gregorio moral final
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Real Estate Credit in Perspective-
Gregorio MoralTuriel
Head of the Analysis and Methodological Advice UnitBanco deEspaa
The views expressed in this presentation are those of the author and do not necessarily represent
those of the Banco de Espaa. All figures, and graphs used as examples are for illustrative
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Loansorcreditfacilitiessecuredbyalienona
realstate
ro ert
Twomainreasonsbehindrealestatelending
o
uy
eve op
or
u
a
proper y
expens ve Togetfunding(extractequity)usingtheproperty
(valuable)ascollateral
Man
differentt es:
borrowers
assets
instruments,goals,
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Focusingontheborrower
Commercialreal
estate
CRE
and
Retailrealestate(RRE)
ypes
o
en ng Commercialconstruction,residentialconstruction,
developers,othercommercialrealestate
Sometimessimilar
to
Pro ect
Finance,
in
other
casestheperformanceoftheborroweristhe
mostim ortantfactor Cor orateModels
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Mortgages
loans
to
buy
a
home
(usually
first
lien)
Owneroccupied
Rentalhousing
Refinancing Mort a estoextracte uit
Conventionalhomeequity(LTV
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Existenceofcertaintypeofcollateral(real
estate)that
Isdifficulttovalue.Differencesamong
,
matters,affected
by
many
factors)
Cost historical re lacement
Price(heterogeneousproduct,opacityandinfrequent
trades)
Withhightransactioncosts
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Prerequisites:anadequateLegalEnvironment
andaccess
to
key
information
ImportanceoftheLegalandRegulatory
Proborrower
vs.
pro
lender,
complexity,
costs
of
foreclosures,timeforre ossessions,etc.
andoftheexistenceofreliableRealEstate
Informationonrights(ownership)andencumbrances i.e.firstlienmort a es
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complex
interactions
affect
both
the
behavior
Modelingofdefaultandrecoveryrisksisdifficult
Largeamounts
and
a
propensity
to
generate
,
In
many
cases,
long
maturities
Needforstablefundingsources,risksassociatedwithmaturitytransformation
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WhyisretailRREsoimportant?
Households:in
urisdictions
with
lar e
middle
classesandhigh%ofhomeownership,
a home is their most im ortant investment and
thelargest
loan
that
they
will
ever
have
is
a
mortgage
loantobuyahome
Banks:manyretailbankskeeplargeportfolios,other
financialinstitutions
invest
in
securities
based
on
these
assets
S stemicnatureinman urisdictions
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on
the
jurisdiction Fu recourseagainstt e orrowerornot e.g.,
Spain,Canadavs.someestatesintheUS)
Typicalmaturities
(term)
can
be:
short
(
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Policymakersinmanycountrieshave
promotedtheincreaseofhomeownership
,ofpublicorquasipublicagencies,taxincentives
:
u c
genc es
an
rograms Thehomeownershipratereachapeakof69%in2004,
rom45 in1940,wit va ues uctuatingaroun 64
duringnearlythreedecades
Sustaina e omeowners ip:Notinallcasesissensibletobecomeahomeowner!
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CyclicalBehavior
House
ricesare
rone
to
boom
and
bust
c cles
butthedurationofthesecyclesvariesgreatly
Bankmanagersshouldrecognizethatisvery
boomphasewithoutsufferingsomeof
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. . .2011
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Portfolios
can
grow
very
quickly
and
seem
to
be
a mos r s ree
Thecompetitiontendstoincreaseovertimeaffecting
pricingand
underwriting
conditions
Banksadapttheirpoliciestothecurrentsituation
Thereisroomforstrategieswithverydifferent
im licationsin
terms
of
risk
rofile
Thebestbanksstartchangingpoliciesbeforethebust
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Whenwilltheboomgobust?
Itis
not
a
science
it
de ends
on
man
factors
not
onlyhouseprices!)andhumanpsychology
,
fallin
house
prices,
a
sustained
high
rate
of
, ,
scarcityoffunding,interestrateincreases,other.
,
indicatorsandwarningsignals
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Lessons:C clicalBehaviorIndicators
and
warning
signals
oc o emograp c ren svs. eman
Rateof
household
formation,
demographic
structureandtrends,immigration
Averagehousepricestoaveragehouseholdsposa e ncomean e tto ncomerat os
Current
riceto
rent
ratio
vs.
historical
average(relativecostofrentalhousing)
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Lessons:CyclicalBehaviorIndicators
and
warning
signals
EvolutionofLTVatorigination,maturities
Verylowlevelsofinterestratesandhigh%of
a justa erate
mortgages
Proliferationofrefinanceandcom lexmortgageproducts
oosen ngo
en ng
s an ar s
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Risktransfermechanismstoathirdparty
Tendto
maintain
ut
back
risks
which
emer e
underextremescenarios
,
therisk
transfer
wont
be
effective
in
case
of
st
semesterin2011werepassedtotheGSES)
ven
e
r
par y
sa
pu c quas
pu c
agency(FreddieFannie)
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Lessons: (Credit)RiskTransferOriginatetodistributemodel
Motivation:Efficiencyandregulatoryarbitrage
Moralhazard,looseningofunderwritingstandards,
Proposalsto
overhaul
securitization
markets
mortgagess ou meet g erun erwr t ngstan ar s,regardlessofwhetherthemortgagesaresoldinto
Riskretentionprovisions(skininthegame)
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Foreclosure,deteriorationoftheproperty,vacanthomes,,
Localdefaults
Severaldefaultsinthesamearea,deteriorationof
neighborhoods,sales,localmarketvaluesdecline,new
,
Globaldefaults Underwatermortgages,shortsales,furtherdepressionof
houseprices,increaseinstrategicdefaults,firesales,no
,
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Underwritingpracticesandpolicies
Roleofmodelsandautomatedsystems
Scorin
s stems
PDoriented
D LGD
estimates
economiccapitalneeds,regulatorycapitalneeds
Automatedunderwritingsystems(limitOpRisk)
Automatedvaluation
systems
(can
help
to
detect
anomalies)
Humanjudgmentandtraditionalappraisals
transfermechanisms
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Commonmistakes
Tothinkthatyouarethesellerwhenyouarethebu er
Incentivesbased
on
volume
and/or
short
term
Managementchallenge
Conservativeperformancemeasurementandincentivesbasedonlongtermresults
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Policiesandke as ects:
Maximumamount,maturities,LTVratio,debtto
,
scoreorscorecardcutoffs,
r c ng,managemen o excep ons opo c es,e c.
Duringtheboomphase,herdbehaviorispervasivebutthereisroomfordifferentpolicies
risk and less risk !
Thefollowingexamplesillustratecertainaspects
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M n m n rin h mBanks can apply different policies in terms of LTV over time
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Over time, different policies in terms of LTV produces verydifferent structures of LTV for the current ortfolio
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Different banks tightened the origination policies at differentdates
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M n m n rin h mDifferences in policies related to maturities
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Balance by origination date can exhibit different patterns
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ManagementduringtheboomDifferences in banks policies are better recognized by observing severalcharacteristics at the same time (in this example: distribution of EAD in thespace {Origination Date, LTV}for a particular portfolio)
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To seriously analyze banks policies it is necessary to explorethe former aspects at sub-portfolio level
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Mortgagepricingisquitecomplex
Creditrisk,prepaymentrisk,operationalrisks,
Butin
com etitive
markets
these
internal
ricin
are
onlyareference
However,asaminimumbanksshouldcovercertain
minimum
costs:
(EL+UL)
capital
costs+
funding
costs
Intheboomphaseincreaseincompetitioncanpromoteunsustainableprices
Challenge:To
establish
a
competitive
and
soundpricingscheme
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ManagementduringtheboomPricing: as a first approximation, byassumin one sin le eriod (!!!),equilibrium spreads can be computedeasily
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Thevirulenceofthedownturnphase
I t e ousingmar etco apses,t erearenoquic oreasysolutions
epo c esapp e ur ng e oomp ase
Ifthesepolicieswereveryaggressiveyouroptionswilleverypoor
Thestrengthofthefirm
Ifyouhavehighcapitalratios,enoughliquidity,otherbusinessormarketswithadifferentcycle,youroptions
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M n m n in h wn rn Ifthedownturnissevere
Lenderswillhavetouseextensivelysensiblemortgagemodifications
Mo i yingse ecte past ue oans
Refinancingselectedperformingloansatlowerrates
Usingforeclosuresandrepossessionsonlyafteracarefulcostbenefitanalysis
e rsuccessor eas y epen son
Theunderwritingpolicies,risktransfermechanismsand
Challenge:Howtomanageforeclosureproceduresand
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Policymakers
can
help
to
stabilize
mortgage
markets
initiatives
Refinancingprogramswithpublicsupport,forexample
. .,
US)
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nyques ons
THANKYOU!gregorio.moral@bde.es
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