Guidelines for prudent residential mortgage lending practices

Transcription

1 Circular Guidelines for prudent residential mortgage lending practices CIRCULAR: 29/2011 DATE: THIS CIRCULAR IS APPLICABLE TO: Savings Banks Commercial Banks Finance companies and mortgage companies Norwegian branches of foreign banks and credit institutions Insurance Companies FINANSTILSYNET P.O. Box 1187 Sentrum NO-0107 Oslo

2 1. Background In recent years household finances have been marked by a rising debt burden, high loan-tovalue ratios on home mortgage loans and greater use of interest-only facilities. Household debt and house prices have shown a largely convergent trend. Both debt and house prices have already reached a very high level. The fact that debt has risen most among groups with the highest debt relative to income gives cause for concern. The high debt level has increased the household sector's vulnerability in the event of an interest rate hike, unemployment or income reduction. Interest rates have long been very low in Norway, and are expected to remain low in the fixed income markets for a long period. Persistent low interest rates increase the danger of large imbalances in household finances and in the housing market. Experience shows that if a bubble develops, there are serious consequences when it bursts. Sudden, hefty household debt consolidation brings lower consumption and housing investment, spreading negative spillover effects to the rest of the economy and potentially threatening financial stability. House prices and household debt are of key significance for financial stability. Prudent mortgage lending practices can dampen the build-up of risk in the household sector. To that end Finanstilsynet issued guidelines for mortgage lenders in March 2010 (circular 11/2010). The guidelines aim to promote solid institutions and financial stability and to safeguard consumer interests. In light of the housing and loan market situation described in Finanstilsynet's report entitled Financial trends 2011, of Finanstilsynet's spring 2011 thematic inspection of bank's compliance with the mortgage lending guidelines and of the home mortgage lending survey from August 2011, Finanstilsynet has tightened some aspects of the guidelines. Requirements on borrowers' debt servicing capacity and for banks to thoroughly assess borrowers' capacity to service their debt remain basic elements of the guidelines. Point 2 of the guidelines makes clear that borrowers' overall financial situation, including all debt and expenses, is to be taken into account in assessing debt servicing capacity. Additionally, banks must make allowance for an interest rate increase of at least 5 percentage points in their assessment. The guidelines are tightened by requiring that a mortgage loan should normally not exceed 85 per cent of the property's market value (compared with 90 per cent in the March 2010 guidelines). Further, it is made clear that the loan-to-value ratio is to include all loans secured on the property, in other words home loans provided by other lenders must be included in the calculation of loan-to-value ratio. For home equity credit lines the reference value for prudent leverage is lowered from 75 per cent to 70 per cent; see point 7 of the guidelines. Point 5 makes clear that instalment payments must normally be agreed where a mortgage loan involves leverage in excess of 70 per cent. 2 Finanstilsynet

3 A basic precept is that a concrete liquidity assessment gives the most correct picture of a borrower's debt servicing capacity. Point 2 of the previous guidelines permitting the use of leverage (total debt relative to gross income) as an alternative measure of debt servicing capacity is accordingly omitted from the new guidelines. In the event of any deviation from the guidelines' reference value, additional collateral or a special prudential assessment is required. The institution's board of directors should set the criteria for prudential assessments and act on deviations from the guidelines; see points 4 and Finanstilsynet's guidelines for prudent residential mortgage lending practices In order to set standards and to provide a basis for reporting and follow-up, Finanstilsynet has formulated 10 "rules of the road" setting out its conception of prudent lending practices for home mortgage lenders. Since they will be part of the general-good rules designed to protect the interests of consumers and the general public (financial stability), the guidelines will apply both to Norwegian banks and financial institutions and to foreign banks' branches in Norway. ʻBankʼ is used as a generic term for institutions covered by the guidelines. Finanstilsynet will oversee compliance with the guidelines by reviewing institutions' replies to a questionnaire included in the home loan surveys, at ordinary on-site inspections and thematic inspections of Norwegian institutions and at meetings with foreign branches. Breaches of the guidelines may prompt an order to raise capital adequacy in keeping with Pillar 2 of the capital adequacy legislation, where necessary after consultation with the home country supervisor in the case of branches of foreign banks. Finanstilsynet expects institutions to start work immediately on adapting their internal guidelines to Finanstilsynet's new guidelines. Finanstilsynet will follow up on the institutions' implementation of the new guidelines early in This circular supersedes circular 11/2010. Finanstilsynet 3

4 Banks' internal guidelines must fulfil the following minimum requirements: 1. Thoroughgoing process. Before granting or increasing a home mortgage loan, the bank must have accurate information on borrowers' income and overall debt (including joint debt in a housing cooperative), normally by obtaining tax assessment data and data on current salary or other income, and on the property to be mortgaged, based on a prudent valuation. 2. Sufficient debt servicing capacity. The bank should have in place procedures for calculating borrowers' capacity to repay their mortgage with a basis in income, all expenses, servicing of overall debt in the form of interest and instalments (liquidity surplus) and the consequences of an interest rate increase; see point 8. Where the borrower is shown to incur a liquidity deficit in the event of an interest rate increase, the loan should as a rule not be granted, and the borrower should in all such cases be dissuaded from taking up the loan; see section 47 of the Financial Contracts Act. 3. Loan-to-value ratio. The bank must have in place procedures for assessing collateral and the borrower's aggregate mortgage debt to ensure a margin relative to property value. A mortgage loan may normally not exceed 85 per cent of the property's market value, where the loan-to-value ratio includes all loans secured on the property. It would also be natural to take the borrower's overall equity capital situation into consideration when determining the loanto-value ratio. 4. Additional collateral. In the event of deviation from the norms in points 2, 3, 6 and 7, either additional formal security in other property or an assurance of personal security for parts of the loan (surety/guarantee) must be available or the bank must have conducted a special prudential assessment. Criteria for prudential assessments should be established by the board of directors of the bank concerned. 5. Instalments. Mortgage loans exceeding 70 per cent of property value should normally require payment of instalments from the first due date, thereby building up a more reassuring safety buffer. 6. Debt servicing capacity for home equity credit lines. Home equity credit lines can pose an increased risk for banks, and guidelines must clarify which customer groups are eligible for such facilities. Banks' guidelines must state that when a borrower's liquidity surplus is assessed, account should be taken of the fact that debt servicing capacity may be significantly impaired during the period of credit due to income reduction upon retirement etc. Where the borrower is required to repay the loan in full upon expiry of the period of credit, banks should, when calculating the borrower's liquidity surplus, include interest and instalment payments as if the credit had been granted as a repayment loan. 7. Loan-to-value ratio for home equity credit lines. Granting of home equity credit lines must be based on a prudential assessment, and the loan should normally not exceed 70 per cent of the property's market value. Assessments should draw a distinction between mortgage 4 Finanstilsynet

5 loans where repayment in full is required after expiry of the period of credit and loans continuing for the borrower's lifetime. 8. Consequences of an increase in interest rates. When assessing a borrower's ability to pay and possible dissuasion from taking out a mortgage, the bank must make allowance for an interest rate increase of at least 5 percentage points from the current level. It is important to make the borrower clearly aware of this. The bank should in all cases make clear the consequences of choosing between a fixed rate and variable rate mortgage. 9. Handling of deviations. Where the bank finds cause to deviate from its internal guidelines based on these minimum requirements, the decision to do so must be taken at a higher level than that normally authorised to grant home mortgage loans. 10. Reporting. Each quarter a report shall be submitted to the bank's board of directors or in the case of foreign branches the management, on compliance with the guidelines for prudent home financing in which deviations from the guidelines are identified and reported. Finanstilsynet will monitor compliance by reviewing institutions' replies to a questionnaire included in the home loan surveys, at ordinary on-site inspections and thematic inspections of Norwegian institutions, and at meetings with foreign branches. Finanstilsynet will also be entitled to inspect the reports submitted to the board of directors or management. Morten Baltzersen Director General Erik Lind Iversen Deputy Director General (acting) Contact persons: Special Adviser Anders N. Kvam, tlf , anders.kvam@finanstilsynet.no Senior Supervisory Adviser Anders Hole, tlf , anders.hole@finanstilsynet.no Finanstilsynet 5

6 FINANSTILSYNET P.O. Box 1187 Sentrum N-0107 Oslo