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Thematic Review on Mortgage Underwriting and Origination Practices Peer Review Report

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Thematic Review on Mortgage Underwriting and Origination Practices Peer Review Report Thematic Review on Mortgage Underwriting and Origination Practices Peer Review Report 17 March 2011 Table of Contents Foreword .................................................................................................................................... 1 Executive Summary ................................................................................................................... 2 1. Introduction....................................................................................................................... 6 2. Regulatory and supervisory framework............................................................................ 9 2.1 Types of mortgage originators ............................................................................... 9 2.2 Consumer protection features related to residential mortgage loans ................... 10 2.3 Coordination and consistency of underwriting practices and oversight .............. 13 2.4 Policy reforms currently underway...................................................................... 14 3. Mortgage underwriting standards and practices ............................................................. 17 3.1 Effective verification of income and financial information................................. 17 3.2 Reasonable debt service coverage........................................................................ 19 3.3 Realistic qualifying mortgage payments.............................................................. 20 3.4 Appropriate loan-to-value ratios.......................................................................... 21 3.5 Effective appraisal management .......................................................................... 22 3.6 No reliance on house price appreciation .............................................................. 23 3.7 Other factors important to effective underwriting................................................ 23 4. Disclosure of mortgage underwriting practices and market trends ................................ 26 5. Conclusions and recommendations ................................................................................ 29 Annex A Suggested elements of a principles-based framework for sound underwriting .............. 33 B Summary of FSB member responses to questionnaire B.1 The role of government in mortgage markets ........................................................ 38 B.2 Mortgage market structure ..................................................................................... 40 B.3 Proportion of regulated and unregulated residential mortgage markets ................ 47 B.4 Regulatory and supervisory oversight responsibilities........................................... 49 B.5 Debt capacity measurements.................................................................................. 57 B.6 Average loan-to-value (LTV) ratios and limits...................................................... 58 B.7 Overview of data collection and disclosure practices ............................................ 62 C Extract from the January 2010 Joint Forum report ......................................................... 65 D Questionnaire: Thematic review on mortgage underwriting and origination practices.. 69 i Foreword The peer review on mortgage underwriting and origination practices is the third thematic review under the Financial Stability Board (FSB) Framework for Strengthening Adherence to International Standards.1 The Joint Forum, in its January 2010 Review of the Differentiated Nature and Scope of Financial Regulation2, recommended improved oversight of the residential mortgage market, including greater consistency in underwriting standards across different types of originators, and suggested that the FSB consider establishing a process to review sound underwriting practices and disclosing the results. At its January 2010 Plenary meeting, the FSB welcomed the report and said that it would monitor policy development on the issues the report identifies and propose action where issues raised are not yet being addressed. As part of this, in June 2010, the FSB decided to take forward the mortgage origination-related recommendations of the Joint Forum report through a peer review surveying existing practices and drawing internationally applicable lessons. The peer review compares residential mortgage underwriting and origination practices across the FSB membership, including recent actions taken by national authorities to promote sound practices. Since there are no internationally agreed standards to act as a benchmark, the review provides a comprehensive picture of existing practices in these areas and draws lessons going forward. This report describes the findings of the review, including the key elements of the discussion in the FSB Standing Committee on Standards Implementation (SCSI). The draft report for discussion was prepared by a team chaired by Guillermo Babatz (Mexico Comisión Nacional Bancaria y de Valores), comprising Luci Ellis (Reserve Bank of Australia), Julio Cesar Paranatinga Carneiro (Banco Central do Brasil), Sören Wieck (Deutsche Bundesbank), Sunny Yung (Hong Kong Monetary Authority), Javier del Rio del Castillo (Banco de España), Lester Miller (US Office of the Comptroller of the Currency) and Olivier Hassler (World Bank). Grace Sone (FSB Secretariat) provided support to the team and contributed to the preparation of the peer review report. The findings of this review are based on responses to a questionnaire (Annex D) designed to gather information from FSB member jurisdictions on existing underwriting and origination practices. In addition, the review benefited from input from industry associations, financial institutions and other stakeholders on practical experiences regarding residential mortgage underwriting practices and interactions with regulatory and supervisory authorities, as well as discussion in the FSB SCSI and in the FSB Plenary. 1 http://www.financialstabilityboard.org/publications/r_100109a.pdf. 2 http://www.bis.org/publ/joint24.pdf. 1 FSB thematic peer reviews The FSB has established a programme of thematic peer reviews of its member jurisdictions. Each review surveys and compares the implementation across the FSB membership of regulatory or supervisory measures in a particular policy area important for financial stability. Thematic peer reviews focus on implementation of international financial standards, policies agreed within the FSB or, where such standards or agreed policies do not exist, a stock taking of existing practices in the policy area. The objectives of the reviews are to encourage consistent cross-country and cross-sector implementation, to evaluate the extent to which standards and policies have had their intended results and, where relevant, to make recommendations for potential follow up by regulators, supervisors and standard setters. They provide an opportunity for FSB members to engage in dialogue with their peers and to share lessons and experiences. Thematic peer reviews complement FSB country peer reviews, which focus on the progress made by an individual FSB member jurisdiction in implementing IMF- World Bank Financial Sector Assessment Program (FSAP) regulatory and supervisory recommendations. Executive Summary The Joint Forum, in its January 2010 Review of the Differentiated Nature and Scope of Financial Regulation3, recommended improved oversight of the residential mortgage market, including greater consistency in underwriting standards across different types of originators, and suggested that the FSB consider establishing a process to review sound underwriting practices and disclosing the results. In June 2010, the FSB decided to take forward the mortgage origination-related recommendations of the Joint Forum report through a peer review surveying existing practices and drawing internationally applicable lessons. Thematic peer reviews typically aim to focus on the implementation across the FSB membership of agreed policies or standards. Since this peer review did not have the benefit of international standards or best practices to act as a benchmark, it instead provides a comprehensive picture of existing practices and oversight – including recent crisis-induced reforms – and where applicable, identifies sound practices (see section 1). As the global crisis showed, the consequences of weak underwriting practices in one country can be transferred globally through securitisation of mortgages underwritten to weak standards. Thus, it is important to have sound residential mortgage underwriting practices at the point at which a mortgage loan is originally made. Internationally agreed principles that build on the Joint 3 http://www.bis.org/publ/joint24.pdf. 2 Forum recommendations could help to strengthen residential mortgage underwriting practices, and the peer review draws lessons from current practices to illustrate some potential principles (see Annex A) that could guide future standard-setting. However, given that the underlying risks can differ across jurisdictions and within countries, the findings of the review suggest that such principles would best be high-level rather than aimed at detailed international standards. Overall, national authorities are making good progress in following the Joint Forum recommendations to promote consistent and effective underwriting standards for residential mortgage origination. As a result, industry practices are moving in the right direction. The degree of change in each FSB jurisdiction reflects their specific characteristics
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