Mortgage market’s response to the COVID-19 crisis is a bid to evolve and improve
The COVID-19 pandemic has driven financial lenders to tighten their standards with respect to credit. There is nothing unusual about it as financial institutions, especially lenders, are known to turn risk-averse in a crisis situation.
What is atypical, however, is the way mortgage lenders have responded to the unique crisis situation we are dealing with currently. Prodded by government policies, lenders have been empathetic towards their consumers and have considered a number of corrective measures in a short time to assist borrowers adversely impacted by COVID-19. They have proactively considered essential measures, including extension of payment due dates, allowing deferred payments, waiving off late payment fees, to help borrowers avoid delinquencies and negate impact on credit agency rating.
Large mortgage players surely have the financial strength and resilience to make their consumers feel at ease, while also withstanding any near-term disruption in mortgage payments.
The outbreak of the pandemic is turning out to be a great teacher for the mortgage market. In retrospect, we are most likely to see a number of changes in the way lenders operate and assess risk.
In the last three months, I have interacted with various business leaders, SMEs and service providers at several lending organizations, and have tried to understand how their businesses will evolve amidst the new crisis situation that has emerged.
Here are a few of my observations:
Capital Adequacy & Profitability:New home buying and home enquiries have definitely seen a temporary stasis, while relief packages and rate support are keeping re-mortgage/re-finance markets buoyant. Traditionally, the segment has operated on a thin spread. While it is widely recognized that no one can really predict the overall exact impact, long periods of uncertainty impact property prices and loan-to-value (LTV) ratios in leveraged segments, and lead to a spike in defaults. Going forward, the applicability will be different for large well capitalized bank lenders vs small community / local banks or lenders. In certain regions, non-bank servicers might also need to handle temporary challenges regarding liquidity.
Access to Credit:Several lenders have taken measures to reduce LTV in some of the key segments they operate in. Lower LTV would mean higher margin requirements for an applicant, even as well-priced segments are expected to have an impact on overall demand. About 10% reduction in LTV, for example, leads to higher contribution from borrowers and results in tightening of access to credit. While moratoria and forbearances will definitely ease the immediate pressure, but prolonged uncertainty can impact the market, as well as, borrower profiles. Forbearances, for instance, typically trigger balloon payments in the 4th month and borrowers with such plans cannot get benefits of reduced interest, as per conventional guidelines, at least for a year. The situation also opens up new challenges in the way credit norms are defined.
Credit Risk Profiling:Industry players will increasingly redefine credit exposure and assessment of credit worthiness. Several profiles that banks considered as safe may be re-categorized in the post-pandemic period. Underwriters I interacted with say that evaluating a long-term exposure is difficult for certain profiles and certain industries. Redefining stability and income for some borrower segments, as a result, will be crucial in the coming days.
Focus on Servicing Efficiencies & Digitalization:Banks and lenders will lay huge emphasis on improving friction-free, direct-to-customer services in the coming months as it implies relatively less stress on their people and technology infrastructure. The crisis brought about by the pandemic has already led many anxious customers to proactively reach out to banks seeking solutions for the loans they have availed. Alternative alert and direct service apps will help reduce the strain on capacity in these areas.
Delinquency & Risk Management:While this won’t be an immediate challenge due to the holidays and moratoriums in the next few months, but certain borrower segments may show signs of stress if the period of uncertainty is prolonged. It will be interesting to see how the dynamics of recent events impact these models and how they correlate defaults with certain sectors, property location, and transaction patterns, to improve efficiency of collections portfolio. Clearly, digital collaboration opportunities will rise as a result, especially in default servicing space, to work-out forbearance plans and other modifications.
The crisis situation notwithstanding, mortgage lenders have the necessary resources to impact the changes elaborated above. Unlike during the financial crisis of 2008 and 2009, lenders are much better capitalized and are better prepared to tackle the uncertainty in the short run. There may be emerging opportunities for large- and mid-sized banks to consolidate going forward, which will further improve service delivery. Customer journeys will get simplified and banks will find new ways to reach out to customers proactively in order to integrate tailored solutions for them. There will be pressure on costs, which will present more opportunities for banks to consolidate service vendors, even as the ratio of digitalization increases.
While technology intervention was well on its way much before the pandemic outbreak struck, risk managers are now more interested to explore predictive tools powered by Artificial Intelligence and Machine Learning to deal with the new challenges arising out of the pandemic situation.
As the COVID-19 pandemic continues to unfold across the globe, we may witness even more far-reaching changes in the mortgage market. The pandemic has surely brought us to the throes of a long-term transformation, and it will most definitely be aided by a strategic use of technology. The fact that risk managers welcome it, is an anecdote in seeing the positive side of things.