Cover Story: Mortgage Origination Under Threat

1 February 2016

http://www.australianbankingfinance.com/banking/cover-story--mortgage-origination-under-threat/

With the local regulator scrutinising the banks’ processes for approving mortgages, mortgage risk weights likely to rise and disruptive newcomers all having an impact, the mortgage securitisation industry is heading for change.

But can a fintech potentially cut out existing banking and origination channels while still appeasing corporate

watchdogs? Elizabeth Fry and Andrew Starke report.

THE AUSTRALIAN SECURITIES and Investments Commission has been keeping a close eye on the banks’ processes for approving mortgages while verification of income is also on the mind of the prudential regulator, which has demanded that the banks query excess income over household expenses when loans are calculated and that interest rate increases are taken into account.

A big part of the problem is that while the mortgage funding market is perceived as highly efficient, the reality is somewhat different. Over the past few years increased efficiency has allowed brokers to become more dominant and this trend has also seen the size of the market and the sizes of mortgages burgeoning as banks and brokers spruik their loan products.

Editor's Fact Check:  Industry stats 49% of all mortgage loans are sold by Bank Managers.  Broker Agents  51%  

However, Graham Andersen, founder of Morgij Analytics, argues that the technological advances have not reached a level where the borrower benefits from cheaper loans. And in his opinion a more efficient mortgage origination lending process will help push borrowing costs down. 

“What is missing is the understanding by the borrower of what his risk is and an effective understanding of how the increases in home loan volumes are affecting the risk on the bank’s lending book,” he said.

Editor  Fact Check: The Bankers do not teach bank officers and agents what the risks are.  Products are sold as low risk according to borrowers.

Andersen believes it would be better to have a standardised way of looking at mortgage risk so that regulators, banks, borrowers and even institutional investors can understand what’s happening throughout the application process and then the life of the mortgage. 

“The application approval process needs to align with the performance risk assessment system,” he said. “Right now we don’t really know exactly what the banks and brokers are asking people.”

Pointing to the level of credit growth - which has for some time been much higher than median income growth - he queried how the banks could possibly be asking the right questions.  “If the banks are asking the right questions and effectively meeting proper underwriting standards, then the median size of loans will decrease from today’s inflated levels,” he argued.

Editor's Fact Check: The  banks ask no questions, no phone calls.  All loans approved by a computer.  Low Docs all unaffordable, unsustainable and unverified. Income changed by bank computer calculator without knowledge or authority of borrower.  BFCSA surveys and investigations in 2000 cases.

‘Spurious reasoning’
Andersen claimed part of the problem related to the widespread expectation that house prices will increase with average incomes.  “Average incomes might be increasing but not median incomes. Average incomes indirectly take into account profits made by increasing house prices so of course average incomes increase - these reports are based on spurious reasoning.

Worse, most banks do not even attempt to verify other liabilities that a borrower might have. And when interest rates rise that’s when liabilities will come home to roost.”

Editor's Fact Check: Yes liabilities intentionally left of the application form.... bank BDM instruct to Seller Channel.  

Clearly, when the housing market is strong people can take on more debt in the knowledge that they can always sell a property without suffering a huge loss. Consequently, a strong market masks liabilities and allows the banks to point to a lower than actual level of arrears.

Andersen’s point is that in cities which have seen big house price increases arrears will remain low as borrowers can sell rather go into default.

So will new technology solve the problem and can a fintech potentially cut out the existing banking and origination channels? Sure the entire process can be done online, which disintermediates the banking system since arrangers can directly approach institutional investors and super funds.

But it’s about a whole lot more than that. As Andersen sees it, mortgage origination will go the way of other lending and investment processes where borrowers put up their own information on a platform and indicate what sized loan they want. The site will assess the risk as well as the likelihood of that applicant getting a loan.

Editor's Fact Check: YES BUT current system is computerised theft.  Expected Bank Trickery could be neutralised IF all borrowers are warned on entry into the site to print out a copy of that submitted.  Then ALSO FOR BORROWERS to demand the bank send out a certified copy of the application prior to funds being paid into the bank account as settlement.  The certified copy MUST contain the words: " this is the Bank's copy it has relied upon for approval process."

While Andersen’s “basically you cut out bank origination and you cut out brokers” view is unlikely to be a popular one, there is a lot of merit in producing an origination platform with a standardised assessment system that is acceptable to all players. Borrowers can then understand their risk and their position using the same tools as investors with transparency throughout the whole industry. The US is moving to mortgage online application approval and there are a few such platforms in the UK as well.

The Big Short
While the launch last month in Australia of The Big Short - a film adapted from Michael Lewis’ bestselling novel which tells the story of the players who shorted the US housing market before its cataclysmic collapse in 2008 - is a cautionary tale as relevant today as it was eight years ago, it has also benefited businesses like years ago, it has also benefited businesses like Andersen’s Morgij Analytics, a web-based analytics platform that provides mortgage lenders and investors with an analytical framework for credit risk assessment and portfolio valuation.

Editor's Fact Check:  In the brilliant movie: Did you notice there are NO BORROWERS.  Standards and Poor never saw the documents.  The Traders went to Florida  searching for borrowers and unable to find the actual borrowers.  BFCSA (Inc) is the only borrower group in the world who have gathered thousands of people

together investigated those cases and produce reports, surveys and presented evidence to Parliament.

“Without the circumstances that created The Big Short, our business wouldn’t exist,”he said. “There was way too much reliance on the credit ratings agencies. That, and a lack of transparency for these types of synthetic securities meant investors couldn’t understand the inherent riskiness in the underlying mortgages. In fact, they were forced to rely on agencies as investors weren’t able to get information on a timely basis to truly understand the risk back in the 1980s and early 1990s.”

Clearly, with today’s new technology it is now possible to both originate and invest in much simpler and much more transparent securitisation structures. Further, with event based reporting, investors can see in real-time anything that affects the underlying mortgage pool. Thus, everyone in the value chain can correctly make their own decision on risk without relying on agencies.

Editor's Fact Check:   The Toxic Mortgage Loans are currently running rampant over Australia.  Borrowers not being advised of risks or the fraudulent misinformation on their LAFs.  Hence the call for ROYAL COMMISSION into Banks due to epidemic of unaffordable loans and lowering of lending standards over two decades.

So while the securitisation industry is still needlessly complex and opaque, Andersen believes he has created a very simple, transparent structure which eschews all the multi-layered complexities that can mask what is really going on with the underlying mortgages. And with more risk in the mortgage markets, investors will find it increasingly difficult to understand what they have actually bought.

Editor's Fact Check:  The Toxic Mortgage securitisation industry is diabolically riddled with fraud and deceit.

“There is still either not enough direct reporting in relation to the individual mortgages themselves or too much reliance on rating agencies,” he argued. Andersen cited recent comments made by US presidential hopeful, Bernie Sanders, to stop companies that issue securities choosing which ratings agency they use. Credit rating firms were widely seen as enabling the financial meltdown, inflating ratings and giving investors false confidence that mortgage-backed securities were safe.

Disruption is coming

But the mortgage securitisation industry is headed for change, partly due to the central bank’s recent move to demand loan level data from issuers. The availability of more data allows brand new players to set up platforms that ensure total transparency in the provision and interpretation of information. “With this much simpler straightforward form of securitisation ‘the big short’ depicted in the movie could not happen,” said Andersen.

“Borrowers can more easily understand their risk and their position using the same tools as investors so you have transparency throughout the whole industry. This new process clearly gives the borrower a better deal. They can better understand the risk and get a cheaper loan.

Editor's Fact Check:  Pure nonsense given today's evidence.

 ”Fitch Ratings last month claimed banks have already made significant changes in borrower-serviceability assessment, and limited annual growth in investor mortgages. However, Fitch analyst Tim Roche warned that the banks’ inability to uphold the recently improved underwriting standards could lead to negative rating action, as it could result in weaker asset-quality, possibly impacting banks’ profitability and capitalisation.

“We believe capitalisation will remain solid, especially in light of APRA’s requirement to ensure that banks are unquestionably strong,” he noted in a report. “We expect the banks to continue to strengthen their capital positions especially in preparation of the implementation of higher risk-weightings on residential mortgages on 1 July 2016.

The new capital regulation is likely to result in a decline of regulatory capital ratios of the four major banks but we expect the ratios to recover, benefiting from high levels of retained earnings.”

A further consideration is that the Basel Committee has released a much tougher second consultative document on revisions to the standardised approach for credit risk, widely referred to as Basel IV. The key change is that mortgage risk weights are determined by the loan-to-value at origination and whether repayment is “materially dependent” on property cash flows.

Morgan Stanley’s initial analysis of the “new Basel IV” proposals suggests mortgage risk weights could rise to 28 per cent for the major banks. However, the analysts said this figure could rise to between 30 and 35 percent if repayment of a meaningful proportion of investor loans are “materially dependent” on property cash flows.

“At first glance, the proposed risk weights for mortgages with an LTV at origination between 60 per cent and 80 per cent will be five percentage points lower under ‘new Basel IV’ than ‘old”Basel IV’,” Morgan Staney said in a report. “However, where mortgage repayment is ‘materially dependent’ on property cash flows, the risk weights will more than double.

While ‘materially dependent’ has not been defined, we think this could apply to a meaningful proportion of Australian investment property loans given the high proportion of borrowers who have multiple investment properties and their gross income distribution.”