Tag: Mortgage Industry

A recent speech by Lars Rohde, Governor of the National Bank of Denmark, included some interesting insights into mortgage risks and their management. Given rising house prices, and credit growth, he reflects on the EU’s approach to risk management of mortgage lenders. Some messages worth reflecting on in the Australian regulatory context! The principle is that losses should be borne by those who took the risks – in other words, owners and creditors – public funds should be protected.

In Denmark, the housing market is now picking up in practically all municipalities, and the annual rate of increase in house prices in Denmark overall has risen since New Year. In some parts of the country, prices have begun to rise only recently, so there are still large differences in the housing market across the country.

As such, it is positive that the housing market is picking up. That is a natural element of the current upswing. But in the large towns and cities there is a risk of price increases being self-reinforcing. The rate of price increase for e.g. owner-occupied flats in Copenhagen has been around 10 per cent for several years, and many buyers seem to expect that prices will continue to rise. It goes without saying that price increases on the scale seen in Copenhagen in recent years are not sustainable in the longer term.

During previous upswings, the housing market has been a source of macroeconomic instability and overheating of the economy. This was particularly true during the upswing in the 2000s. A contributory factor was the absence of sufficient automatic stabilisers in the structure of housing taxes. The current housing tax rules have also led to a considerable geographical spread in the rate of taxation – by which I mean the tax payable relative to the value of the property.

In the Danish mortgage credit system, everyone has access to loans if they can pledge sufficient collateral. Marginal lending is typically provided by the banks. But there is reason to exert caution in this respect. In many cases it would be prudent for the banks to require a considerably larger down payment than the 5 per cent of the purchase price that will be included in the rules on good practice for financial enterprises from 1 November. More equity among the households will strengthen their resilience and the robustness of the financial sector.

He went on to talk about what the new crisis management regime means for the mortgage banks.

Basically, the Bank Recovery and Resolution Directive establishes a common framework for the resolution of credit institutions across the EU. The underlying philosophy is that losses should be borne by those who took the risks. In other words, owners and creditors. Public funds should be protected. Those are the rules applying to other firms, and they should also apply to banks and mortgage banks. That will support market discipline.

It shall be ensured that resolution of an institution does not have serious implications for the economy and for financial stability. The functions that are critical to general economy must therefore be preserved in the event of resolution, irrespective of the organisational set-up. In this way, society in general is not taken as a hostage and forced to bail out an institution in difficulties. That can only be achieved via robust planning of recovery and resolution. Such planning will also ensure that bail-in becomes a real option in the future.

Since mortgage credit is a core element of the Danish financial system, the new framework will obviously affect the individual mortgage banks. Overall, there are three reasons why difficulties experienced by a mortgage bank may have serious implications for the economy and for financial stability. These should be taken into account in our planning.

Firstly, the mortgage credit sector is large and highly concentrated. Mortgage loans make up around three quarters of all lending by credit institutions to households and the corporate sector. And these loans are provided by just a small number of mortgage banks.

Secondly, the mortgage credit sector is closely interconnected with the rest of the financial system, in that mortgage bonds, especially covered bonds – SDOs, are used as liquidity and wealth instruments. So if their value deteriorates, this will affect the rest of the system.

Thirdly, all mortgage banks are based on more or less the same business model. This means that they are also faced with more or less the same risks. If the market loses confidence in a bond issued by one mortgage bank, confidence in and thus funding for the rest of the sector may rapidly evaporate.

Therefore recovery and resolution planning should ensure that a mortgage bank in difficulties will still be able to lend on market terms so that the lending capacity of the system does not decrease. And it is necessary to ensure that the problem is contained within the mortgage bank in question. Finally, it is essential that the government is not compelled to take on any significant risk.

To prevent a situation where resolution becomes necessary, each mortgage bank must prepare a recovery plan. The plan should examine the steps that may be taken if the mortgage bank is in difficulties. This will allow you to spot any weaknesses and inappropriate structures yourselves.

The recovery plan should take into account challenges in relation to both solvency and liquidity. Obviously, it is critical for an institution if losses reach a magnitude that jeopardises its solvency. But that will happen at a very late stage. Doubt about the viability of the business model will arise at a much earlier stage, namely when the mortgage bank can no longer maintain SDO status for bonds issued and fund itself on market terms. So it is crucial for the mortgage bank to have a reliable plan to minimise the risk that this situation arises.

The plan should cover situations where only the mortgage bank itself is under stress as well as situations where stress affects the entire financial system. This has a bearing on the potential courses of action. In a situation where the entire financial system is under stress, the option to divest and access to new capital may be limited.

In the event that a mortgage bank is deemed likely to fail, resolution procedures must be initiated. If this is to be effected in an expedient way, it is necessary to have a robust plan ready. That is the responsibility and task of the authorities. This task is fundamental to financial stability. Together with the two resolution authorities – the Danish Financial Supervisory Authority and Financial Stability – Danmarks Nationalbank is therefore working actively with such plans for the systemically important financial institutions in Denmark.

The work on the resolution plans and the assessment of whether they will work involves a large element of learning by doing. It is not work that will be completed this year. And the plans will need to be updated on a continuous basis.

The mortgage banks are fully comprised by the crisis management regime. However, there is one significant exemption, in that the minimum requirement for own funds and eligible liabilities does not apply to them. This means that bail-in is not an option in connection with resolution. Instead, the mortgage banks must hold a “debt buffer” of 2 per cent of their lending.

Right now, it is an open question whether a plan for resolution of a mortgage bank can observe the resolution targets I have already mentioned without the bail-in tool. This also applies in relation to the special winding-up model which the Mortgage Credit Act provides for. As we have previously said, it would have been better if a minimum requirement for own funds and eligible liabilities had to be set. In a resolution situation it would then have been possible for perform bail-in on uncollateralised liabilities to a sufficient extent to ensure the operation of the mortgage bank and the value of the SDOs – thereby supporting confidence in the mortgage credit system. And the Danish mortgage credit model would not have acquired yet another element that is not in conformity with the market.

From MortgageBusiness.

A new report examining the impact of regulatory changes on the Australian mortgage market has concluded that nine per cent of home loans written so far this year would now fail current underwriting standards.

Released this week, The Property Imperative Report V report from Digital Finance Analytics (DFA), applied the typical underwriting criteria being used today to the 26,000 households surveyed in the DFA Household Finance Confidence index.

The modelling assumed that, as a result of regulatory changes, all mortgages written today will be assessed on a serviceability hurdle rate of 7.5 per cent, interest-only loans require a repayments path, and real spending must be used rather than a standard ratio.

“Given the tighter criteria in play now, we were not surprised to discover that some loans would now not be approved without an override – meaning they were outside current norms,” DFA principal Martin North said.

“Overall about four per cent of loans in the national portfolio would now fail underwriting standards and two-thirds were for investment purposes,” Mr North said.

The report found that the majority of loans fell in the $500,000 to 750,000 range, predominately in NSW (six per cent) and Victoria. The loans were most likely to have been written in 2014 or 2015.

“Nine per cent of loans written so far this year would now fail current underwriting standards,” Mr North said.

“We expect underwriting criteria to continue to tighten, so more loans will fall outside current underwriting standards, representing some potential downstream portfolio risks.”

The report also found that there is almost no difference now between an interest-only loan and a principal- and-interest repayment loan.

“This is a significant change, highlighting the fact that the previous affordability benefit for an interest-only proposition has dissipated,” Mr North said.

The DFA report examined banks, non-banks and the mutual sector.

 

From Mortgage Professional Australia.

Lending to tighten as banks look to avoid mortgage risk​
Specific postcodes or suburbs won’t be denied home loans, but one financial analyst believes Australia’s big banks are moving to a path of more restrictive lending.

Martin North, the principal of Digital Finance Analytics, believes major lenders will soon be introducing different lending criteria and stricter servicing requirements as they look to reduce the amount of risk they carry on their mortgage books.

“I think what we’re seeing is a general drift towards the end of the more sporty loans we were seeing, the dial has been turned up in terms of the capital requirements banks are facing and the risk dial has been turned up as APRA says these are the things we want to see happen,” North said.

“We’re not going to see ghettos were you can’t get a loan, but LVRs are going to be dialled back, it’s going to be harder to get interest only loans and there could be changes to terms and conditions so we see things such as risk premiums on loans for certain areas,” he said.

North’s comments come after Fairfax media revealed earlier this week that NAB has two groups totalling more than 80 Australian postcodes identified as either being “areas where significant deterioration in credit risk has been observed” (Group A postcodes) or “areas which are exhibiting characteristics which may indicate future deterioration in credit risk” (Group B postcodes).

There are 40 Group A postcodes, which are predominantly located in areas affected by the downturn in the resource and manufacturing industries, with 22 Western Australian and 11 Queensland postcodes in the group.

The remaining seven postcodes are found in South Australia, Northern Territory and Tasmania. The Group A postcodes are now subject to a 70% LVR.

The bank has classified 43 postcodes in Group B, with 34 of them located in Sydney, while five are found in Melbourne and suburbs in this group are now subject to an LVR of 80%.

According to North, the identified postcodes present risks due to a number of different reasons.

“The first reason is the probability of default, which is tied to economic and employment conditions, and would apply to places in Western Australia or Queensland where the mining boom has deteriorated or areas like South Australia where the manufacturing industry has been hit,” he said.

“There are also concentration risks where you have a location that has been popular and a bank has a lot of people in that area with loans and they’ll then look to throttle back on lending to there.

“The final one is overvaluation, where a bank thinks the value of properties in the area are extended and they’re concerned that in a corrective market they’ll be worth less than what the loan. These are usually areas that have seen rapid growth and an area like inner Sydney would be a good example of that.”

While banks such as NAB may be introducing measures to reduce the level of risk they take on in the future, North said the current risk position of their mortgage portfolios may not yet truly be known.

“If you look back at the loans that were written over the last 12 – 18 months when lenders were being more aggressive, then I would estimate that about 8 – 9% wouldn’t meet today’s lending criteria.

“There’s some implicit risk there and most mortgage trouble start in the first two or three years, so in the near future we’ll see whether that leads to an increase in defaults.”

In the latest DFA video blog we discuss the recent mortgage rate changes. The regional banks, who will not be impacted by changes to capital weightings, and are not over the investment loan 10% speed limit, lifted their investment loan rates, following the majors. Across the industry, new and refinanced owner occupied loans are now potentially cheaper.

We argue that whilst the banks have used the APRA speed limits and the proposed capital weighting changes (which do not come in until next year) as the excuse, the changes have more to do with competitive dynamics and pre-positioning for driving owner occupied lending hard. In addition, APRA has no interest in building competition in banking, its all about financial stability. We conclude their interventions have provided a convenient platform for the banks, en masse, to increase margins at the expense of investment borrowers. It also demonstrates the pricing power of the majors.