Tag: Mortgage Risk

Canada Reinforces Mortgage Underwriting Guidelines

From Moody’s.

On Tuesday, Canada’s Office of the Superintendent of Financial Institutions (OSFI) published the final version of “Guideline B-20 − Residential Mortgage Underwriting Practices and Procedures,” which mandates more stringent stress-testing for uninsured mortgages. The guideline, which takes effect on 1 January 2018 and applies to all federally regulated financial institutions in the country, is credit positive because it will improve asset quality for Canadian banks.

The guideline sets a new minimum qualifying rate, or stress test, for uninsured mortgages at the higher of the five-year benchmark rate published by the Bank of Canada, the central bank, or the contractual mortgage rate plus 2%. Lenders also will be required to impose and continuously update more effective loan-to-value (LTV) limits and measurements.

A key vulnerability of Canadian banks is the high and rising level of private-sector debt/GDP. Canadian mortgage debt outstanding has more than doubled in the past 10 years (see Exhibit 1) and the index of house prices to disposable income has increased 25% over this period (see Exhibit 2), raising the prospect that real estate overvaluation is driving up overall household debt and overextending borrowers.

OFSI’s action is the latest in a series of macro-prudential measures aimed at slowing house-price appreciation in Canada and moderating the availability of mortgage financing. These measures will address the increasing risk that that growing private-sector debt will weaken Canadian banks’ asset quality. Canada’s growing consumer debt and elevated housing prices threaten to make consumers and Canadian banks more vulnerable to downside risks.

In addition to requiring that all uninsured mortgages be stress-tested against a potential rise in interest rates (high-ratio insured mortgages are already required to meet such tests to qualify for mandatory mortgage insurance), the guideline requires that banks establish and adhere to risk-appropriate LTV limits that keep current with market trends. Additionally, the guideline expressly prohibits banks from arranging with another lender a mortgage, or a combination of a mortgage and other lending products (known as bundled mortgages), in any form that circumvents a bank’s maximum LTV ratio.

Housing prices are at record highs owing to price increases in the urban areas of Toronto, Ontario, and Vancouver, British Columbia. Macro-prudential initiatives dampened volumes and prices in Toronto over the summer, but the effects of similar moves in Vancouver last year appear to be lessening this year as prices regain momentum. We believe that high consumer leverage could result in future asset-quality deterioration in an economic downturn or a housing price correction. Although Canadian banks have demonstrated prudent underwriting standards in the past, this is attributable in part to thoughtful regulatory oversight.

The new guideline follows a consultation period that ended in August. Some industry participants recommended a delay in implementation, cautioning that the combined effect of multiple macro-prudential measures affecting the mortgage market risked unduly depressing the housing market, thereby triggering a severe price correction.

The spooky mortgage risk signs our bankers are ignoring

From The Conversation.

I’m not normally a fan of parliament hauling private sector executives before them and asking thorny questions. But when the Australian House of Representatives did so this week with the big banks it was both useful and instructive.

And, to be perfectly frank, terrifying.

Let’s start with Westpac CEO Brian Hartzer. First, he confirmed the little-known but startling fact that half of his A$400 billion home loan book consists of interest-only mortgages.

Yep, half. Of A$400 billion. At one bank. Oh, and ANZ, CBA and NAB are all nearly at 40% interest-only.

Hartzer went on to make the banal statement: “we don’t lend to people who can’t pay it back. It doesn’t make sense for us to do so.”

So did it make sense for all those American mortgage lenders to lend to people on adjustable rates, teaser rates, low-doc loans, no-doc loans etc. before the global financial crisis?

Of course not. The point is that banks are not some benevolent, unitary actor taking care of their own money. There are top managers like Harzter acting on behalf of shareholders. Those top managers delegate authority to lower-level managers, who are given incentives to write lots of mortgages. And, as we know, the incentives of those who make the loans are not necessarily aligned with those of the shareholders. Those folks may well want to make loans to people who can’t pay them back as long as they get a big payday in the short term.

ANZ CEO Shayne Elliot repeated Hartzer’s mantra, saying: “It’s not in our interest to lend money to people who can’t afford to repay.” Recall, this is the man who on ABC’s Four Corners said that home loans weren’t risky because they were all uncorrelated risks (the chances that one loan defaults does not affect the chances of others defaulting). That is a comment that is either staggeringly stupid or completely disingenuous.

Messers Harzter and Elliot must take us all for suckers. They have made a huge amount of interest-only loans, at historically low interest rates, to buyers in a frothy housing market, who spend a large chunk of their income on interest payments. This certainly looks troubling. It may not be US sub-prime, but it could be ugly. Very ugly.

To put it in context, there appears to be in the neighbourhood of A$1 trillion of interest-only loans on the books of Australian banks. I say “appears to be” because reporting requirements are so lax it’s hard to know for sure, except when CEOs cough up the ball, like this week.

The big lesson of the US mortgage meltdown is that the risks on these mortgages are all correlated. If a few people aren’t paying back an interest-only loan, that is a fair predictor that others won’t pay back their loans either. Yet it seems Australian banks are a decade behind the learning curve.

The Reserve Bank cautions that one-third of borrowers don’t have a month’s repayment buffer. And where are interest rates going to go from here? Up. It is just a question of when. And when that does happen – or when the interest-only period on loans (typically five years) rolls off and principal payments start having to be made – watch out.

We should all remember that the proximate cause of the US mortgage meltdown was borrowers with five-year adjustable-rate mortgages (ARMs) that had huge step-ups in repayments and needed to be refinanced to be serviceable. When the market couldn’t bear that refinancing, defaults went up. Then the collapse of US investment bank Bear Stearns, then Lehman, then Armageddon.

Australia’s large proportion of five-year interest-only loans – turbocharged by an out-of-control negative-gearing regime – looks spookily similar.

It’s one thing for borrowers to do silly things. When it becomes dangerous is when lenders not only facilitate that stupidity, but encourage it. That seems to be what has happened in Australia.

And APRA’s “crackdown” and the Reserve Bank’s warning may be far too little, way too late.

We might stumble though this. I hope we do. But if so, it will be because of dumb luck, not good institutional and regulatory design. And definitely not because of good corporate governance.

Whatever happens, we should learn those lessons.

Author: Richard Holden, Professor of Economics and PLuS Alliance Fellow, UNSW

Are IO Households Aware They Have IO Loans?

DFA analysis shows that over the next few years a considerable number of interest only loans (IO) which come up for review, will fail current underwriting standards.  So households will be forced to switch to more expensive P&I loans, assuming they find a lender, or even sell. The same drama played out in the UK a couple of years ago when they brought in tighter restrictions on IO loans.  The value of loans is significant. And may be understated, according to new research.

A few observations. ASIC in 2015, released a report that found lenders providing interest-only mortgages needed to lift their standards to meet important consumer protection laws. They identified a number of issues relating to bank underwriting practices. We would also make the point that despite the low losses on interest-only loans to date in Australia, in a downturn they are more vulnerable to credit loss.

In April this year we addressed the problem of IO loans.

Lenders need to throttle back new interest only loans. But this raises an important question. What happens when existing IO loans are refinanced?

Less than half of current borrowers have complete plans as to how to repay the principle amount.

Interest-only loans may seem like a convenient way to reduce monthly repayments, (and keep the interest charges as high as possible as a tax hedge), but at some time the chickens have to come home to roost, and the capital amount will need to be repaid.

Many loans are set on an interest-only basis for a set 5 year term, at which point the lender is required to reassess the loan and to determine whether it should be rolled on the same basis. Indeed the recent APRA guidelines contained some explicit guidance:

For interest-only loans, APRA expects ADIs to assess the ability of the borrower to meet future repayments on a principal and interest basis for the specific term over which the principal and interest repayments apply, excluding the interest-only period

We concluded:

This is important because the number of interest-only loans is rising again. Here is APRA data showing that about one quarter of all loans on the books of the banks are interest-only, and that recently, after a fall, the number of new interest-only loans is on the rise – around 35% – from a peak of 40% in mid 2015. There is a strong correlation between interest-only and investment mortgages, so they tend to grow together. Worth reading the recent ASIC commentary on broker originated interest-only loans.

But if households are not aware they have IO loans in the first place, then this raises the systemic risks to a whole new level. The findings from the follow-up study by UBS, after their “Liar-Loans” report (using their online survey of 907 Australians who recently took out a mortgage – they claim a sampling error of just +/-3.18% at a 95% confidence level) are significant.

They say their survey showed that only 23.9% of respondents (by value) took out an interest only loan in the last twelve months. This compares to APRA statistics which showed that 35.3% of loan approvals in the year to June were interest only.

They believe the most likely explanation for the lack of respondents
indicating they have IO mortgages is that many customers may be
unaware that they have taken out an interest only mortgage. In fact, around 1/3 of interest only borrowers do not know that they have this style of mortgage.

Source: UBS

They also says 71% of respondents who took out an interest only mortgage during the last 12 months indicated they are already under moderate to high levels of financial stress.

Source: UBS

Finally, they found that Interest Only borrowers via the broker channel are more likely to be under high financial stress from recent rate rises.

 

 

 

Australian 2Q17 Mortgage Arrears Remain Stable

Australia’s mortgage arrears remained stable in 2Q17, with a 4bp decrease to 1.17% from the previous quarter, reflecting Fitch Ratings‘ expected seasonal recovery from Christmas and holiday spending.

The 30+ days arrears were 3bp higher from 2Q16, despite Australia’s improved economic environment and lower standard variable interest rates for owner occupied lending.

Unemployment improved by 20bp and real wage growth was low, but positive. Underemployment also improved by 20bp, reflecting a proportional increase of full-time employment during the quarter.

Repayment rates have decreased as borrowers recover from Christmas and holiday spending. The Dinkum RMBS Index borrower payment rate fell to 21.2% at end-2Q17, from 21.9% in the previous quarter. The conditional prepayment rate also dropped qoq to 19.1%, from 19.8%.

Losses experienced after the sale of collateral property remained extremely low, with lenders’ mortgage insurance payments and/or excess spread sufficient to cover principal shortfalls in all transactions during the quarter.

Fitch’s Dinkum RMBS Index tracks arrears and performance of mortgages underlying Australian residential mortgage-backed securities.

Mortgage Arrears at Five Year High

From Australian Broker.

The number of Australian residential mortgages that are more than 30 days in arrears has shot up to a five year high, according to Moody’s Investors Service.

The ratings agency recorded a 30+ delinquency rate of 1.62% in May this year with record high rates in Western Australia, the Northern Territory and South Australia. Arrears were also up in Queensland and the Australian Capital Territory while levels decreased in New South Wales, Victoria and Tasmania.

“Weaker conditions in states reliant on the mining industry, high underemployment, and less favourable housing market and income dynamics will continue to drive delinquencies higher. Regions with exposure to the resource and mining sectors dominated the list of areas with the highest delinquencies in May 2017,” analysts said.

Eight of the 10 regions with the highest 30+ day delinquency rates were found in either Western Australia or Queensland and are locales indirectly or directly related to mining and resources.

“The ten regions with the lowest mortgage delinquencies in Australia in May 2017 were all in Sydney and Melbourne, where housing market and economic conditions were the most supportive for mortgage borrowers.”

Ratings agency Standard & Poor’s (S&P) Global Ratings also recorded an increase in the higher number of delinquent housing loans underlying Australian prime residential mortgage-backed securities (RMBS).

This rate rose from 1.15% in June to 1.17% in July according to the agency’s monthly report RMBS Arrears Statistics: Australia. This latest percentage was lower than the July average for the past decade, S&P analysts said.

Delinquent loans underlying the prime RMBS at the major banks made up almost half of all outstanding loans and increased from 1.08% to 1.11% from June to July. For the regional banks, this level rose from 2.30% to 2.35%.

Arrears for prime RMBS at non-bank financial institutions actually dropped from 0.49% to 0.47% over the month while non-bank originator RMBS arrears declined from 0.88% to 0.85%.

“The pronounced improvement in nonbank originator prime RMBS arrears since their peak of 2.99% in January 2009 reflects a general improvement in the overall collateral quality of this sector. This is evidenced by a fall in low documentation loans from 22% in December 2009 to 15% in June 2017 across their prime portfolios. Higher loan-to-value (LTV) ratio loans – ie, those exceeding 75% – in this sector have declined to 28% as of July 2017 from around 50% in 2009.”

Long Term Mortgage Delinquencies Rise

The latest S&P data shows that mortgages more than 90 days in arrears increased to 2.20% in June from 2.10% the previous month, despite a seasonal easing. Loan balances continue to grow.

From Australian Broker.

The volume of delinquent housing loans underlying Australian prime residential mortgage-backed securities (RMBS) has dropped from 1.21% to 1.15% between May and June, according to S&P Global Ratings.

While S&Ps report, RMBS Arrears Statistics: Australia, stated that arrears usually fall month-on-month at this time of year, analysts also attributed the decline to an increase in outstanding loan balances in June.

Declines were experienced across the board with the Standard & Poor’s Performance Index (SPIN) falling for prime Australian mortgages in arrears by over 30, 60 and 90 days.

Queensland experienced the largest decline in arrears in percentage terms falling from 1.72% to 1.62% between May and June. At the other end of the spectrum, Western Australia retained top place with arrears at 2.32%.

Looking at the type of lenders, arrears fell in all categories except ‘regional banks’ which recorded an increase in the number of delinquencies from 2.27% to 2.30%.

“The SPIN for nonconforming home loan arrears fell to 4.84% in June from 5.16% in May against a backdrop of increasing loan balances. The largest improvement was for loans 60-90 days in arrears, which fell 0.31 percentage point to 0.78% in June. Mortgages more than 90 days in arrears increased to 2.20% in June from 2.10% the previous month, however.”

Banks shouldn’t underestimate the risk of concentration in the housing market

From The Conversation.

The view of Australian banks on the risk that mortgage stress poses to our economy and the banks’ own viability is worrying. Shayne Elliott, CEO of ANZ Bank commented in this week’s Four Corners report:

The reality is that housing loans are pretty good because they’re quite diverse in terms of lots of relatively small loans across ah across the country.

This view is in contradiction to research from the United States which finds housing markets there are less diversified than previously thought. This means any house price shocks will likely occur simultaneously across the country, causing large cumulative losses to borrowers and banks via mortgage defaults. Australian housing markets are likely to be even more concentrated than in the US because of the population size of Sydney and Melbourne.

Banking regulator the Australian Prudential Regulation Authority (APRA) has already issued guidelines to the banks on tracking exposure to mortgages and limiting the growth of loans to investors, in particular for interest-only loans. An independent review by Stephen Sedgewick on behalf of the industry also recommended banks stop paying mortgage brokers based on the volume of loans they secure, in an effort to reduce risks. But these steps might not be enough to ensure security.

Australian bank exposure to mortgage risk

Bank losses during the global financial crisis were in large parts driven by borrowers not being able to make their mortgage repayments. After receiving a loan, borrowers may experience income shocks like loss of jobs or demotion and expense shocks like higher petrol prices or interest rates, that affect their ability to service their mortgages.

Australian mortgage contracts are risky for borrowers in international terms. Unlike other countries, Australian banks offer to lend only up to five years at a fixed rate and the majority of loans are at a variable rate.

This leaves Australian borrowers exposed to interest rate increases. In the past few years, interest rates were lowered as Reserve Bank of Australia economists targeted low inflation rates.

Interest rates are now close to zero, limiting the ability of the RBA to stimulate economic growth. There’s the possibility the RBA could raise interest rates, causing shocks to mortgage borrowers. My research shows this shock could increase bank losses substantially.

At the moment 23% of consumer expenses are housing related and this number is likely higher for mortgage borrowers and could be growing. Interest rate increases, in combination with the current high debt levels, are therefore likely to increase inflation and trigger further interest increases.

Dealing with the risk of mortgage stress

Current bank portfolios are not well diversified, if 60% of bank assets are in mortgages. Other loan classes such as commercial real estate loans and small to medium enterprise loans are also often property-backed.

Bank lending standards need to be more consistent to avoid borrowers shopping around for the lender that offers them the highest loan amount. Lending standards should also consider the concentration of housing income and expenses in a borrower’s portfolio.

Banks should promote fixed rate mortgages. This type of mortgage transfers interest rate risk from borrowers to the banks, that are better placed to manage this risk. This may come at an additional cost but should be small compared to the cost borne by consumers should the housing bubble ever burst.

There also needs to be more scrutiny of the use of offset accounts and redraw facilities, being used as an offset for outstanding loans. Borrowers often use these funds to purchase additional properties and they may not be available in the case of mortgage default. Instead of promoting offset accounts it may be better to give borrowers a prepayment on their mortgage, but not an option to redraw. Should consumers want to draw down on the equity in their homes, they could then apply for a second mortgage.

Mortgage brokers should act as independent advisers, a tool for consumer information and bank competition, as smaller lenders in particular rely on mortgage brokers. The Sedgwick report suggested the loan to value ratio of mortgages should be considered when paying mortgage brokers. This would mean that loans with high loan-to-value ratios (where the borrower is more likely to default) would earn a lower fee.

The Sedgwick banking review has been a step in the right direction, but the focus should be on banks rather than mortgage brokers, as it’s ultimately the bank that is in a contract with the consumer.

Some of this may require a fundamental value change. It’s not likely the Australian appetite for property will change but this means we need to hedge our bets against any risks by improving diversification and the way banks finance mortgages.

Author: Harry Scheule, Associate Professor, Finance, UTS Business School, University of Technology Sydney

Where Are The Mortgage Risks Lurking?

Traditional thinking is that higher loan to value loans are more risky than lower loan to value loans. We see this in the way banks price in risk, through their underwriting standards, and Lenders Mortgage Insurer premiums rise as LVR rises.

However, portfolio analysis from our core market model shows this is a myopic view of risk. When we run our weekly updates of the model we market to market property values, and also update incomes and mortgage payments to take account of changes.

In a rising market, LVR’s tend to improve, because the value of the property rises, creating capital which can insulate the lender in a case of default.

Loan to income metrics give a much more accurate calibration of risk, as we see mortgage stress rising significantly in line with higher LTI measures. In the current environment debt servicing ratios are also important, as mortgage rates are on the rise as incomes are only growing for some, whilst costs of living are rising.

So, here is a (pretty) chart which shows our take on risk of default across LVR and LTI metrics. LTI gives a better read on risk, and in fact the matrix of the two dimensions offers the most accurate calibration.

Interestingly, similar conclusions were cited by the Bank of England recently, using data from Irish borrowers after the GFC.

Rate rises driving up arrears

From Australian Broker.

Global ratings agency Standard & Poor’s has reported that recent rate moves by the major and non-major banks are behind a rise in national mortgage arrears.

The number of home loan delinquencies underlying Australian prime residential mortgage backed securities (RMBS) increased from 1.16% in March to 1.21% in April, according to a recent S&P report, RMBS Arrears Statistics: Australia.

“Part of the increase reflects a decline in outstanding loan balances, but we believe interest-rate rises announced by different lenders during the past few months affected the Standard & Poor’s Performance Index (SPIN) for Australian prime mortgages, given that most of the loans are variable-rate mortgages,” S&P analyst Erin Kitson said.

The SPIN looks at the weighted average of arrears more than 30 days past due on residential mortgages in publicly and privately rated Australian RMBS transactions and is calculated on a monthly basis.

Arrears increased in all states and territories except the ACT, NT and Tasmania. NSW, Victoria and Queensland – which account for about 80% of total loan balances – all recorded increases in arrears between March and April. The largest surges in delinquencies in this time period were as follows:

  • Queensland (1.58% to 1.66%)
  • New South Wales (0.85% to 0.91%)
  • Western Australia (2.27% to 2.32%)

However, the number of delinquencies in NSW and Victoria remain below the weighted average SPIN for prime mortgages.

The increase in arrears was greatest amongst the regional banks with mortgage payments more than 30 days late rising from 2.02% in March to 2.27% in April. This was around 1.8 times higher than the prime SPIN, Kitson said.

“We attribute this in part to a decline in outstanding loan balances and the regional banks’ greater exposure to Queensland; around half of all regional banks’ outstanding loan balances are domiciled in the state.”

In comparison, non-regional banks recorded an increase in arrears from 1.10% to 1.14% between the two months while non-banks rose from 0.87% to 0.95% in the same time period. These figures remained below the SPIN.

Finally, for non-conforming loans, arrears fell from 6.17% to 5.03% between April and March, due to a backdrop of increasing loan balances.

“Interestingly, mortgage repayments more than 90 days past due made up around 41% of the total nonconforming arrears in April compared with 60% for prime arrears. The proportion has been broadly consistent in the nonconforming sector for the past 10 years, but has increased more markedly in the prime sector during the period.”

Improvements in the seasonally adjusted unemployment rate in May are credit positive for mortgage arrears, Kitson said.

“Relatively stable employment conditions in Australia have underpinned the low levels of arrears and losses in Australian RMBS transactions; loss of income is a key cause of mortgage default. Declining unemployment and positive jobs growth are fundamental to the ongoing stable collateral performance of Australian RMBS.”

Tighter Property Regulations to Weigh on Hong Kong Banks

Fitch Ratings expects tighter regulations on property-related lending to have a material but manageable capital impact on Hong Kong banks.

The Hong Kong Monetary Authority has further tightened regulations on mortgages and bank lending to property developers that in turn extend mortgages outside the supervisory framework in an effort to cool the property market and strengthen the banks’ credit risk management.

We expect the growth in domestic residential mortgages, which accounted for 5.6% of system-wide assets at end-March 2017, to slow while direct lending to property developers (6.3%) may shrink.

Fitch estimates that increasing the risk weight on loans to property developers to 50% or 100% from an assumed 30%, coupled with an increase in the risk weight floor for residential mortgages to 25% from the current 15%, could reduce Fitch Core Capital ratios by at least 50 bp and up to 420 bp for banks that use the internal ratings-based approach.

The impact will be manageable as the new rules will be phased in and banks have maintained above-average capitalisation, supported by internal capital generation and one-off disposals.

Notwithstanding the above, Fitch revised the banking system outlook over the next 12 months to stable from negative on 11 May 2017 while the medium-term outlook for Hong Kong banks’ operating environment remains negative as the financial systems of Hong Kong and China continue their integration.

We expect short-term cyclical pressure on the banks’ financial performance to ease, based on positive signs in the domestic economy. Fitch expects annual GDP growth of around 2% in 2017 and 2018 for Hong Kong.