bubble is being reduced.

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