Asia Pacific Union for Housing Finance

International Conference on Housing April 10-13, 2013 New Delhi, India

Mortgage Lending

Overview of International Regulatory Developments

Olivier Hassler ohhfinance@gmail.com

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Main Lessons from the 2007-2009 Crisis

A crisis mostly acute in the US (starting point) and in Europe,

…But with global implications – contrarily to the regional , also real estate related, crises of the 1990s, and generally valid lessons: Do not lend irrespectively of repayment capacities

Do not base credit worthiness assessment on stated, undocumented incomes

Create incentives for lenders to behave responsibly

Prevent or limit the use/impact of mortgages on speculation and housing market overheating

Avoid losing track of credit risks through risk transfer mechanisms

Prevent funding mortgage loans by short term wholesale resources

The last financial crisis = the reference stress scenario behind the new global regulatory landscape

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I) Ensure Sound Underwriting Criteria

A flurry of regulatory adjustments world wideEx.: FSB Principles for Sound Residential Mortgage Underwriting Practices March 2011 & Apr 2012

US Dodd Frank Act Jul 2010, UK Mortgage Market Reviews Dec 2010 and 2011,

Hungary, Lithuania, Malaysia, Norway, Poland, UAE etc. since 2010

EU: preparation of a Mortgage Credit Directive

Ability to Repay = primary criteria (mortgage = safety net) Requirement to verify income, no self-certificationAssessment of free disposable income and expenditures (simple DTIs % not enough)

Verification of total indebtednessVariable rate mortgages:

Disregard initial teaser rates (fully indexed rates) Stress tests , at origination and on an on-going basis

LTVs still important – Typically determine Risk Weights Note: Basle III only changes Risk Weights of mortgages by setting a 20% floor for Internal rating Bases Approach 3

I) Sound Underwriting Criteria, Ctd

Avoid risk layering

Addition of products and borrowers risky features: typical subprime lending, also a way to create apparent affordability

Provide discipline incentives to lenders :Linkage soundness of lending / capacity of funding: 5% risk retention rule for

securitizing originators (Basle, Mexico, US, EU)

In the US: “Qualified Residential Mortgages” exempted from the ruleExpected loss based provisioning (Mexico)

Ensure that risk transfers do not hide risksShadow banking system: dissuasive treatment of re-securitization (Basle III,

Solvency II – new risk based prudential framework for insurance in Europe)

Mortgage insurance - prudent regime already in various countries (ex. India, Australia) – Generalization: Basle Joint Forum Feb 2013 report :

same soundness criteria as for lending, prudential standards = a condition to lower risk weights in lenders’ balance sheets no regulatory arbitrage 4

II) Strengthen Consumer Protection

Reckless lending targeted by most framework enhancements Responsible lending has been defined… Not lending against borrower’ interest Affordability based lending Fair information advisory services (ex.: Office of Housing Counseling created within HUD by the US Mortgage

Reform and Anti-Predatory Act – MRAPA -, Title 14 of Dodd- Frank)

… and its legal implication strengthened Direct legal responsibility of bankers in some systems (South Africa, France),

Important innovation in the USA: lenders legally liable for not complying with MRAPA Dodd Frank / CFPB: “Qualified Mortgages” provide legal safe harbor protecting lenders against

lawsuits (“irrebuttable presumption” of fair lending)

Indirectly in many jurisdictions: unfair lending = defense against foreclosures

“Passive” over-indebtedness (post-origination hardship) = an on-going debate Ex. EU: draft mortgage Directive, countries in economic distress Several options: personal bankruptcy, loan restructuring (pre-set rules? judicial discretion?) Risks: strategic defaults (US) , moral hazard

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III) Restrict mortgage lending from fueling price bubbles

Mortgage lending far from being the main engine of market exuberance

Speculative investments, demand/supply leads and lags intrinsic to real estate market dynamics

Anti-speculative measures must first target the housing market Taxation– see China 2013, Singapore 2009-2011 (level of registration charges linked to the

holding period, up to 16%; + 3% or 10% stamp duty surcharge for second houses)

Off-plan sales regulation to avoid purchase contract flipping (Dubai, Saudi Arabia)

Housing market observatories, price index, ratio prices/household income, stocks of unsold units, etc. of utmost importance – Thailand a pioneer

Stimulation of affordable housing supply

Macro prudential gearing of mortgage lending of growing importance First lever: LTVs, moved in a countercyclical way (ex.: India)

Differentiation of LTV limits: required for efficient targeting: by areas (ex. Korea), by products (Home Equity Loans), for second & subsequent houses (ex: Malaysia, Norway, Singapore, UAE), non- owner-occupied houses (CND 2010), or non-individual borrowers

Dynamic provisioning (Chile, Colombia, Spain) Risk weights also a possible variable 6

IV) Funding- (A): Control of underlying risks - Securitization most affected

Draft revised Basle Rules sets strong restrictions to securitization (Dec 2012)

Examples of risk weights (Rating Based Approach) in %

Source: Bank of America Merrill Lynch (low thickness tranches)

However: capital charge capped to the capital requirements on underlying assets

Securitization to become largely a funding-only tool

Negative impact of new Insurance prudential frameworks (EU, Australia)

Draft solvency II: very high capital charges – 3 to 10 times more than Cov. Bonds

Due diligence, Representations & Warranties strongly enhanced (US)

Higher disclosure requirements (see also Covered Bonds) Regulation: Basle III (Pillar III), US (FDIC), EU (CRD, Draft new Market in Financial Instruments

Directive) Market initiatives: Prime Collateralized Securities (Asso. for Financial Markets in Europe label)

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Senior Tranches (5 years) Non-senior Tranches (5 years)AA(currently)

97(8)

233(15)

A(currently)

141(12)

360(20)

BBB-(currently)

235(100)

689(100)

Purpose : resilience to a stressed liquidity scenario (ex: downgrade, deposit run, interruption of short term whole funding renewal) in a one month horizon

Stock of High Quality Liquid Assets LCR = ------------------------------------------------------ >= 1 Total net cash outflows next 30 days

qualitative & quantitative liquidity criteria

Mortgage Securities eligible HQLA – Cov. Bonds well treated, Residential MBS introduced in Jan 2013 version:

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IV) Funding - (B) Improved Liquidity Management: Basle III Liquidity Coverage ratio

    Assets Eligibility Criteria Haircut

Level I

  Central Bank reserves, marketable securities from sovereigns, multinationals Basle II 0 Risk Weight 0%

Level IIMax = 40%

II A Max = 40%Corporate Bonds,

regulated Cov. Bonds > AA- 15%

II B Max = 15% RMBS

Risk retention regulation

LTV < 80% Full recourse

mortgages > AA -

25%

IV) Funding – (B) Improved Liquidity ManagementBasle III Net Stable Funding Ratio

Purposes: for non easily monetizable assets, use of a minimum volume of stable

resources on an on-going basis, withstand a 1 year interruption of liquidity access due to rating

downgrade, loss of market confidence (avoid cliff effect of LCR)

Structure: Stable resources: capital, secured or unsecured debt with remaining

maturity > 1 year, retail deposit base (assumptions on run-off rhythm) Minimum ratio required on a case-by-case basis by national regulator

Implementation: 2018?

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