Mortgage Portfolio Research Articles

Income-contingent repayment scheme for non-performing mortgage loans in Hungary

At the end of 2014, more than 23% of the foreign currency denominated mortgage portfolio in Hungary was overdue; about 20% was classified as non-performing and the tendency is worsening. In this paper, we propose a solution to effectively reduce the credit and systemic risk inherent to this portfolio – the proposed model can be applied to other mortgage portfolios in trouble as well. The main element of our proposal is income-contingent repayment complemented with effective incentives to motivate debtors to repay their debt. We demonstrate that the proposed scheme is attractive for both the debtors and the lenders; therefore, contrary to some recent policy measures, in this case there is no need for direct state intervention to force modifications to the existing legal contracts. In order to evaluate the possible effects, we simulated a realistic population of borrowers with different age, debt, loan-to-value, and income. Then we calculated the expected income paths, the repayments of the borrowers as well as the profit of the lenders on the basis of the non-performing FX mortgage portfolio. The results underpin that the proposed scheme creates significant value added and, most importantly, that it can effectively reduce the vulnerability of the entire economy to future shocks.

On the Use of Leveraged-Inverse ETFs to Hedge Risk in Publicly Traded Mortgage Portfolios

The authors evaluate U.S. Treasury and real estate indexed leveraged-inverse exchanged traded funds (LIETFs), mortgage-based put options, and real estate futures as risk hedges in publicly traded mortgage portfolios under conditions of large and rapid interest rate increases. They find that two LIETFs, TBT and TTT, indexed to U.S. 20+ year T-bonds, were the most effective and efficient risk hedges. TTT performed the best. TYO, a LIETF indexed to 7–10 year U.S. T-notes, performed poorest overall. Liquidity issues limited the effectiveness of mortgage-based put options. Real estate futures proved less successful than the best of the LIETFs. The authors find that the advantages of LIETF include simplicity of implementation, limited loss potential, and high liquidity; additionally, tracking error was not a problem over the lengthy risk hedge implementation period for the LIETFs. The authors conclude that the potential for severe tracking error, when used beyond a single trading day, is the primary limitation of LIETFs, so caution is appropriate, and frequent monitoring and management by skilled traders and well-informed portfolio managers are essential.

From housing bust to credit crunch: Evidence from small business loans

AbstractThis paper provides evidence that the 2007–2009 housing bust in the United States precipitated a “credit crunch” for small businesses. To remove demand‐driven correlations, we rely on within‐city comparisons. We ask whether banks whose mortgage portfolios were more heavily weighted in harder‐hit cities cut back lending to a greater extent in all cities where they make small business loans, relative to other banks in those cities. The evidence is consistent with a credit crunch. Large banks reacted with heavier cuts, but consistent evidence is also found among smaller banks. Quantitatively, the detected contribution to the overall decline in lending from the crunch appears modest.

Holes in the Dike: The Global Savings Glut, U.S. House Prices and the Long Shadow of Banking Deregulation

We explore empirically how capital inflows into the US and financial deregulation within the United States interacted in driving the run-up (and subsequent decline) in US housing prices over the period 1990-2010. To obtain an ex ante measure of financial liberalization, we focus on the history of interstate-banking deregulation during the 1980s, i.e. prior to the large net capital inflows into the US from China and other emerging economies. Our results suggest a long shadow of deregulation: in states that opened their banking markets to out-of-state banks earlier, house prices were more sensitive to capital inflows. We provide evidence that global imbalances were a major positive funding shock for US wide banks: different from local banks, these banks held a geographically diversified portfolio of mortgages which allowed them to tap the global demand for safe assets by issuing private-label safe assets backed by the country-wide US housing market. This, in turn, allowed them to expand mortgage lending and lower interest rates, driving up housing prices.

A Method of Retail Mortgage Stress Testing: Based on Time‐Frame and Magnitude Analysis

AbstractIn this study, a non‐stationary Markov chain model and a vector autoregressive moving average with exogenous variables coupled with a logistic function (VARMAX‐L) are used to analyze and predict the stability of a retail mortgage portfolio, based on the stress test framework. The method introduced in this paper can be used to forecast the transition probabilities in a retail mortgage over pre‐specified states, given a shock with a certain magnitude. Hence this method provides a dynamic picture of the portfolio transition process through which one can assess its behavior over time. While the paper concentrates on retail mortgages, the methodology of this study can be adapted also to analyze other credit products in banks. Copyright © 2015 John Wiley & Sons, Ltd.

European Banking Union C: Cross-Border ResolutionnFortis Group

In August 2007, Fortis Group, Belgium’s largest bank, acquired the Dutch operations of ABN AMRO, becoming the fifth largest bank in Europe. Despite its size and its significant operations in the Benelux countries, Fortis struggled to integrate ABN AMRO. Fortis’s situation worsened with the crash of the US subprime market, which impacted its subprime mortgage portfolio. By July 2008, Fortis’s CEO had stepped down, its stock had lost 70% of its value, and it was on the verge of collapse due to a severe liquidity crisis. The governments of Belgium, Luxembourg, and the Netherlands quickly came together and agreed to inject funding into the bank to keep it afloat. However, the deal fell apart when the Netherlands reversed course and nationalized Fortis’s Dutch assets. As a result, Fortis underwent an uncoordinated resolution, bifurcated along national lines. This case permits examination of this attempt at a cross-border rescue of a failing systemically important financial institution, analysis of why the effort failed, and consideration of how it might proceed differently under current regulations.

Forecasting mortgage defaults: evidence from UK portfolio-level data

This paper considers an equilibrium/error correction modelling (ECM) approach to identify determinants of mortgage portfolio default rates at firm level. Using mortgage portfolio data from a UK lender we estimated the lender's portfolio concentration weights in different UK regions to estimate portfolio–adjusted unemployment rate and portfolio–adjusted house price index. The modelling results suggest that the portfolio–adjusted unemployment rate and house price index along with Council of Mortgage Lenders' (CML) default rates, interest rates and household savings are useful determinants of firm–level default rates within an ECM framework. These findings may be of practical use for forecasting or back–populating default rates in financial institutions and especially for the smaller lenders where a long time–series with default rates may not be available. However, modelling and forecasting at portfolio level should be made carefully, as we argue that data quality and changes in the lending policy should be carefully monitored.

Holes in the Dike: The Global Savings Glut, U.S. House Prices and the Long Shadow of Banking Deregulation

We explore empirically how capital inflows into the US and financial deregulation within the United States interacted in driving the run-up (and subsequent decline) in US housing prices over the period 1990-2010. To obtain an ex ante measure of financial liberalization, we focus on the history of interstate-banking deregulation during the 1980s, i.e. prior to the large net capital inflows into the US from China and other emerging economies. Our results suggest a long shadow of deregulation: in states that opened their banking markets to out-of-state banks earlier, house prices were more sensitive to capital inflows. We provide evidence that global imbalances were a major positive funding shock for US wide banks: different from local banks, these banks held a geographically diversified portfolio of mortgages which allowed them to tap the global demand for safe assets by issuing private-label safe assets backed by the country-wide US housing market. This, in turn, allowed them to expand mortgage lending and lower interest rates, driving up housing prices.

Mortgage Lending for Slum Clearance

The paper investigates into allocation of treasury funds when major repairs are being funded. Slum clearance is part of major repairs costs. It is shown that mortgage lending can be used to reduce loading on treasury funds and make slum clearance quicker. The world experience in mortgage lending improvement is studied. In particular, mortgage securitization effect is looked into. A model of government co-financing of mortgage lending is proposed. The effect on economic performances due to application of this model is assessed. Guidelines are suggested in order to maintain high quality of the mortgage portfolio.

Activating the Covered Bonds Market in Poland The Need for Regulatory Improvements

The institutional framework for the functioning of covered bonds in Poland was established already in 1997 and first issues took place in 2000; by 2013, L.Z. accounted for a few percent of property market funding, mostly with respect to commercial property. The latest liquidity limits introduced by the requirements of Basel III and the Capital Requirements Directive/ Regulation (CRD/ CRR4) will persuade banks to show greater interest in long-term funding instruments to some extent, but in order to improve the L.Z. system in Poland more comprehensively, further changes to the legal environment are necessary so as to achieve significantly better ratings compared to unsecured bonds. The adjustment of the mortgage banking business model that assumes a synergy between the credit policy and the policy for funding mortgage portfolios with L.Z. within groups will also be of essential importance.The direction of systemic solutions represented by the Polish L.Z. and the quality of the collateral provided by safe assets are commensurate with the expectations of investors who tend to be wary following the sub-prime crisis. The key issue will be to achieve a larger issuance scale as well as to ensure market liquidity. The authors of this analysis express their opinion on success factors in the Polish market.

Decomposing the Smile: Systematic Credit Risk in Mortgage Portfolios

This study analyzes systematic and non-systematic credit risk in mortgage portfolios given US loan-level information by controlling for time-varying observable information in relation to the borrower, the collateral and the macro economy. The total risk in relation to rating class default rates is decomposed into systematic and class-specific non-systematic risk by a state space model. The paper finds that the total risk relates to credit quality in a smile-shaped pattern: systematic risk is negatively related and non systematic risk is positively related to average default rate levels. In addition, total risk increases during and after the Global Financial Crisis. The impact of the crisis on systematic risk is persistent whereas the impact on non-systematic risk appears to be temporary. The analysis of regulatory capital suggests that mortgage risk models in conjunction with periodic updating warrant a sufficient level of regulatory capital given the current regime. These findings are relevant to prudential regulators who are currently discussing the implementation of a monotone relationship between default probabilities and asset correlations under Basel III.

An Option Based Model of Rational Residential Mortgage Default

For recent years, the subject of residential mortgage default has claimed the attention of scholars, policy analysts, government officials and common consumers. This article analyzed the relation between the possibility of rational residential mortgage default and the market value of the house, and on the basement of option theory, suggested a model to estimate the possibility of rational default. Using this model, holders of residential mortgage portfolios could predict the possibility of rational default.

Gambling on Our Financial Future: How the Federal Government Fiddles While State Common Law Is a Safer Bet to Prevent Another Financial Collapse

Many politicians and commentators agree that credit default swaps (CDS) played a significant role in the worldwide financial crisis of 2008. Yet, few who observe this role are aware that CDS were set loose on the economy by the pre-emption of thousands of years of public policy. Since the time of Aristotle law, philosophy, and public policy have been united in their opposition to gambling, and in particular, financial gambling. Viewed as a socially unproductive zero sum wealth transfer, the law has generally refused to permit parties to use the courts to enforce wagers. For centuries, courts and legislatures worked in harmony to control, and in some cases punish, financial wagers particularly on the heels of financial panics precipitated by speculative wagering. When the financial industry developed complex derivatives that permitted banks and other institutions to bet on the financial health of companies and portfolios of mortgages and other financial assets, legal experts recognized these contracts would be unenforceable as against public policy under state law. The industry turned to the federal pre-emption power which was wielded not only to exempt CDSs from all state law but to exempt CDSs from all federal regulation. This strategy within the United States was repeated in other countries such as the United Kingdom. Ironically, claiming to reduce systemic risk, governments issued a “Get out of Law Free” card to these financial gamblers. The result was an exponential increase in the size and frequent spinning of this newly engineered roulette wheel. When the wheel stopped it was not the gamblers but the U.S. economy which lost the bet. After describing the nature of CDS contracts and the market for them, this article traces the ancient philosophical (beginning with Aristotle’s Nicomachean Ethics) and legal antipathy to gambling, examing the nuanced distinctions made between gambling and socially useful transactions such as insurance. Next the article traces the rejection of that wisdom by federal preemption and concludes that CDSs and other financial wagers should again be subjected to state law and public policy against financial wagers. CDS contracts that serve an economic purpose other than gambling, such as insurance or risk hedging, should be legally enforced (subject to appropriate regulation) but pure financial gambling should be constrained by the highly developed and ancient state common and statutory law still on the books of the various states. We cannot afford to continue to gamble with the world’s financial future by allowing legally enforceable financial wagers to drive the economy. The U.S. federal government needs to stop fiddling with regulatory turf wars between the SEC and CFTC and place a safer bet on state courts and legislatures enforcing ancient public policy.

Optimal Opacity on Financial Markets

We analyze the incentives for information disclosure in financial markets. We show that borrowers may have incentives to voluntarily withhold information and that doing so is most attractive for claims that are inherently hard to value, such as portfolios of subprime mortgages. Interestingly, opacity may be optimal even though it increases informational asymmetries between contracting parties. Finally, in our setting a government can intervene in ways that ensure the liquidity of financial markets and that resemble the initial plans for TARP. Even if such interventions are ex-post optimal, they affect incentives for information disclosure and have ambiguous ex-ante effects.

Time-to-default analysis of mortgage portfolios

Time-to-default analysis of mortgage portfolios

Dynamic Model of Losses of a Creditor with a Large Mortgage Portfolio

We propose a dynamic model of mortgage credit losses, which is a generalization of the well-known Vasicek's model of loss distribution. We assume borrowers hold assets covering the installments and own real estate which serves as collateral. Both the value of the assets and the price of the estate follow general stochastic processes driven by common and individual factors. We describe the correspondence between the common factors and the percentage of defaults, and the loss given default,respectively, and we suggest a procedure of econometric estimation in the model. On an empirical dataset we show that a more accurate estimation of common factors can lead to savings in capital needed to hold against a quantile loss.

Crédito imobiliário: uma análise das carteiras dos maiores bancos do país

Given the current macroeconomic environment experienced in Brazil, where inflation has stabilized and the basic interest rate of the economy is in one of their historical lows, demand for mortgages is increasing. In this context, the mortgage is presented with great emphasis to meet the demand for purchasing housing in addition to being a catalyst for the reduction of the high housing deficit. From a descriptive and empirical-analytic was analyzed the mortgage loan portfolio of the largest banks of the country between the years 2001 and 2010 through Quarterly Financial Information (IFT) available on the Central Bank website. It was settled a comparative relationship between the data in order to check the development of mortgage portfolios over the years and the factors that influenced this evolution, and evaluate the timeliness and quality of those loans. For the evolution of the portfolio there was an economic context in which Brazil was included in the period, and observed that for most of these operations are long term the banks are more exposed to market risk. With regard to credit risk parse that, over the years, Brazilian banks are presenting a mortgage loan portfolio with lower risk, and it is found that institutions with real estate credits with higher levels of portfolio risk are subject to have higher losses on such operations in the possibility of default.

When Do Securitized Reverse MortgagesBecome Liabilities

Reverse mortgages expose investors to the uncertain lifetimes of the borrowers. If a borrower lives longer than originally expected, the value of the reverse mortgage will have more time to approach and eventually surpass the value of the mortgaged property. A reverse mortgage is designed to negatively amortize; the mortgage value grows as interest accrues. Additionally, the home value may rise and fall over time. The time after mortgage origination at which the value of the reverse mortgage loan and the value of the mortgaged property are equal is called the cross-over point. In this article, the authors compute this time <i>t</i>*, relative to changes in rate of interest on the mortgage, inflation, and the value of the amount owed relative to the property value. They map the cross-over times with respect to these variables. Their conclusions offer important insights to those responsible for managing portfolios of reverse mortgages and risks derived from these mortgages. <b>TOPICS:</b>MBS and residential mortgage loans, risk management

Issuing 50 to 100-Year Bonds

In 2010-2011, investment-grade borrowers such as the California Institute of Technology (Caltech), Norfolk Southern Corporation, Rabobank Netherlands, United Mexican States (UMS), the Massachusetts Institute of Technology (MIT), and the University of Southern California issued 100-year bonds with no call provisions; and the Tennessee Valley Authority (TVA) issued a 50-year bond with no call provisions. AAA-rated TVA’s 50-year bond, and BBB-rated UMS’s 100-year bond had coupons of 4.625%, and 6.125%, respectively. Also in the same period, Goldman Sachs twice issued 50-year bonds with attractively-priced five-year call provisions, as the retail market traditionally under prices bond call options. Similar to Goldman Sachs, Telephone and Data Systems Inc, and its subsidiary United States Cellular Corp issued retail-targeted 49 NC-5s (non-calls) with attractively priced call provisions. The confluence of record-low 30-year Treasury yields and relatively tight corporate spreads are among the factors driving the issuance of bonds with 50 to 100-year maturities. The market for 50- and 100-year bonds (ultra-long, or super-long bonds) was invigorated in 1992 and 1993 by the: first-of-its-kind deal-of-the-year TVA 50 NC-20 (50-year non-call 20), Texaco 50 NC-20, Boeing 50 NC-L (non-call life), Walt Disney 100 NC-30, and Coca Cola 100 NC-L bonds. Typically, asset-liability managers such as insurance companies buy ultra-long bonds to match the duration of their assets and liabilities. The duration and, thus, the quarterly mark-to-market sensitivity of such bonds are only marginally higher than 30-year bonds. Asset managers may also buy ultra-long bonds to mitigate the negative convexity of their mortgage portfolios. Therefore, even small amounts of additional yield may tend to compensate investors for the incremental risks that they undertake.

Editorial

Editorial