Ind-Ra: Conservative Lending Standards, Stable Interest Rates Crucial to Mortgage Performance

Conservative underwriting standards are crucial to the performance of mortgage loans, says India Ratings & Research (Ind-Ra). Moreover, a hike in interest rates beyond a certain threshold leads to accelerated fresh delinquencies in loans that are otherwise performing.

A study of loan performance in the three-year period of rising interest rates from 2010 to 2013 suggests the loans that faced over 2% hike in rates were 50% more delinquent than average during the same period. The study included only those loans that were making timely repayments at the beginning of the rate hike cycle.

While studying the impact of underwriting standards, both instalment-to-income ratio (IIR) and loan-to-value (LTV) ratio were found to be important predictors of mortgage delinquency. Loans to residential mortgage borrowers whose repayments were above 50% of their income were found to be riskier, with delinquency rates almost 35% higher than average says Purav Shah, Associate Director, Structured Finance at Ind-Ra.

Likewise, borrowers who contribute over 40% towards the purchase of a dwelling unit (LTV below 60%) have shown greater willingness to pay, with nearly 25% lower delinquency rates than the average. While high delinquencies were observed at high LTVs, underwriting practices have been made stringent for loans with LTV over 80% by limiting IIRs to 50% for such loans.

A study of borrower characteristics suggests that loans to self-employed borrowers are 50% more susceptible to default than those extended to salaried customers because of higher income volatility, which is accentuated during economic downturns. The higher credit risk of self-employed borrowers was observed to be priced in by lenders with the average rate of interest charged being 50bp higher than that offered to salaried customers for a similar vintage of mortgage origination.

The report findings are based on a loan-level analysis of the agency's rated residential mortgage-backed securities portfolio over 2008-2013, representing a full economic and interest rate cycle. Although the broad trends are still likely to remain valid, the delinquency factors may significantly vary for loans and lenders from those studied in Ind-Ra's rated universe.

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